Consumer prices rose 8.5% in July over the previous year, leaving many retirees and pre-retirees wondering how inflation impacts retirement savings.
They have a right to worry. After all, living on a fixed income is tough when the price of everyday goods and services accelerates past the returns retirees can expect on their investments.
To illustrate how inflation can erode retirement savings, SmartAsset analyzed the impact of three different inflation rates on savers. Here’s what the data shows.
If you need help inflation-proofing your investment portfolio, talk to a financial advisor.
Our Analysis
SmartAsset ran the numbers on three sample retirement portfolios. Each scenario has the same assumptions about the retirees’ saving, spending and investment habits. The one difference is this: They each experience a different rate of inflation, escalating their costs of living at different speeds.
- Retiree A experiences inflation of 2% per year.
- Retiree B sees her cost of living tick upward by 4% per year.
- Retiree C grapples with 6% annual lifestyle increases.
Typical Saving, Spending and Investing Habits for Retirees
To illustrate these retirees’ saving, spending and investment behaviors, we used data to create an average profile upon which to run the numbers.
Saving: Each retiree has $500,000 in savings for retirement. This money will supplement Social Security benefits.
Spending: In this study, each retiree spends $50,595 per year, which means they start retirement needing $4,216 per month. That figure is based on the average amount someone between the ages of 65 and 74 spends in retirement, according to a Fidelity analysis of Bureau of Labor Statistics data.
Despite some uncertainty about the future of Social Security, we assume it continues into the future for the purposes of this study. Thus, we determined that Social Security covers 39% of those expenses each year, based on a $1,657 average monthly disbursement in January 2022, according to Social Security Administration data.
Therefore, each retiree launches into retirement by withdrawing $2,559 from his or her account in the first month to cover expenses. After that, each retiree’s expenses increase by his or her personal inflation rate each year (2%, 4% or 6%), meaning that their monthly withdrawals change in size.
Investments: To run these numbers, SmartAsset assumed that the account owner doesn’t need to take required minimum distributions (RMDs) and is withdrawing only what he or she needs to live in retirement. We’re also assuming this account is something like a Roth IRA in which no taxes are due upon withdrawal.
We also considered a retiree who is invested in a diversified investment fund returning 5% per year.
Running the Numbers
Here’s how different inflation rates chipped away at each retiree’s savings portfolio.
Retiree A: This saver basked in the lowest inflation rate among her peers. Her expenses increase by 2% per year, or 0.17% per month.
That’s in line with recent long-term averages. Year-over-year inflation averaged about 2.3% a month between the beginning of 1991 and end of 2019, according to Pew Research. Inflation exceeded 5% just four times.
At this rate, Retiree A withdraws $2,559 from her account in the first month of retirement and $2,568 in her second month.
After 10 years of retirement, Retiree A’s withdrawals are up to $3,115 per month. At year 20, they begin at $3,797 per month. Her savings last her 22 years. If she retired today at age 65, her account will last until age 87 in the year 2044.
Retiree B: This retiree experiences 4% annual inflation, or 0.33% per month. While this rate is higher than Retiree A’s rate, it’s not outside of the realm of possibility. Folks who retired in the 1970s, for example, would have seen an inflation average of about 4% over a 30-year retirement.
Like Retiree A, she withdraws $2,559 in the first month. But she needs $2,568 for the second month. In year 10, her first withdrawal is $3,776. Inflation has caused her to need to withdraw $661 more than Retiree A’s withdrawal per month.
Her savings last 213 months, or until 2039 and age 83 (if she retired at 65).
Retiree C: The highest inflation rate catches up to Retiree C. That’s a high rate by historical standards in the U.S., but well below the current annual inflation rate of 8.5%.
She pays 6% more over the course of each year, or 0.49% per month. At year 10, she’s withdrawing $4,561 per month, nearly $1,500 more than Retiree A.
The long-term cost? Additional years are shaved from the lifespan of her savings account. It lasts just 182 months. That’s around 15 years, or until about 2037 when she’s 80.
How to Inflation-Proof Your Portfolio
Folks concerned about how inflation will impact their retirement savings can look toward investments that serve to protect their portfolio against inflation.
Some common financial vehicles that investors may use to protect against inflation include Treasury Inflation-Protected Securities (TIPS), commodities, real estate, short-term bonds and gold.
Additionally, a financial advisor may be able to help retirees and pre-retirees manage risk within their portfolios to maximize returns while maintaining sufficient liquidity to make monthly withdrawals.
These experts can also help savers identify which accounts are best to withdraw from first in order to prevent retirees from locking in losses or skipping out on potential investment returns, during periods of high inflation.
Bottom Line
Inflation is a beast. Even an increase in a percentage point or two over the long term degrades savings quickly. And while inflation is generally a macroeconomic trend, which is difficult to control on an individual level, working with a financial advisor may help retirees identify strategies they can employ to prepare for it.
Retirement Planning Tips
- Planning for retirement can feel like solving a complicated puzzle, but you don't have to go at it alone. A financial advisor can help you put the right pieces together by assessing your needs and connecting you with the services that are right for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Social Security plays a critical role in the retirement plans of many. By delaying Social Security beyond your full retirement age, you can increase your benefit up to 8% per year until age 70. SmartAsset's Social Security calculator can help you determine the best time to claim your benefits.
Questions about our study? Contact press@smartasset.com.
Photo credit: ©iStock.com/FatCamera