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WillInflationRuinYourRetirement

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Over the decades of your working and investing career as a CPA, your portfolio has likely begun to experience exponential, compounding growth. It took a while to earn that first $100,000 and then your first $500,000, but as the decades pass, your portfolio will probably begin to grow faster and faster.

However, there’s one minor issue. Something else is compounding alongside your portfolio, frequently even outpacing its growth, and it isn’t aiding your journey but instead putting a dent in your gains. Like compound growth, you may not notice it right away, but only decades later. And if you haven’t put a plan in place to deal with it, this dangerous factor you won’t read in the fine print – inflation – may just ruin your retirement.

How Inflation Affects Your Portfolio

Inflation is like a dead weight dragging down your portfolio. In times of high inflation or subpar investment (or a combination of both!), inflation may even outpace your investments! However, even in the best of times, inflation can still weaken your gains.

The S&P 500 has a historical growth rate of around 10%. If your investments can at least keep up with the S&P 500, it will take a $100,000 portfolio about 24 years to become a million dollars, assuming no further contributions.

But what would that million dollars be worth in ‘current year’ dollars? Let’s wager on a 3% average inflation rate over those same 24 years—a reasonable assumption.

24 years of 10% annual growth minus 3% yearly inflation:

Your $1,000,000 is worth only about $484,000 in ‘today’s money.’

This means you’d only be about to purchase $484,000 worth of goods in today’s money with your future $1,000,000.  

To earn $1,000,000 in ‘current dollars’ at the same growth rate,  you would need 35 years of compound growth.

Alternatively, if you’d like your $100,000 investment to be worth $1,000,000 in today’s dollars in 24 years, you’d need a growth rate of about 13.4%.

Your portfolio needs not just to keep pace with inflation but routinely and significantly outpace it to grow to the value you need for a comfortable retirement. And then it needs to keep growing!

How Inflation Affects Your Retirement

One particular issue with inflation is, barring runaway inflation like what Argentina is going through (an annual inflation rate of 288% as of March 2024!) or a period of high, consistent inflation like what Americans felt in 2022, inflation may go largely unnoticed for years. Yes, the cost of living does increase, but during your working career, you generally get pay raises and promotions that significantly offset inflation.

It goes without saying that pay raises and promotions disappear in retirement, and often, what you have in your savings is what you have for the rest of your life. You have to make it last, and inflation will accumulate and eat away at your savings without respite.

You may not feel the pinch too bad in the first ten years and perhaps even the second decade if inflation rates remain steady. The longer your retirement, though, the worse it will affect you, as shown in the table below.

[table]

 

Let’s return to that $1,000,000 portfolio. You’re recently retired at age 62. You have a prudent asset allocation of 38% equities and 62% bonds, and you begin withdrawing $70,000 a year. Again, let’s assume a 10% growth rate for your equities, a 4.5% growth rate for your bonds, and 3% inflation. Each year, you limit your exposure to the equity markets to mitigate market risks and increase your bond holdings relatively.

[Interactive Table]

After 19 years, your savings are depleted due to the combined factors of decreased equity exposure (necessary to mitigate the risk of a market downswing), increased exposure to lower-yielding bonds, and the continuous increase in withdrawal amounts to keep pace with inflation.

What Are Your Solutions?

Well, do you need a solution? A twenty-year retirement at age 62 does indeed push you past the average life expectancy and average retirement length. You also have Social Security to rely on, which includes Cost-Of-Living Adjustments to help offset inflation.

We hope that after a long career crunching numbers as a CPA, you can appreciate the importance of a flexible financial plan that should attempt to account for unpredictable variables such as market conditions, personal circumstances, and changing tax rates – something we haven’t even mentioned thus far.

The above scenario is likely an ideal one that could just as quickly be rendered worthless by a medical emergency, a market slump, a period of high inflation, and a longer-than-anticipated lifespan. So we believe that, yes, it would behoove you to have a solution in place to deal with inflation!

Have a Tax Plan in Place

It’s possible to achieve a $70,000 income (or even more) without paying any federal tax at all, as long as you have good account diversification. Combining your Standard Deduction and Social Security income with dividend income, long-term capital gains withdrawals from brokerage accounts, tax-deferred retirement account distributions, and tax-free Roth account withdrawals can keep your taxes low year after year, helping to improve the health of your retirement portfolio.

Implement a Dynamic Withdrawal Strategy

You may not always need $70,000 (plus inflation) any given year, so consider reducing your withdrawals to just what is necessary in low-expense years. Alternatively, in a market downturn, you can choose to buckle up and purposefully reduce your lifestyle for a while. These strategies will give you more wiggle room in years of higher expenses and leave more of your savings in a position to grow and recover after market dips.

Adjust Your Asset Allocation

Albeit risky, staying exposed to the markets holds the promise of greater long-term returns. To help you overcome inflation, you may want to adjust your asset allocation to a more aggressive position, especially if you feel you’ll live a long, full life, giving your assets more time to recover in the event of a crash.

However, this approach could backfire on you, especially if other factors converged on your portfolio concurrently.

Purchase an Annuity

Annuities are a contract between you and an insurance company that guarantees a fixed payment at a predetermined start date, and some of them offer inflation-adjusted payouts, helping you to maintain your purchasing power over time. An annuity could be particularly beneficial at the later stages of your life as a supplement to your Social Security income once your savings have been exhausted.

In Conclusion

Inflation is an ever-present factor of life, and we shouldn’t count on it going away. Just like we need to have a plan for taxes, medical expenses, and financial emergencies, we need to have a plan to deal with inflation or risk having a less than ideal retirement. Of course, it’s impossible to accurately predict times of high inflation and it’s length, especially on your own.

As professional retirement planners, we don’t want your retirement to be left to chance. We want guarantees, fallback plans, and assurances that you won’t just run out of money but thrive in every way in retirement. And that’s completely possible with the right team and financial products by your side.

If you’d like to consult with a financial professional that understands the unique retirement needs of CPAs, click the buttom below!