Take Steps To Manage Inflation’s Impact

JEFFREY R. GREEN, CPA

Retirement planning is all about managing risk. Longer life expectancies generally mean longer retirements, which increases the risk that you will have to live on less income. Other risks include rising or unexpected medical expenses and sudden changes in the financial markets.

One risk that is often overlooked is inflation. Although the inflation rate has been very low in recent years, most experts predict higher inflation for the foreseeable future. Such increases have the potential to disrupt your retirement plans.

How it erodes value

Inflation can slow the growth of certain assets or even reduce their value and erode the purchasing power of your investments. Let us say you have a money market account that earns a two percent annual return and inflation is three percent. That investment you thought was growing at a modest rate is actually shrinking in spending power.

Many people invest in fixed-income securities (bonds) to reduce overall portfolio risk. But if these holdings are not keeping pace with inflation, your retirement savings may not last as long as you originally planned.

What you can do

Here is what you can do to help manage inflation risk:

• Estimate the length of your retirement, based on your family’s longevity history and other factors.
• Determine how much income you will need, considering the money you may require to cover not only the daily costs, but also discretionary expenses and unexpected medical and other costs.
• Work with your financial advisors to develop a budget and an investment strategy designed to protect your wealth from inflation.

Managing inflation risk may involve saving more for retirement or reallocating some of your portfolio to assets that tend to keep pace with or outperform inflation, such as stocks or real estate. It may also mean rethinking the traditional rule that says the percentage of your portfolio in equities (stocks) is 100 minus your age. In other words, if you are 60, then 40% should be in stocks and 60% in bonds.

But given increasing life expectancies and the potential impact of inflation in coming years, you may want to consider subtracting your age from a larger number, such as 110 or even 120. Thus, 60-year-olds would allocate 50% to 60% of their portfolios to equities.

Why you need advice

Your retirement plan should achieve your goals and consider possible threats, including inflation risk. Although it is impossible to eliminate all risks — including the risk that you will lose your original investment money — your ORBA financial advisors can help you minimize them.

Related Read: Approaching Retirement? How to Deal With Market Volatility

For more information, contact Jeffrey Green at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

Saving for Retirement: Your 401(k) Is Maxed Out — Now What?

ADAM M. LEVINE, CPA, CFP

A 401(k) plan is an attractive employee benefit that allows you to set aside significant savings for retirement on a tax-deferred basis. And if your employer offers matching contributions, the benefits are hard to ignore. But what if you have maxed out your 401(k) contributions?

For 2022, you can defer up to $20,500 per year in pretax salary to a 401(k) plan, plus $6,500 in “catch up” contributions if you are 50 or older. For many people, this amount is enough to help them achieve their retirement goals. But if you wish to invest more in tax-advantaged savings vehicles, you have several options.

Related Read: Three Tips for Making Retirement Less Taxing

After-tax contributions

Some 401(k) plans allow you to make additional, after-tax contributions after you have maxed out your pretax contributions. Currently, the total contribution limit — which includes both employee and employer contributions — is $61,000 ($67,500 if you are 50 or older).

Let us say you are 40 years old and you are currently contributing the maximum — $20,500 — in pretax dollars to your 401(k) plan. If your plan permits after-tax contributions, you can set aside up to an additional $40,500 per year, reduced by any employer matching contributions. Even though these additional amounts are not deductible, earnings on contributions grow tax-free and are not taxed until they are withdrawn.

Also, many 401(k) plans allow participants to make Roth contributions. Contribution limits are the same as for traditional 401(k)s.

Traditional and Roth IRAs

Another option for boosting your tax-advantaged retirement savings is a traditional or Roth IRA. For 2022, the combined maximum contribution to traditional or Roth IRAs is $6,000 ($7,000 if you are 50 or older).

Depending on your income level, contributions to a traditional IRA may be only partially deductible or even nondeductible, but they still provide tax-deferred earnings. Higher-income earners are ineligible to contribute to a Roth IRA, although there may be ways to circumvent this restriction.

Annuity contracts

An annuity is an investment contract, typically with an insurance company. Annuity holders invest a lump sum or make annual premium payments in exchange for a guaranteed income stream for life. This income stream either begins right away (with an “immediate” annuity) or at a later date (“deferred” annuity).

Annuities do not offer current tax deductions. But their earnings grow on a tax-deferred basis, so they can be an attractive supplement to your 401(k) and other savings vehicles. Rates of return on annuities typically are modest, but the benefit of guaranteed income can make them valuable. There are several types of annuities — including fixed, variable and equity-indexed — so be sure you understand their terms before you invest in one.

Health savings accounts

A health savings account (HSA) can be an effective way to fund medical expenses while supplementing other retirement savings vehicles. Like a traditional IRA or 401(k), an HSA — which must be coupled with a “high-deductible health plan” — is funded with pretax dollars. Currently, the maximum annual contribution is $3,650 (self-only coverage) and $7,300 (family coverage), plus an additional $1,000 if you are 55 or older.

An HSA’s earnings grow tax-free. And you can withdraw funds tax-free at any time to pay for a range of qualified medical expenses. Withdrawals used for other purposes are taxable, but there are no penalties for those age 65 or older.

An HSA can boost your retirement savings by funding medical expenses with pre-tax dollars, freeing up other funds that can be invested. Also, if you do not use your HSA for medical expenses, it acts much like an additional IRA or 401(k) account.

Unique plan

These are just a few examples of the many retirement saving tools available to supplement your 401(k) plan. Even if you have not maxed out your employer-sponsored account, you may want to consider one or more of them. However, it is usually best to first invest enough in your 401(k) plan to secure the maximum employer matching contribution.

Be sure to work with your ORBA advisor to develop a plan that takes into account your risk tolerance and retirement income needs. Also, make sure you have put funds aside for emergencies and shorter-term financial goals.

For more information, contact Adam Levine at [email protected] or 312.670.7444.  Visit ORBA.com to learn more about our Wealth Management Services.