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  • Writer's pictureRetirement and Annuity Advisor Jennifer Lang

How to Combat Inflation Risk When Facing Retirement In a Bear Market.

Updated: Nov 8, 2020

Does the prospect of saving for retirement seem more daunting than ever? You may be concerned with market losses, the risk of outliving your money and Inflation.

Ronald Reagan once famously said “Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man,” The worst time to try to fight inflation is when you are in retirement, living on a fixed income.

According to a survey by Allianz Life, a top economic worry among retirees, is inflation. Nearly one-third, or 32% of Americans said that they are “panicked” or “very worried” about inflation and its effects on their retirement.

It’s good that retirement investors are aware of inflation, but many underestimate it as a significant risk. In the survey, 64% said they don’t have a plan to address inflation. Among the 36% who do, 51% indicated “being more frugal with their money” would be their plan of action. And what about when it comes to actual planning? The Society of Actuaries reports that 45% of retirees and 28% of pre-retirees neglect inflation in their retirement plans.

Because inflation can be a real deal breaker for retirement lifestyle – especially as lifespans increase – here’s a look at the power-punch that inflation can land over time.

While concerns about inflation were clear, the survey indicated that many Americans have a misunderstanding of inflation and how to address it. Overall, people overestimated typical cost-of-living increases in retirement. Those surveyed predicted an average 4.4% increase in the cost of living each year. And some respondents gave even higher annual predictions as to what they expected for inflation in retirement.

Despite these predictions, Allianz Life estimates average inflation over the last 20 years to be just 2.15%. From 1999-2016, annual inflation hovered in a range of 0.1%-4.1%. Like everything, inflation adds up over time. To put this into perspective, it may help to think it over for a moment. Did the last car you purchased cost more than the first home you purchased years ago? That could be one potential illustration of the long-term impact of cost-of-living increases.

Don't Forget about Healthcare Inflation

According to HealthView Services, retiree healthcare expenses will rise an average of 5.47% annually for the foreseeable future. That's almost 300% greater than U.S. inflation from 2012-2016, which was an inflation rate of 1.9%, and over 200% greater than annual expected cost-of-living adjustments to Social Security payments (projected to be 2.6%).

The biggest driver of this rapid rise in costs is due to retirement healthcare inflation, says HealthView. An average 65-year-old couple retiring in 2017 will pay $11,369 in projected costs for healthcare in their first year of retirement. By the time they reach age 85, they are projected to be paying $39,208 in annual health costs, including payments for Medicare Parts B and D, supplemental insurance, dental insurance, and out-of-pocket expenses. Their total overall retirement lifetime healthcare expenses is expected to be $607,662, with annual inflation factored in.

Projected annual healthcare costs for the retiring couple at different ages are, according to HealthView:

  • $11,369 at age 65

  • $15,226 at age 70

  • $21,064 at age 75

  • $28,900 at age 80

  • $39,208 at age 85

Some other sources don't peg total retirement healthcare expenses at this high, but they are still substantial. In recent times, Fidelity has reported total healthcare cost projections of $275,000 -- a $15,000 increase from its estimates in 2016. Regardless of these projections, all of these statistics underscore the prudence and value of creating a long-term strategy to manage inflation, other risks, and income in retirement.

Be Proactive and Plan for Your Financial Future

When you are ready to retire you must convert the growth of your savings and investments into a source of regular and reliable income, an income that will last for 20 or 30 years of retirement.

Of course most financial advisors will advise you to withdraw only the interest dividends or profit on your investments so that you can never run out of money.

But we know that interest rates, stock dividends, market valuations and taxes will vary considerably from year to year.

Especially over 20 or 30 years of retirement and if your investment earnings cannot provide you with enough income, you will need to take withdrawals of both earnings and principle and manage those withdrawals very carefully as you spend down your savings over 20 or 30 years.

