401(k) Inflation and its Impact on Your Retirement Plan

401(k) | Retirement Planning | Individual Retirement Account

 Plancorp Team By: Plancorp Team

With inflation continuing to rise, many investors are concerned about the impact that this may have on their 401(k) plans. These concerns have become even more valid as inflation rates continue to hit decades-high levels, reaching 8.52% in August 2022.

Investments and their dividends don’t adjust for inflation. This means that the money you’ve invested in your 401(k) isn’t going to increase as the cost of living rises. And as inflation increases, the purchasing power of a dollar decreases. As a result, your 401(k) returns can be negatively impacted during periods of high inflation.

Here's an example: If you’re getting a return of 10.5% on your 401(k) and inflation reaches 8.5%, then you’ll only be getting a two-percent net gain on your investment. Likewise, if you’re only getting a return of 8% on your account, then your net gain will be in the negative. Since a typical target is a 5-8% return on a 401(k), the numbers show that inflation can significantly impact your investment gains.

However, having money in a 401(k) during times of high inflation has an advantage over other investments. 401(k) retirement accounts have a relatively high interest rate compared to savings, money market, or CD accounts. 

Advantages of a 401(k) During Times of Inflation

Here’s a look at some of the other advantages of having a 401(k) compared to other types of accounts during high-inflation periods.

Withdrawal Flexibility

A 401(k) allows for a certain level of flexibility that other plans lack. For example, you’re allowed to start taking money from your 401(k) after you’ve turned 59 ½, and you can also withdraw money once you turn 55 if you’ve lost your job. Being able to withdraw money earlier can be a great advantage during times of economic crisis.

Tax Breaks

Another advantage of a traditional 401(k) is that you don’t have to pay taxes on the money until you take a disbursement, or withdrawal, from your account. You can also deduct the amount you’ve placed in your 401(k) from your net income, bringing you a sizable tax benefit for that year.

Larger Contributions

You can deposit more money annually into a 401(k) than in an IRA. In 2022, the contribution limit for 401(k) plans increased to $20,500, while the contribution limit for IRA plans was $6,000. These advantages may not have a direct bearing on 401(k) inflation, but they do have an impact on how well you leverage your finances during high-inflation periods. A 401(k) allows you to have greater access to your funds and control over how you manage them. 

Emergency Access

While we typically discourage taking a loan, we will give an honorable mention to the fact that a 401(k) plan does allow the flexibility to take out a loan against the account in case of a financial emergency. Any interest paid on a 401(k) loan will go back into the account, rather than the bank. 

How to Protect Your 401K from Inflation

By monitoring your account regularly, you can find ways to minimize costs and maximize returns, especially during a volatile market. Here are some tips for protecting your 401(k) from losses caused by inflation.

Grow Your Contributions

This is the best time to increase your contributions if you can afford to do so. At the very least, you’ll want to maintain your eligibility for the full company match from your employer. If you can’t afford to max out your contributions right now, try to keep them at the same level.

Look for Excessive Fees

Fees can quickly eat up your net gains, especially during periods of high inflation when your net return is down. In particular, make sure that your expense ratios are under control, with rates that are compatible with your earnings.

Consider Diversifying Your Investments

When inflation rates are high, diversify your investments by allocating some of your funds to other types of accounts. These could include foreign stocks, with equities based in another currency (one that is currently appreciating), or short-term bonds, which won’t lock you in over a long period of time.

Pay Close Attention to the “Real Return” Numbers

Make sure you’re still getting enough of a return on your investment by looking at your “real return” numbers. The real return is the amount that you’re actually getting. With a 401(k) adjusted for inflation, the real return numbers may indicate that you’re only getting a two-percent return. If this happens, you may want to make adjustments to your portfolio.   

Get Professional Advice

In the long run, stocks continue to be the best hedge against 401(k) inflation, with a track record of global return equities that are 7% higher than the average inflation rate. But even 401(k)s can suffer during higher-than-average inflation rates—a complete game-changer when it comes to choosing the right investments for your money.   

When it comes to the question, “How do I protect my 401(k) from stock market crashes?” the answer isn’t always straightforward. And this can cause anxiety for many investors. During high inflation periods, it isn’t easy to make educated decisions for investment growth. Navigating your way through a constantly changing playing field can become more manageable when you have professional advice and the resources you need to make the right calls. That’s where Plancorp can help.

Plancorp specializes in wealth and asset management, tax strategies, estate planning, equity compensation, and more. We’re evidence-based investors, and our elite team can work for you, putting your mind at ease so that you can enjoy a comfortable retirement despite the current economic situation. We have the experience and knowledge to help our clients find the most reality-based investments personalized to match current needs.

If you’re ready to get professional advice on how to invest in your future, complete your financial assessment today and let Plancorp's advisors help you achieve your financial goals.     

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