How Advisers Can Help Clients Prepare for Future Inflation

Inflation has been tame, but there are certain costs -- like healthcare -- that still outrun it.
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Inflation has been relatively benign in recent years, but this doesn’t mean that it isn’t still a threat to our future financial health. This is especially true for those nearing or in retirement.

It may seem like inflation is a thing of the past; the Consumer Price Index dropped 0.8% in April of 2020 and is up a mere 0.3% over the past year ending April, according to the U.S. Bureau of Labor Statistics.

What’s more important than the overall rate of inflation is the level of inflation on items that people spend their money on. This includes things like the cost of healthcare in retirement which has consistently outpaced the general rate of inflation, the cost of college, the cost of purchasing a new home in many locations and a host of other items.

Here are some thoughts on helping individuals and couples prepare for future inflation.

Use Conservative Assumptions

While inflation has been low for the past few years, assuming that it will stay that way could be detrimental to a person’s financial planning efforts. Historically an inflation rate in the 2.5% to 3.0% range is not uncommon.

Using the rule of 72, a 3.0% average rate of inflation could cut the purchasing power of a person in retirement in half over a span of 24 years, and a 24-year retirement is not an unreasonable assumption given our longer life expectancies today.

Invest to Stay Ahead of Inflation

Pre-retirees and retirees look to their financial advisers to devise an investing strategy to help them achieve their various financial goals, while balancing this against their risk tolerance. Depending upon a person’s time frame to achieve these goals, this will likely include an allocation to stocks and other types of investments that have historically outpaced inflation over time.

During periods of market volatility this might be a tough sell for some, but their advisers need to show them the benefits of these types of investments as part of their portfolio and the potential consequences of inflation upon their ability to achieve their goals like a college education for their kids or a comfortable retirement.

Retirees are especially susceptible to the potential ravages of inflation. Expenses for things like prescription drugs and long-term care have outpaced the general rate of inflation. Add to this that the cost-of-living increases for Social Security have not always kept up with this “retiree inflation” and your clients face the real prospect of running out of money.

Steps to Mitigate the Impact of Inflation

While every client’s situation is different, here are some things to consider on helping them to combat the potential impact on inflation.

Health savings accounts (HSAs) allow pre-tax contributions to a medical savings account that grows tax-free. Withdraws for qualified medical expenses are tax-free. The contributions can be carried over year-to-year in the account if not used and saved for medical expenses in retirement including for Medicare premiums. HSAs are only allowed in conjunction with a high-deductible health insurance plan, so your client would need to have access to this type of plan.

When to claim Social Security is a key decision. Claiming Social Security at age 62 results in a 25% reduction in benefit compared to waiting until full retirement age (FRA). It’s a 30% reduction for those born after 1959. Additionally, each year claiming is deferred after FRA adds 8% to the initial benefit amount.

Long-term care insurance can help cover costs associated with long-term care, whether in a nursing facility or home care. This is an expense that continues to increase yearly, and this insurance can help people keep up with these potentially devastating costs if needed.

Decisions for those covered by a pension are critical as well. Your client might have options as to when to begin taking their pension with commensurate changes in their benefits. They may also have a lump-sum option, which should be considered if the money can be invested in a way that outpaces the monthly benefit.