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$1 Million Isn’t What it Used to Be
Don’t let inflation erode the value of your retirement portfolio with these simple strategies
It used to be that $1 million sounded like a dream. When we were young, most of us probably imagined how wonderful life would be if only we were millionaires. And while $1 million is still a considerable amount of money, it’s important to realize that $1 million is no longer the gold standard for financial security and success. Why? It all comes down to inflation.
The Inflation Factor
Put simply, inflation erodes your money’s value. Inflation has often been nicknamed the silent retirement killer because so many people forget to account for it in their income planning. Unfortunately, inflation is one of the few certainties in life. Over the last 50 years, the cost of goods and services has increased an average of 3.7% per year. Let’s say inflation continues to average 3% a year. In 40 years, $1 million will be worth $306,000 in today’s dollars, and that’s not enough to buy you a comfortable 30-year retirement.
To put these numbers in perspective, let’s look at history. If you wanted to have the same purchasing power as a millionaire from 1914, you would have needed $3 million in 1980. But here’s the shocking number: in 2019, you would need $25 million to match the $1 million of 1914.
Rising inflation tends to happen so gradually that it’s difficult to see the effects of it on your wallet year to year. When saving for retirement, you need to calculate that effect forward anywhere from 10-50 years in the future. So, if a new car costs around $5,000 in 1980 and $34,000 in 2019, you could find yourself spending over $65,000 to upgrade your vehicle in 2041.
How to Protect Your Retirement from Inflation
We can’t predict the future, but we can prepare well based on historical data. Since you need your retirement savings to last many decades, consider implementing these potential solutions in your financial plan.
Conservative Withdrawal Rates
Since you know that stocks have historically earned an average of 7-8% a year, you might assume that you can afford to withdraw 7-8% of the initial portfolio value (plus a little more for inflation each year). But in reality, to protect against the uncertainty of the market, you may want to limit your withdrawals to around 4%. Because there is no simple, one-size-fits-all plan, you need to figure out what will work for you and your unique situation, taking various factors into account, such as time horizon, risk tolerance, asset allocation, and unexpected living expenses.
Set Up Contingencies
A competent and trust worthy planner can factor in inflation and calculate how long your money will last based on where you live, which withdrawal rate you choose, and what the markets may do. But there are some things that can’t be predicted, such as your health.
According to the Employee Benefits Research Institute, the average couple at age 65 will require anywhere from $151,000 to $255,000 just to cover their healthcare costs in retirement. Build contingency funds over and above your regular retirement account to give yourself a bit of a savings buffer. There will always be unexpected expenses in life, whether it’s needing a new car, home repairs, or unexpected long-term care expenses. Proper planning will give you peace of mind.
Make a Strategy to Reduce Future Taxes
Cost of living expenses aren’t the only cost that rises with inflation. It’s certainly possible – perhaps even probable given the poor fiscal state of our government – that future tax rates will be higher than they are today. Future tax rates are especially consequential to retiree’s because any money taken from an IRA or 401(k) will be taxed at ordinary income rates.
The table below gives some historical perspective on the Top Federal Tax Rates. As you can see, there is certainly historical precedent for higher tax rates in the future.
Source: IRS gov
Investors have several opportunities to protect their nest egg from the chance of future tax hikes. Knowing which accounts to draw from and when in retirement can help reduce a future tax bill. For example, the first places you should generally withdraw from are your taxable brokerage accounts—your least tax-efficient accounts subject to capital gains and dividend taxes. By using these first, you give your tax-advantaged accounts (IRA, Roth IRA) more time to grow and compound, even while you are in retirement.
For those still working and saving, the foresight to make Roth contributions can reduce future taxes due. The Roth IRA is perhaps the most attractive retirement savings vehicle for investors. Unlike traditional IRAs which provide tax-deferred growth (you pay the tax eventually), Roth IRA assets grow tax-free. The Roth IRA protects you from paying future income taxes, and this protection also continues for your heirs.
A third tax-efficient strategy is to ensure that you receive the maximum benefit for your charitable intentions. Gifting appreciated stock to charities instead of gifting cash will increase both the amount of money you can give an organization and the size of your tax savings. This is because anyone who donates stock that has appreciated in value (and held at least 12 months) is able to deduct the full value of the investment without being forced to recognize the capital gain in the process. By donating appreciated stock, your capital gain disappears entirely, allowing you to permanently avoid any long-term capital gains tax liability that you would otherwise owe in the future.
Adjust Your Mindset
Retirement often means major lifestyle changes. As a result, your expectations may need to change as well. If you want a comfortable retirement, you may have to rethink how much you will be able to give your children as a down payment on a house or an inheritance.
You may even need to downsize your home or relocate to a more affordable area. Cost of living varies drastically across the U.S. When you are determining how much money you need for retirement, location can make all the difference. For example, if you live in Illinois, $1 million (in today’s dollars) will only last 22 years and 7 months. But if you live in Mississippi, it’s estimated that $1 million will last almost 26 years because of affordable living expenses that fall below the national average cost.
Stay flexible and be willing to adjust in order to secure your financial future and stretch your wealth as far as possible.
Secure Your Retirement
It can be disheartening to look at the numbers and realize that what you were aiming for is not enough. But by making small changes now and planning, you can set yourself up to experience the retirement you dreamed of. Use these pivotal years to implement strategies to protect, grow, and transfer your wealth. If you want a customized financial plan to get you from point A to point B, Windgate Wealth Management is here to help. Reach out to us now at (844) 377-4963 or email firstname.lastname@example.org. You can also book an appointment online here.