Perspectives

Planning for a Long Retirement – Part 2

INFLATION RISK

It’s vital to consider the impact of inflation on your income. Over the long term, inflation can dampen the real—or inflation-adjusted—returns on your investments. U.S. consumers have experienced average annualized price increases of 3% since 1926. Using that number as a guide, you can anticipate that your purchasing power will erode by close to half in the next 20 years. “If you need $100 to buy an item when you are age 65, you probably will need nearly $200 to buy that same item when you are 85,” says Fahlund.

Four common-sense strategies can protect your purchasing power through retirement.

1. Continue to invest in equities.

Be sure to continue to invest a significant portion (60% to 40%) of your portfolio in equities for your retirement—especially in the years between ages 55 and 75. Over the long term, equities have been shown to provide more growth potential than either fixed income investments or cash. Because you may need to support yourself with withdrawals from your nest egg for more than 30 years, it is important that you understand that you will need to dip into principal as you age. Income from dividends and interest only will not be able to sustain the needs of most retirees for that many years. Therefore, by continuing to rely on the growth potential of your portfolio, the amounts you can afford to withdraw are more likely to increase sufficiently to keep up with inflation. In other words, we are living in a different world than that of our parents and grandparents. No longer can we plan to spend the income and never invade the principal; instead, we must take measured withdrawal amounts from the portfolio each year, regardless of whether they are principal or income.

2. Develop an inflation-adjusted withdrawal strategy.

Your aim should be to live and spend comfortably while giving your savings a high probability of lasting up to 30 years or more, depending on your retirement age. A good rule of thumb for a 30-year retirement is to withdraw no more than 4% of your retirement assets in the first year that you stop working—then increase your withdrawal amount every subsequent year by approxi-mately 3% to keep pace with inflation. “In our studies, we found that if markets decline temporarily during your retirement, you can stop those increases for a few years to provide a little cushion,” Fahlund says. “Then resume the increases later when markets have rebounded. This can greatly increase your odds of a successful retirement.” Remember that your lifestyle and spending can determine how inflation affects your retirement. The larger your withdrawal amounts each year, the more rapidly inflation will erode the remaining balance of your portfolio.

3.  Consider supplemental and long-term care health insurance.

Inflation in health care has far outpaced the overall annual inflation rate. This trend makes it difficult to predict medical or long-term care costs 30 years from now and makes it important to consider medigap insurance options to supplement Medicare—and to consider the costs of future premiums, deductibles, and potential copays. Most people should also look into purchasing long-term care insurance, says Fahlund, since the cost of nursing home or other long-term care generally is not covered by Medicare. Unfortunately, these policies are becoming increasingly difficult to find. More insurance companies are leaving the marketplace because they do not want to be exposed to significant financial risks they could face as retirees live longer, due in part to rapid advances in medicine.  Consider that today women live an average of 4.9 years longer than men, according to the Centers for Disease Control and Prevention. A longer lifespan means women are likely to have greater medical expenses than men.

4. Use Social Security as a backstop.

Your Social Security benefits are increased each year for inflation, as measured by the consumer price index. In January 2012, for example, 55 million Social Security beneficiaries received a 3.6% bump in their monthly benefits. These inflation adjustments strengthen the case for delaying benefits as long as possible: The higher your initial benefit, the larger the dollar value will be of any cost-of-living adjustments. And if your portfolio were to be completely depleted, you would still have a predictable, steady stream of inflation-adjusted income for the rest of your life—and for the life of your surviving spouse as  well.

LOOK AHEAD TOGETHER

Be sure to talk with your family about your plan for a long retirement. By letting members of younger generations know of your intentions, and what you do and don’t expect from them, you can help them make their own financial plans. Those conversations, combined with sound risk-reduction strategies, will give you and your loved ones confidence that you have the financial security and flexibility to address your evolving needs throughout a long and fulfilling new chapter in your life.

 

A good rule of thumb for a 30-year retirement is to withdraw no more than 4% of your retirement assets in the first year that you stop working—then increase your withdrawal amount every subsequent year by approximately 3% to keep pace with inflation.