But if you make any mis-calculations or if your investments do not perform as well as you expect them to, or if you should live longer than 20 or 30 years, you could very easily run out of money.

So what's the alternative? Well, you can convert your retirement savings into three separate ten-year payout periods, each one with a certain guaranteed income and the third one with a guarantee to continue the payout for as long as you live.

Even if you live into your hundreds. These payout periods are referred to as income buckets and they can replace the uncertainty of interest rates, stock dividends, bond yields and market valuations with the certainty of a regular and reliable guaranteed monthly income.

It's like having your own personal pension plan. What's more, income buckets enable you to safely and confidently take as much as thirty percent more income during the first 20 years of your retirement because you know with certainty and assurance that you will have sufficient income guaranteed during the second 20 years of your retirement or for as long as you live.

What's more you can do it all without any risk of taking out too much or too little and without any dependence on interest rates, bond yield, stock dividends or market valuations.

So you never need to worry about the safety of your money or the need to carefully manage your investments.

Dr. David Pfau, a chartered financial analyst (CFA) and Professor of Retirement Income at The American College and holder of a doctorate of economics from Princeton University states:

“A low-interest rate environment is risky for investors, especially those approaching retirement. First, it is important to understand that bond prices will decrease if interest rates rise. Bond funds can be volatile and experience losses, and individual bonds may also experience loss when sold before maturity. Bond duration is a measure of just how sensitive bond prices are to interest rate changes.”

In considering deferred fixed annuities and the benefits they might provide relative to other fixed choices, Pfau points out four advantages:

1. Protection of the annuity’s value from investment volatility.

Deferred fixed annuities support growth at a specific interest rate without exposure to price fluctuations and potential losses as interest rates change,” Pfau observes. “Principal is protected and secured. This provides a way to take risk off the table in the pivotal years before the retirement date.”

2. The ability to earn higher yields than Treasury bonds.

Insurance company general accounts may invest in higher-yielding corporate issues to provide diversification (similar to a bond fund), while protecting the annuity contract holder from interest rate risk. And they provide the principal protection similar to an individual bond held to maturity.

3. Reduction in credit risk.

Because insurance companies can diversify their holdings across a wide range of fixed-income securities, deferred fixed annuities may offer lower credit risk.

4. Tax deferral.

Assets grow faster when investors are able to defer taxes on the interest earned until they actually withdraw it, or it is distributed to them. Because an annuity is tax-deferred for individuals, deferred fixed annuities postpone the taxes on growth until the annuity’s maturity date, allowing interest to compound, untaxed.

Wait Until Closer to Retirement?

If you think you won’t face this risk anytime soon because you have several years until retirement, Pfau has a finding on that, too.

Laddering annuities could be a good strategy if your retirement isn't eminent, according to Pfau. This approach lets you put money into annuities over time instead of all at once. That can help you manage inflation risk, along with maximizing your guaranteed lifetime income.

Here's an example of how annuity laddering works. The first income bucket might begin at age 60 or 65 and pay out all of that money over the first ten years of our retirement before it would be replaced by the second income bucket.

So the second income bucket would begin at age 70 or 75 and pay out a new monthly income guaranteed for another ten years to age 80 or 85 and this second ten year payout can be higher than the first ten year payout in order to offset the rate of inflation.

Now the third income bucket would only begin the payout if you make it to age eighty or eighty-five and this third bucket would be guaranteed not just for another ten years but for as long as you live. Even if you live to be a hundred and twenty and if you don't make it to age eighty or eighty-five, your heirs will receive annual installments until all the money you put into that bucket is paid back out.

An annuity -- or any financial or insurance solution for that matter -- must make sense for you and your financial circumstances.

​The strategies and solutions that can help you reach your retirement goals must be customized to your unique situation. Jennifer Lang Financial Services is an Independent Agent and closely monitors the most competitive life insurance carrier rates to help you get the best possible fixed index annuity. Get in touch with us to get a financial plan design that works best for your specific circumstances.

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