Successful retirement savings faces a squeeze. IRA and 401(k) balances got clobbered over the past year. Meanwhile, inflation is arcing as high as a space launch. Both factors erode future purchasing power.
To counter inflation, how much do you need to boost your rate of retirement savings?
"Inflation attacks purchasing power," said John Graves, founder of G&H Financial Group. "If you earn $100,000 today, how much money do you need to buy all of the same things in 10 years?"
The answer: $187,713.75 if inflation continues at its 2022 pace of 6.5%, according to the inflation calculator at upstart.com.
That's a whopping big extra nut to crack for most Americans. What's the solution?
Retirement Savings Solution
First, remember that inflation is unlikely to remain as high as 6.5%, its 12-month rate as of the end of December.
It's already falling. The annual rate peaked at 9.1% last June, according to the Bureau of Labor Statistics. It was down to 7.1% in November.
Going forward? "Realistically, at some point not too long from now, it will be back to its long-term historical average of about 3%," Graves said. The rate of inflation is 3.27% since 1914, says ycharts.com.
Excess Inflation Is A Problem
That long-term rate of inflation is generally baked into the number crunching used by a big financial firm such as Fidelity Investments when they advise people to save 15% a year of their pay, including any company match, to keep their retirement savings on track to pay for a comfortable retirement, says Fidelity vice president of Thought Leadership Kirsten Hunter.
So, if inflation is higher than about 3%, you only have to compensate for the excess inflation, not for all of the inflation, says Ray Prospero, partner-advisor at AdvicePeriod.
Prospero, for example, views 2% to 4% as normal inflation. So clients only need to make up for any inflation that's above 4%, he says. "For example, if inflation is at 7%, that's approximately 3 percentage points above the normal range," he said. "I would recommend that investors try to save an additional 3 percentage points a year on top of their normal retirement savings rate."
How To Neutralize Inflation
Advisor Graves sees the numbers similarly. He treats 3% as the long-term historical average inflation rate. So last year's rate was 3.5 percentage points above average. "To be able to buy the same amount of goods and services in the future, this year you should save 18.5% of your pay instead of just 15%," Graves said.
You only need to jack up your savings rate as long as inflation is above the long-term average, he says.
You can adjust the rate quarterly if your 401(k) or similar workplace plan lets you, he says. Otherwise, yearly will do. If you boost your savings rate longer than necessary, big deal. No one ever complained about having retirement savings that are too big. And you have total control over the pace of contributions to your IRA.
Your Personal Inflation Rate
If you like, you can fine-tune the process even more, Graves says. Instead of basing your saving rate adjustment on a general, national inflation rate, base it on your personal inflation rate.
Do that by figuring out how much your household spending has actually climbed recently — if it has at all.
Do that by making detailed yearly budgets. You've probably already got the information you need in your yearly tax organizers or worksheets. "You can use online calculators for personal rate of inflation," Graves said.
Websites for Investor's Business Daily sister publications Barron's and the Wall Street Journal are two of many that offer online calculators.
Looking for strategies to save enough for a comfortable retirement? This other IBD report has your back.
Boost Your Retirement Savings
So, boosting the amount of money that you save every year is a key to offsetting inflation. One way you can increase your retirement savings contributions is by taking advantage of catch-up contributions, if you're eligible, Evan Potash, a wealth management advisor with financial services titan TIAA, reminds workers.
Catch-up contributions are higher annual contribution limits for people age 50 and older.
Annual catch-up contribution caps for 401(k) plans are $7,500. That's in addition to the $22,500 basic contribution limit. IRA contribution caps are $6.500, plus $1,000 for catch-up contributions.
Boosting the amount of money you save every year isn't the only way to offset inflation. Experts recommend these steps too:
- Invest more aggressively. That generally means investing more in stocks and stock funds. "Their returns have generally stayed ahead of inflation in the long term," said Jill Gonzalez, analyst for WalletHub.com, a personal finance website.
- Delay the start of Social Security benefits. Generally, the longer you wait after age 62, when you're first eligible to begin, and age 70, when benefits peak based on age alone, the higher your monthly benefit, says Sophie Raseman, head of financial solutions at employee financial care company Brightside.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
