7 Ways to Stay Ahead of Inflation in Retirement

In Pictures: 10 Essential Sources of Retirement Income

Inflation will gradually erode the purchasing power of your nest egg in retirement. But there are many steps you can take to help your retirement savings keep pace with the rising cost of living. Here are seven strategies to stay ahead of inflation in retirement:

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Social Security. Social Security payments are adjusted for inflation each year, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers. Social Security cost-of-living adjustments have ranged from zero percent in 2010 and 2011 to 14.3 percent in 1980. To maximize the dollar amount of your inflation adjustment, take steps to boost the amount of Social Security you will get. "Focus on when you start your Social Security benefits and maximizing that will help you deal with inflation," says Steve Vernon, a fellow of the Society of Actuaries and president of retirement consulting firm Rest-of-Life Communications in Oxnard, Calif. Payouts increase for each year you delay claiming between ages 62 and 70.

TIPS. Some types of government bonds promise a rate of return above inflation. The principal amount you invest in Treasury Inflation-Protected Securities increases with inflation and decreases with deflation, as measured by the Consumer Price Index. TIPS pay a fixed interest rate twice a year on the inflation-adjusted principal. Interest payments will rise each year as inflation occurs, but could fall when there is deflation. Interest income and growth in the principal value are exempt from state and local income taxes, but are subject to federal income tax.

Inflation-fighting investments. It's a good idea to allocate part of your portfolio to investments that have historically kept pace with inflation. "Have some exposure to commodities, stocks, and real estate, but don't go overboard," says Lyle Benson, a certified financial planner and founder of L. K. Benson and Company in Baltimore, Md. "You don't need to shift your entire portfolio into inflation-fighting investments."

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Pay off your mortgage. Paying off your mortgage eliminates one of your biggest monthly expenses and insulates you from rent hikes. "If you pay off a $2,500-a-month mortgage, you have saved yourself $30,000 a year in cash-flow needs," says Larry Rosenthal, a certified financial planner and president of Financial Planning Services in Manassas, Va. "In inflationary times, you should keep your monthly overhead as low as possible." If you need to, you may be able to tap the equity in your home using a loan or reverse mortgage. Some retirees also downsize to a smaller home or a more inexpensive area of the country to further cut costs.

Inflation-adjusted annuities. Some investors turn over a portion of their savings to an insurance company in exchange for a promise to receive a specific monthly payment for the rest of their lives, no matter how long they live. Some annuities offer the option of payments that are indexed for inflation. "Consider putting part of your money in an annuity, and then the other part you invest and draw down over time," says Vernon. "Annuities sometimes have a bad name because some annuities have high fees and poor performance. Look at the strength of the insurance company and shop among insurance companies to get the best price."

Work part time. Continuing to work part time in retirement allows you to be paid at current rates. "If you are working, inflation will probably drive up wages as well," says Benson. "Maybe you can save a little more as wages go up."

[See How to Save for Retirement on a Low Income.]

Reduce spending. When you reduce or eliminate some of your discretionary expenses, you will be better prepared when the prices for necessities rise. For example, to cope with rising gas prices, retired couples could downsize from two cars to one. Your savings on insurance and maintenance and the income from the sale could finance years' worth of higher gas prices. "Things that are going to definitely go up are consumer staple items, food, fuel, and energy," says Rosenthal. "Maybe you can cut back on eating out a little bit because you know your gas bill is going to go up."

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