10 Steps to Take to Protect Your Retirement Nest Egg From Inflation

Inflation is a scary wild card in your retirement plan. In recent years, the inflation rate has been low -- ranging from 0.1% in May of 2020 to 2.9% in May of 2018. But if that trend changes and inflation rises to 5% or higher, as it did in the second half of 1990, you could see your nest egg lose purchasing power over time. And, if you're already in retirement, you'd also see a distressing increase in your living expenses that you can't offset with a raise at work. You'd likely have to take larger retirement withdrawals instead, which increases the chances you'll run out of money before you die.

Insulate yourself from those outcomes by building some inflation protections into your retirement plan. Here are 10 strategies that may work for you.

5 Winning Stocks Under $49
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

Investing in stocks is an appealing inflation strategy, because share prices have historically outpaced inflation by a decent margin. While inflation averages a little more than 3% long term, average annual returns in the stock market are closer to 10%. That equates to a real rate of return, or growth in purchasing power, of about 7%.

Cash yields, on the other hand, are often below the rate of inflation. Today, for example, you could buy a five-year CD that earns between 0.6% and 1.1%. Sadly, even the high side of that range is less than the current inflation rate of 1.3%. Your real rate of return in that scenario is negative, which means your money is losing value.

ALSO READ: 3 Safe Stocks to Buy in a Not-So-Safe Market

Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds that are indexed to the Consumer Price Index (CPI). When the CPI rises, the bond's value is adjusted upward. That also increases the bond's interest payment, because it's calculated by applying a fixed interest rate to the principal value. In that way, TIPS deliver rising income when you need it most.

Note that the value of TIPS can also be adjusted downward when inflation is falling, but it never drops below your initial investment.

Fixed rates on TIPS are generally meager, currently as low as 0.125% for 10-year maturities. These bonds aren't going to be the heavy hitters of your investment portfolio, but they are safe and should deliver income that keeps pace with inflation.

Dividend Aristocrats are public companies that have increased their dividend payments regularly for 25 years or more. Examples include Procter & Gamble (NYSE: PG), which has raised its dividend for 60-plus consecutive years, and Walmart (NYSE: WMT), which has been increasing its dividend since 1974. That rising dividend can help you manage higher living expenses resulting from inflation.

Also, dividend-paying stocks often produce higher yields than you'd earn from TIPS or cash savings. Procter & Gamble's dividend yield is 2.5%, for example, and Walmart's is 1.54%. Plus, you'd also benefit from share-price appreciation over time.

There's no guarantee that dividend increases will keep pace with inflation, or even that a particular Dividend Aristocrat will continue its habit of raising the dividend annually. But that's often an acceptable trade-off, given that the total returns of your dividend payers can be so much higher than other inflation hedges.

Gold tends to rise in value during extreme economic conditions, such as the double-digit inflation seen in the late 1970s and the pandemic-prompted recession of 2020. Between the beginning of 1977 and the end of 1979, for example, gold rose from $136 per ounce to $524 per ounce. In that time frame, inflation shot up from about 5% to 13.29%. Also, the spot price of gold hit an all-time high of $2,025.32 in August of this year -- as investors worried about the ongoing economic repercussions of the COVID-19 crisis.

The precious metal is quite volatile, though, and can move in the opposite direction of stock prices. That, of course, only benefits you when share prices are falling. For that reason, experts recommend keeping no more than 5% of your wealth invested in gold.

You might start with 1% or 2% just to make sure you're comfortable with how gold behaves.

ALSO READ: Best Gold Stocks for 2020

If you're close to retiring or already retired, you likely want to keep a chunk or your nest egg in cash to manage your exposure to stock market volatility. Take a look at your returns on that cash and see if you can increase them. Options might include moving some money to a high-yield savings account or investing in cash equivalents, which are cash-like instruments that are stable in value and highly liquid. Treasury bills and money market funds are examples of cash equivalents.

5 Winning Stocks Under $49
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

An annuity is a contract between you and an insurance company that involves you purchasing a future stream of payments. You can buy an annuity with a single cash payment or by making monthly payments into the contract over time. The contract would specify your rate of return, the size of your income payments, and how long the income stream lasts.

Some insurers allow you to add an inflation rider to your annuity, which would adjust your income payments as the inflation rate changes.

Annuities in general are complicated instruments, and an inflation rider adds to that complexity. If you pursue an inflation-protected annuity, make sure you understand all of the terms, the fees involved, how the inflation rider works, and whether there's a cap on the inflation-related increases.

Many retirement planners recommend capping your annual withdrawals at 4% of your savings balance in the first year of retirement, and then adjusting for inflation thereafter. That withdrawal rate can keep you solvent for three decades or more under a variety of economic and financial market conditions.

The 4% withdrawal rate, however, could fail to live up to its promises under certain conditions. It may not hold up, for example, if today's historically low bond yields continue. Add in an extended period of high inflation, which would increase your retirement withdrawals, and the rule becomes even less reliable.

A lower withdrawal rate, say closer to 3%, improves your resilience to manage through any type of economic turmoil, including high inflation.

Your Social Security income is already tied to inflation by way of cost-of-living adjustments or COLAs. Unfortunately, COLAs have their drawbacks. They're based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which may not be the best measure of the cost increases that affect seniors most.

Fortunately, there is another way to raise your Social Security income. The longer you can delay claiming your Social Security benefit past age 62, the higher your benefit will be. The increase can be as much as 8% annually if you put off your claim past your full retirement age (FRA). The higher income helps you manage through inflation by supporting lower withdrawals from your savings.

ALSO READ: 4 Things Retirees Need to Know Before Claiming Social Security

Continuing to work and earn income in retirement supports lower savings withdrawals and allows you to keep your money invested for longer periods of time. That can add to your savings balance significantly.

Say you have $500,000 in savings, invested to earn 5% annual returns. If you plan on withdrawing $1,500 monthly, your balance after five years would be about $539,000. Assuming a 2% inflation rate, the spending power of that balance is about $487,000.

On the other hand, you could forgo retirement withdrawals temporarily and, instead, live on part-time income along with your Social Security benefit. After five years, you'd have about $642,000 with a spending power of $580,000. That's a $100,000 swing to your advantage.

Inflation pushes interest rates higher, which increases your interest expense on credit cards, adjustable-rate mortgages, and home equity lines of credit. You're also likely to see higher minimum monthly debt repayments. That can be a budget killer at a time when the costs of groceries, gas, and healthcare are rising, too.

Head off that problem by paying off those variable-rate debt balances before inflation becomes a problem. And going forward, be cautious about how you're using debt. Make sure you have a plan for paying it off quickly, so you don't get caught off guard by rising interest rates.

5 Winning Stocks Under $49
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

Rising inflation eats into your buying power and increases the chances that your retirement nest egg will dry up before your final days. Without knowing exactly how inflation will play out over the next several decades, the best way to protect your money is a multipronged approach. You can invest for returns that have historically outpaced inflation, secure sources of increasing income, consider inflation-indexed bonds or annuities, delay retirement and your Social Security claim, and keep variable-rate debt to a minimum.

Catherine Brock owns shares of Procter & Gamble. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.