The biggest threats to your financial stability in retirement include unrealistic budgeting, inflation, health care costs and living longer than anticipated.
The first threat is, in some ways, the easiest to control. Be honest with yourself about how much you can spend in retirement. Just as when you were starting out, you need to account for regular expenses such as rent or mortgage, utilities, taxes and unexpected costs before you calculate how much you can allocate for vacations or other luxuries.
While health care costs, longevity and inflation are challenging to budget for, there are ways to mitigate inflation’s impact.
Social Security is a useful defense against inflation, as it includes an annual cost-of-living adjustment. However, the COLA reflects price changes from the previous year rather than current conditions, making it an inconsistent safeguard.
While it may be tempting to take larger withdrawals from your IRA and/or 401(k) to address inflation, this approach risks depleting your accounts too quickly, especially during market downturns. Instead, consider these alternatives:
- Dividend-paying funds. These can provide a potentially steady income stream, though dividend payments can fluctuate.
- I bonds. These bonds are adjusted twice a year to account for inflation.
- Treasury Inflation-Protected Securities. TIPS are federal investments that have their principal adjusted for inflation, allowing interest payments to grow as prices rise.
Strategically planning withdrawals from your traditional 401(k) and Roth IRA can also be beneficial. Withdrawals from a 401(k) are taxed as ordinary income, while qualified withdrawals from a Roth IRA are tax-free. However, if you are subject to required minimum distributions from your 401(k), you must take withdrawals starting at age 73 or 75, depending on your birth year. Balancing required withdrawals from your 401(k) with discretionary withdrawals from your Roth IRA creates a tax-efficient strategy that pairs well with inflation-protected investments.
If you have a public-sector pension, its payouts may account for inflation, though the COLA might be capped at a specific level (such as 3%) or tied to the Consumer Price Index. In contrast, pensions from private companies usually do not include COLAs, meaning payouts generally remain fixed, leading to reduced purchasing power over time as inflation rises.
Annuities can offer a reliable source of guaranteed income. When you purchase an annuity, your payment to the insurance company is invested with the promise of regular future payments to you. Some annuities include a COLA provision, which provides annual increases to help offset inflation. However, annuities with inflation protection often come with lower payouts and higher fees than those without such provisions.
To minimize inflation’s effects on certificates of deposit, consider short-term options. These allow your money to mature sooner, giving you the flexibility to reinvest in higher-yielding options as interest rates rise. While long-term CDs may offer higher initial rates, short-term CDs provide the advantage of adapting to changing economic conditions, potentially offsetting the impact of inflation.
Achieving financial security in retirement requires thoughtful planning and discipline. However, with these strategies in hand, you can enjoy a more comfortable and less stressful retirement.
