It’s official: Social Security’s 2025 cost-of-living adjustment (COLA) has been announced. In January, current beneficiaries will receive 2.5% more than they receive now, reflecting the 2024 headline inflation rate.
Somehow, though, it doesn’t seem enough. Although it is a purely mathematical issue, most people – and retirees in particular – appear to be having more difficulty than in the past in keeping up with rising costs. The small additional costs can add up quite a lot.
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With that as background, even though I’m not retired yet, those days are on my radar. Here’s what I plan to do, based on what I see now. Feel free to borrow my inflation-reducing retirement strategies for yourself.
In general, the older you are, the less exposure you should have to the stock market. If you need safety and security, more reliable investments such as interest-bearing bonds and even higher-yielding cash balances take priority. And that is understandable.
However, here’s what I’ve decided: Now that interest rates are finally at least slightly higher, the trade-off of owning significantly more fixed income and fewer equities is no longer worth it. No, I’m not going crazy – I will still want and even need reliable investment income. I also need at least some growth (price appreciation) from the stocks that pay my growing dividends.
This is best achieved by names like The Coca-Cola Company(NYSE: KO) And Procter & Gamble(NYSE:PG). They may not have the highest dividend yields, but they do offer above-average yields of 3% and 2.2% respectively, and their dividend growth rates are higher than average long-term inflation. Both companies have been increasing their payouts every year for decades. Both stocks are also posting respectable price gains, given enough time.
One prospect I’m no longer interested in? Treasury Inflation-Protected Securities, or TIPS. Although these government-issued bonds achieve their intended goal of adjusting their interest payments to inflation, they have never actually beaten inflation. Sooner or later you’re going to want a little more edge.
In light of my plans to own more dividend-paying stocks in retirement than I thought I wanted a few years ago, I will also own a lot fewer growth stocks in retirement. I may decide not to own one. That doesn’t mean I’m giving up on capital growth altogether. I just do it through dividend-paying names.
It’s not a strategy that everyone will agree with these days. Don’t own red hot tickers like Nvidia(NASDAQ: NVDA) or Amazon(NASDAQ: AMZN) seems like a plan that easily leaves money on the table. However, don’t be fooled. While these stocks have indeed delivered incredibly strong performance since the broad market hit a pandemic-induced low in early 2020, this strength has been an exception to the norm rather than the norm.
So don’t look for a repeat performance, from them or other growth names. In any case, we could be moving to a phase where value stocks will perform at least as well as growth stocks, if not better. It’s a potential risk for retirees because no one wants to be forced to sell growth stocks at a temporary low simply because there is a desperate need for disposable cash that could otherwise be provided by dividends.
Of course, managing my investments to minimize my overall risk while maximizing my short- and long-term income is only half the battle. Knowing where my money is going, before and after it goes, is another important part of my plan. That’s why I’m going to create a detailed budget based on my actual monthly bills.
And then I’m going to cut out all the silly expenses. Assuming I’m like most other consumers/investors, I don’t expect blatantly ridiculous expenses. (Like most of you, I don’t fly to the French Riviera regularly.) But that’s not how most retirees slowly spiral into financial trouble.
The real hardship often comes from too many costs adding up. Time shares, a few too many fancy dining experiences, using public storage facilities, and buying insurance they don’t really need are some of the common expenses that many retirees end up complaining about.
Less obvious costs that can harm your financial health include not taking advantage of senior discounts, not paying cell phone plans, or carrying credit card balances that can be paid off. This is as much a mental and psychological exercise as it is a mathematical one. Reducing these costs will likely require effort and perhaps even sacrifice.
Finally, while it doesn’t directly combat inflation, converting my conventional individual retirement account (IRA) to a Roth IRA could be a way to save money by limiting the taxes I ultimately pay on these retirement savings.
But first things first. For most people, regular IRA contributions are usually deducted from taxable income; the Internal Revenue Service taxes this money as income when it is removed from these retirement accounts.
Roth IRAs work in the opposite way. These contributions are not tax deductible as they are made, but if money comes out of the Roth accounts in retirement, it will come out tax free. Because I’ll be paying taxes on any money taken out of my traditional IRA – including 401(k)s – I try to pay this money when my potential tax liability is lowest.
So how can I use these withdrawal rules to my advantage? I have the option to convert some – or even all – of my regular IRA to a Roth IRA, after which any withdrawals will be tax-free. The only catch is that I have to pay taxes on all this money the year it converts to a Roth.
However, it may be worth it at the time if the market and account value decline and if I have the money available for these taxes when I am ready to make the conversion.
Conversely, you probably don’t want to make this move after a big market rally. Your account value may be slightly too high, so the conversion will maximize your tax bill.
Also keep in mind that Roth conversions are taxed like ordinary income. If they are large enough, this could put you in a higher tax bracket for that particular year. It may make more sense to convert just enough to pay a minimum amount of tax on this money, and perhaps wait to convert another portion of your traditional IRA to a Roth in another year.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. James Brumley has positions in Coca-Cola. The Motley Fool has and recommends positions in Amazon and Nvidia. The Motley Fool has a disclosure policy.
I’m not counting on Social Security COLAs to get me through retirement. This is what I do to fight inflation. was originally published by The Motley Fool
