3 ways to fight inflation in retirement

You’ve spent years preparing for retirement. Your income strategy likely accounts for the things you want to do once you’re retired. But does it also account for inflation?

While inflation has come down from its recent highs, it can have an impact on your retirement strategy even at lower levels. As a rule of thumb, what you buy today will cost about twice as much in 25 years, assuming a 3% annual inflation rate. For example, if you need $40,000 a year for expenses today, you could need more than $80,000 in 25 years to maintain your standard of living.

Over the course of your retirement, your actual expenses will likely vary. You may find you’re traveling less but spending more on health care. Different expenses can also experience different inflation rates — for example, the average inflation rate for health care expenses is 4%.

Inflation may be inevitable in retirement, but you can control your response to it. Here are three areas that can help you fight back against higher costs.

1. Your withdrawal rate

How much you withdraw in retirement is one of the biggest factors affecting how long your money lasts. In general, if you retire at age 65 and increase the amount you withdraw each year for inflation, an initial withdrawal rate of 4% may be a good starting point.

However, this rate may not work for everyone. A variety of factors could cause your rate to be higher or lower, and it will likely need to be adjusted over time.

The following table highlights our recommendations for initial withdrawal rates, based on age. Consider starting with a more modest withdrawal rate, which can give you room to potentially raise it as your expenses rise over time.

Portfolio tip: The rule of 25

As a quick guide, take the pretax amount you will need to withdraw from your portfolio in the first year of retirement and multiply this by 25. This is a rough estimate for the size of a portfolio a 65-year-old retiree would need to build to sustain a 4% initial withdrawal rate, which would be adjusted each year for inflation.

2. Your investment mix

Some people shift all their money to short-term fixed income and cash in retirement. We believe this is a mistake. While you may be able to earn 2% to 5% on fixed-income investments over the long term, putting all your money in fixed income provides little growth potential to help you meet rising expenses.

The odds of an all-cash and short-term fixed-income portfolio lasting more than 25 years are less than 1%, assuming an initial 4% withdrawal rate and a 3% increase in withdrawals each year for inflation. On the other hand, with a portfolio invested 50% in stocks and 50% in fixed income, those odds increase to more than 80%.

To help you meet rising costs, growth investments should remain a part of your investment portfolio. However, market declines — particularly those early in retirement — can jeopardize whether your money will last throughout your lifetime. As you transition toward retirement, we believe a more balanced allocation between equities and fixed income is important to help keep up with inflation while being sensitive to market risk.

3. Your Social Security benefit

One of the biggest retirement-related decisions you’ll make is when to start collecting Social Security. This isn’t a choice to take lightly — Social Security is one of the most valuable retirement assets you have.

When it comes to claiming Social Security, there are three important ages to know:

• 62 — the age at which you can first receive benefits
• 67 — the age at which you can receive your full retirement benefit (known as your full retirement age or FRA)*
• 70 — the age at which you can receive your maximum benefit

The age at which you claim Social Security has a twofold effect on your ability to fight inflation with it. The first is with the amount you receive. While you can claim as early as age 62, claiming before full retirement age (FRA) permanently reduces your retirement benefit by up to 30%. Conversely, delaying Social Security benefits past FRA permanently increases your benefit by as much as 24%. Your claiming decision may also impact your spouse’s benefit.

Delaying Social Security can also help fight inflation beyond just the higher amount that you receive. That's because your Social Security benefit will likely get an inflation adjustment each year. If you’ve delayed claiming, those inflation increases are applied to a higher base, which increases the total amount of the increase.

Delaying Social Security generally helps improve the likelihood you can meet your retirement goals. But if deferring to age 70 isn’t realistic or desirable, you should try to wait until at least your FRA to avoid a reduced benefit.

How Edward Jones can help

A successful retirement strategy should take inflation into account. Your financial advisor can help you analyze your strategy and adjust as necessary to help position you to achieve your retirement goals. Together, you can develop a strategy designed to best suit your situation.