How to Safeguard Your IRA Against Inflation

In March, annual inflation was measured at 3.5%, per that month's Consumer Price Index. But typically, inflation hovers closer to the 2% mark year to year. When that's the case, living costs rise gradually from year to year, but not as drastically as they've risen over the past few years.

Still, inflation has the potential to erode your retirement savings. Think about it: If you save $1 today, that $1 may only offer you $0.80 of buying power well into the future. So you need to take steps to help your individual retirement account (IRA) keep up with inflation. And in that regard, there's one important thing for you to do in the years leading up to retirement, as well as during retirement itself.

Load up on stocks

Some people worry about buying stocks because of the risks involved. But if you don't invest in stocks, you run a different risk -- having your nest egg fall short of your financial needs. In fact, if you want to protect your IRA from inflation, it's important to load up on stocks in that account, whether by buying shares of individual companies or by investing in index funds (for example, S&P 500 index funds, which effectively let you invest in the stock market on a whole).

Over the past 50 years, the stock market has rewarded investors with an average annual 10% return. That return reflects years of strong market performance as well as downturns.

So, let's say you fund an IRA to the tune of $400 a month over a 40-year period. If you play it safe and keep your money in cash and bonds, your returns over that time span might be just 3%. That could mean retiring with about $362,000.

However, if you were to invest your $400 a month in stocks and score a 10% return in your IRA over 40 years, you'd be looking at a little over $2.1 million instead. That makes it far more likely that your IRA will be able to cover your living costs throughout your senior years.

Keep your stocks around in retirement, too

Investing in stocks while you're building retirement savings is a good way to help your IRA outpace inflation. But don't rush to dump your stocks once your career comes to an end and you're ready to start tapping your nest egg. You need some stocks in your IRA to allow that money to continue to grow even while you're taking withdrawals.

The extent to which you maintain a stock portfolio should depend on factors like what income you have access to outside of your IRA and what your personal tolerance for risk looks like. But you should know that financial experts have long suggested that retirees follow the 4% rule to manage their retirement savings. This rule has you withdrawing 4% of your IRA balance your first year of retirement and then adjusting subsequent withdrawals for inflation.

The 4% rule, however, assumes that you have a fairly even mix of stocks and safer investments, like bonds. If you have no stocks at all in your retirement portfolio, then you may end up having to withdraw much less than 4% a year.

So let's say you manage to retire with $2 million. Sticking to the 4% rule could help ensure that your money lasts as long as you need it to. It also leaves you with roughly $80,000 a year in income from your savings alone. But if you were to dump your stocks entirely in retirement, you might have to stick to a 2% withdrawal rate instead of 4%, leaving you with just $40,000 of annual income from your savings.

All told, investing in stocks both before and during retirement is quite possibly the best way to safeguard your savings against inflation. So even if buying stocks tends to fall outside of your comfort zone, it's important to push yourself to take that step if you want to be financially secure once your career comes to an end.