To maintain your purchasing power through retirement, you’ll need to consider diversifying your income sources.

 

The acid rain of inflation
Think back to what your salary was in your first job. Chances are you’d struggle to live on that amount today, especially if you received your first paycheck over a decade ago. And that isn’t necessarily because your tastes have become more extravagant, but because the price of goods and services has gone up—in the case of healthcare, they’ve gone way up.

 

When people embark on the adventure of retirement, they don’t always go in thinking of their income as a “starting” income, even though inflation will continue doing the corrosive work it did throughout their careers. At least when you’re working, there is typically an annual cost-of-living increase and the possibility of merit-based pay raises—neither of which are guaranteed in retirement!

 

So…how can retirees help ensure they don’t gradually lose their purchasing power, in the absence of a company policy that adjusts its salaries annually?

 

Let’s look at the three main sources of income for retirees, and assess how well each of them is designed to weather the acid rain of inflation:

 

1. Pension
If you are fortunate enough to have a company pension, your employer is obligated to pay you an annuity at retirement. Around a third of today’s seniors receive income from private company or union pension plans, federal, state, or local government pension plans, or Railroad Retirement, military or veterans pensions.1

 

Your benefit amount will likely be calculated based on your salary and years of service. As you might imagine, a tenured professor stands to receive a very different pension than that of a part-time teaching assistant. In 2015, the median private pension benefit of individuals aged 65 and older was $9,376 a year. The median state or local government pension benefit was $16,742 a year.1

While automatic cost-of-living allowances are provided for by Social Security, pension plans increase their benefits on a more discretionary basis. And even when annual increases are given, they often fail to keep up with inflation. So several years into your retirement, even if you’re getting a post-retirement pension increase, you may never fully recover the loss of the buying power you had at the onset of your retirement career.

 

2. Social Security
Like pensions, Social Security benefits provide a basic stream of income based on how much you earned while working and for how long. If available to you, you should consider having both: The Pensions Rights Center calculates that in 2014, the median income of retirees (with no earnings from work) age 65 and over with Social Security AND pension was more than twice the income of aged retirees receiving just Social Security: While the median income for retirees only receiving Social Security benefits was just $15,871, the median for retirees receiving both Social Security and a private pension was $36,270.1

 

3. Your savings and investments
Pensions and Social Security together may replace a sufficient portion of your income initially, but generally, they don’t do a very good job of outpacing inflation. The fact is, they often aren’t adequate for the long haul, especially when most 65-year-olds can expect to live for 20, even 30 years more.

 

Why do I say that? Well, assuming a 2.5% annual rate of inflation, the price of goods will more than double in 30 years. What that roughly means is, you would need more than $2,000 in 2047 to purchase something that costs $1,000 today.

 

That’s why I think it’s crucial for even “pensioned” employees to avoid complacency—and to realize the importance of saving and taking advantage of any defined contribution plans offered in the workplace.

 

Think of investments as the third leg to your diversified-income stool
Exposing your portfolio to the risk and volatility of the stock market provides more potential for growth—but also for losses—than safer investments like Treasury bonds. Which is why after you stop working and begin spending your savings, you’ll likely want to become more conservative with your remaining assets. But if your strategy is too conservative, your purchasing power may shrivel like a raisin in the sun. Once you’ve decided on an age-appropriate asset allocation, the question becomes: How do you turn your assets into income?

 

  • Periodic withdrawals: Many retirees choose to roll all their 403(b) plans and IRAs into one single IRA, and then withdraw a set percentage of the principal (the account balance) each year. A 4% withdrawal rate is often suggested, or at least the required minimum distribution (RMD) that traditional IRAs force you to take after age 70½. By choosing to control the amount you receive annually, you may avoid the danger of being pushed into a higher tax bracket (as can happen with pension payments and other annuities). However, the downside to this strategy is that you might whittle down your savings to nothing and outlive your assets.
  • Fixed annuities: The problem with many pension fund payments is that they are not indexed to inflation. In other words, as inflation rises, you’ll be able to afford less and less. This is why many retirees choose to use their savings to purchase an annuity, a third source of income that may be inflation-adjusted and therefore maintains the same purchasing power throughout retirement. But be advised that fixed annuities won’t be inflation-adjusted, meaning that over the years your income might dwindle significantly.
  • Variable annuities: Fixed annuities can be attractive because they offer the security of a fixed sum. But $1,000 today will likely buy you a lot more than it will in 10 years. Do you really want your income fixed at the same rate, when you could live for another 20 or 30 years? Variable annuities are more likely to maintain your purchasing power and keep up with inflation rates. The downside is, the amount of income you receive is dependent on the underlying investments—meaning your income can rise or fall depending on how the stock market is performing.

 

Build a diversified income plan
While there are pluses and minuses to these various forms of retirement funding, the point is to set up a steady stream of income, instead of—or in addition to—pensions and Social Security. And that means multiple sources of income to help reduce the effects of inflation, market volatility, longer lifespans and unexpected costs like healthcare.

 

Leaving behind the 9-to-5 grind is liberating, because you’re no longer expected to sing for your supper. On the flipside, you can no longer expect promotions or raises, so it’s completely up to you to maintain your purchasing power and to protect your lifestyle in retirement.

 

Source:

1. Pension Rights Center website, http://www.pensionrights.org/publications/statistic/income-pensions, accessed April 2017.

 

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