Over time, a fixed income will offer less purchasing power. Image source: Frankieleon, Flickr.
You might think of retirement as a time when you have to survive on a fixed income, but that's not the case. There are several ways to set up retirement income streams that increase over time -- and that's well worth doing, too.
Inflation danger
Why is it so important to avoid a truly fixed income? Well, because of inflation.
Inflation refers to the gradual increase (or, occasionally, decrease) in prices over time. While gradual increases might not seem like they'd give a shock to your system, they can really add up and have a major impact on your finances -- especially if your income is fixed.
Imagine, for example, that you're living relatively comfortably in retirement on a fixed income of $50,000 per year. The $50,000 today may seem ample for buying food and gas and paying your utility bills and property taxes, among many other things, but while that $50,000 may be fixed, the price of most things you buy will keep rising, shrinking the buying power of that money. If your retirement lasts 25 more years and inflation runs about 3% annually, on average, during that time (its historic average rate), then by the time you get to the end of the 25 years, your $50,000 will have the purchasing power of about $23,350, in today's dollars. Ouch, right?
Beat inflation with increasing income
Fortunately, all is not lost. At least some of your retirement income is likely to rise over time, and with a little planning, much of it could.
Let's start with Social Security. The average Social Security benefit, as of September 2015, was $1,338 per month, or about $16,000 per year. Clearly, that's not enough to sustain most folks comfortably. That's just the average, though. If you've been an above-average earner, you'll receive above-average benefits in retirement -- but they still won't look anything like the paychecks you used to receive. Still, one good thing about Social Security checks is that they tend to increase over time, thanks to cost-of-living adjustments. If you're receiving $16,000 per year and that's increased by an annual average of 3% over 25 years, you'll eventually be collecting $33,500.
When we think of fixed income, we typically think of bonds, and it's true that most bonds do come with a fixed interest rate. Not TIPS, though. TIPS are Treasury Inflation-Protected Securities, bonds that are indexed to keep up with inflation. You can buy them with maturities of five, 10, or 30 years, and you can also invest in them through bond mutual funds or ETFs. They're guaranteed by the U.S. government, but that means that their interest rates are relatively low, reflecting their low risk.
Ideally, your income should increase during retirement. Image: Pixabay
Another solid option for you is dividend investing. Dividend income is not guaranteed, but when it's paid by healthy, growing companies, it's pretty reliable. For example, Coca-Cola and Procter & Gamble have paid uninterrupted dividends for more than 100 consecutive years. Better still, healthy and growing dividend-paying companies also tend to increase their dividends over time. Johnson & Johnson has been upping its payout for more than 50 consecutive years. For many years now, dividend stocks have offered yields considerably higher than what banks have been paying -- the S&P 500, for example, sports an overall dividend yield of 2% -- though interest rates are due to rise soon. If you hold solid dividend-paying stocks, you can look forward to dividend income that will rise over time, often surpassing inflation.
A last consideration is an annuity. Many annuities are problematic and often to be avoided -- such as indexed annuities and many variable annuities -- but immediate fixed annuities are worth considering. With them, you pay an insurance company a significant chunk of change and in return, you can get income for the rest of your life -- and perhaps your spouse's life, too. If you pay a little extra or accept a little less, you can opt for payments that are inflation-adjusted, giving you even more peace of mind.
One way or another, you can set yourself up to receive a lot of income in retirement that keeps up with or even beats inflation.
