5/17/2011 11:23 AM ET|
7 ways to outlive inflation
Even modest inflation can eat away a life's worth of saving. These strategies can help keep your golden years golden.
Inflation will gradually erode the purchasing power of your nest egg in retirement. But there are many steps you can take to help your retirement savings keep pace with the rising cost of living. Here are seven strategies for staying ahead of inflation in retirement:
1. Social Security. Social Security payments are adjusted for inflation each year, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers. Social Security cost-of-living adjustments have ranged from none in 2010 and 2011 to 14.3% in 1980. To maximize the dollar amount of your inflation adjustment, take steps to boost the amount of Social Security you will get.
"Focus on when you start your Social Security benefits, and maximizing that will help you deal with inflation," says Steve Vernon, a fellow of the Society of Actuaries and president of retirement consulting firm Rest-of-Life Communications in Oxnard, Calif. Payouts increase for each year you delay claiming from age 62 to 70.
2. TIPS. Some types of government bonds promise a rate of return above inflation. The principal amount you invest in Treasury Inflation-Protected Securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. TIPS pay a fixed interest rate twice a year on the inflation-adjusted principal. Interest payments rise each year inflation occurs, but payments could fall during periods of deflation. Interest income and growth in the principal value are exempt from state and local income taxes, but they are subject to federal income tax.
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3. Inflation-fighting investments. It's a good idea to allocate part of your portfolio to investments that have historically kept pace with inflation. "Have some exposure to commodities, stocks and real estate, but don't go overboard," says Lyle Benson, a certified financial planner and the founder of L.K. Benson in Baltimore. "You don't need to shift your entire portfolio into inflation-fighting investments."
4. Pay off your mortgage. Paying off your mortgage eliminates one of your biggest monthly expenses and insulates you from rent hikes. "If you pay off a $2,500-a-month mortgage, you have saved yourself $30,000 a year in cash-flow needs," says Larry Rosenthal, a certified financial planner and the president of Financial Planning Services in Manassas, Va. "In inflationary times, you should keep your monthly overhead as low as possible."
If you need to, you may be able to tap the equity in your home using a loan or reverse mortgage. Some retirees also downsize to a smaller home or a less-expensive area of the country to further cut costs.
5. Inflation-adjusted annuities. Some investors turn over a portion of their savings to an insurance company in exchange for a promise to receive a specific monthly payment for the rest of their lives, no matter how long they live. Some annuities offer the option of payments that are indexed for inflation.
"Consider putting part of your money in an annuity, and then the other part you invest and draw down over time," says Vernon. "Annuities sometimes have a bad name because some annuities have high fees and poor performance. Look at the strength of the insurance company and shop among insurance companies to get the best price."
- Calculator: How much will your 401k provide?
6. Work part time. Continuing to work part time in retirement allows you to be paid at current rates. "If you are working, inflation will probably drive up wages as well," says Benson. "Maybe you can save a little more as wages go up."
7. Reduce spending. When you reduce or eliminate some of your discretionary expenses, you will be better prepared when the prices for necessities rise. For example, to cope with rising gas prices, retired couples could downsize from two cars to one. Your savings on insurance and maintenance, in addition to the income from the sale, could finance years' worth of higher gas prices.
"Things that are going to definitely go up are consumer staple items, food, fuel and energy," says Rosenthal. "Maybe you can cut back on eating out a little bit because you know your gas bill is going to go up."
This article was reported by Emily Brandon for U.S. News & World Report.
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I don't agree with the pay off the mortgage advice. I'm not an economist, or even financially-inclined, per se, but it would appear to me that there are at least two good reasons not to pay off you mortgage: (1) If there is inflation, interests rates will likely rise to try to counter - if that happens borrowing would get more expensive. Most mortgages are locked in for an extended duration, so if rates go up, you're probably locked into the cheapest money you're going to see for a while, and (2) if you have debt in current dollars, and are paying off with future, weaker (less purchasing power) dollars, it would appear that you are saving money on the repayment of the debt. I believe this is similar to what the government is trying to do with our national debt (weaken the dollar and repay with the weaker dollar).
I won't feel bad if someone corrects me, but this advice doesn't make sense to me.
I think you confuse paying off a mortgage with saving. Sceptically inclined has it right.
Anyone taking out a mortgage today (or refinancing) will be getting a near historcally low interest rate. If there's inflation (and that's the hypothesis of the article), then interest rates are bound to rise. If one saves the cash one doesn't spend prepaying the mortgage, then he'll be able to invest in interest bearing instruments that pay higher interest than the mortgage cost.
There's another advantage to not prepaying. What if you get into a financial bind where your income is interrupted? If you have no income how would you prefer your balance sheet to be: No debt, no savings; or $100k mortgage + $100k savings? With the former, you can't pay your bills (and no one will want to lend you money). With the latter, you can pay your bills (including your mortage) for a while until things improve.
Sceptically inclined; Your lack of understanding regarding mortgage payments is to look at your home as investment or nest egg. As an investment you are correct you will lose, the problem we have today. As a nest egg, your cash flow can increase by 30-35% when paid off. Since the issue is to off set inflation, do you think inflation would increase beyond 30% per year? As someone who focused on paying off our home as #1, we now have not only additional income to invest, but are not subject to the major drop in home prices. Granted we took a hit in value, but if we did sell our home today, we would make a 300% return on the price paid, including interest paid. More important is that there is no bank to bring foreclosure. We will always have a roof over our heads!!!!! In the event we move, we have an excellent down payment or rental income. We did this by buying and selling rental homes. Keep in mind, the tighter credit is, the better for the landlord. For most people, they do not want to get their hands dirty and hire a management co that suck up profit. Same as investment with the Stock Market, rather than do the work invest, management co like Madeoff with your money happens. As Forrest Gump said "Stupid is as stupid does!"
Currently one of the best investments is home real estate, provided you do your homework, acquire a reasonable mortgage rate and are willing to become a landlord. Home rents are increasing in our area by 10 to 15% over last year as foreclosures are increasing by 40%. This tells me that more and more people cannot afford to own and are now renters. They will also be renters for the next 10-15 years to repair their credit in order to purchase again, about the time you might want to consider selling these investments and retire to a warmer climate.
Just another point of view.
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