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How Inflation Affects Your Retirement Plan and Savings


Since the mid-1990s, inflation has stayed very close to the Federal Reserve’s benchmark of 2% per year, often dipping much lower than that. The upshot has been a long run in which prices have changed little from year to year, with the noticeable exception of an 8% overall jump in 2022. Fortunately, current inflation has largely stabilized and, while still high compared with recent years and the Federal Reserve’s target rate, is back within overall historic norms. All told this has created an environment in which consumers don’t usually think about changing prices all that often.

For retirees, on the other hand, the picture is very different. They have to think in terms of years and decades. For them, inflation is a very powerful force. As prices rise decade over decade it can meaningfully eat away at your retirement savings unless you have prepared in advance. A financial advisor can help you better protect your retirement savings from the effects of inflation and plan for the future.

What Is Inflation?

Inflation measures changing prices in the marketplace. Specifically, it measures how prices increase for the same goods and services over time. For example, when the price of milk increases from $2.85 per gallon to $4.04 per gallon, that’s inflation. The opposite effect, when prices fall, is known as deflation and it is counterintuitively a borderline disaster for most households and consumers.

There are as many ways to measure inflation as there are economists, but the standard measure is known as the Consumer Price Index or CPI. It measures how prices change on an annual basis for a representative group of goods and services across the United States, omitting energy prices and agricultural products. These last two, while essential to household spending, are left out of the inflation statistics because they’re extremely vulnerable to geopolitical and natural events, respectively.

Economists consider a little bit of inflation beneficial. It shows that the economy is producing at capacity, which encourages growth. This is why the Federal Reserve has its inflation benchmark set at 2%, not zero.

For most households, inflation is reflected in both costs and incomes. As prices rise, employers typically increase pay scales to compensate. This is why economists treat inflation as such an emergency because it can create a feedback loop of rising incomes and prices with no natural stopping point. This also makes inflation, under ordinary circumstances, a minor issue. Most households don’t notice small price adjustments over short time frames and pay increases help them keep up over the long run.

Costs of Living in Retirement

In retirement, your basic math is simple: money in vs. money out. If your retirement accounts can generate more money than you spend, you can afford to retire.

The problem with inflation is that it gradually changes the math in this formula. Each year, your “money out” gets a little bit more expensive. Up front, it’s hard to notice. If a gallon of milk goes up by $0.02, that doesn’t stand out. But in the aggregate, these changes add up. For example, say that your costs come to $5,000 in spending per month. With 2% inflation, the next year you would spend $5,100 per month. The year after that, $5,202. The year after that, $5,306.

Even with just a 2% annual price increase, within just three years of retirement, you’re spending $300 more per month than you initially budgeted. And since retirement lasts for decades, inflation has plenty of time to set in.

Some Areas Are Particularly Vulnerable

One of the biggest things to remember about inflation is that it often hits some areas harder than others. For example, a disproportionate and large amount of 2022’s high inflation came courtesy of astronomical prices in the used and rental car markets. For retirees, this can be a double-edged sword depending on how you have structured your finances. You might be safe from some of the worst sectors or you might be particularly exposed.

A few costs of living that are particularly vulnerable to inflation and price swings are:

  • Housing: In recent decades the cost of housing has risen sharply. If you own a home, whether it’s paid off or on a fixed mortgage, you’re safe from these rising costs. If you rent, particularly in a big city, this will be a huge cost sector as prices go up year-over-year.
  • Energy and food: These two sectors are omitted from the core inflation measure because they’re extremely volatile. However, that volatility tends to make them particularly sensitive to inflation across the marketplace at large. That’s a particularly big problem because, ultimately, utilities and groceries make up the bulk of most households’ bottom line and just because they’re not in the BLS’ official report doesn’t mean you won’t feel the squeeze.
  • Imports: Historically, imported goods tend to experience inflation earlier and sooner than most other products in the marketplace. If you buy or rely on products brought in from overseas, this will show up in your budget.
  • Travel: If you want to travel in your retirement, inflation can make that more expensive. Airfare often jumps during periods of inflation and if you are leaving the country a weaker dollar will make your trip that much more expensive.

Savings and Social Security

how does inflation affect retirement

Most retirees rely on three sources of income for the “money in” side of their retirement: savings, investments and Social Security. Let’s take a look at each.

  • Savings: Savings generally refers to the money you have in cash or cash-like assets. Basically, this refers to the money you have in banking products like checking, savings and certificates of deposit. The appeal of keeping money in savings is a certainty. Just putting everything into a savings account is about the lowest-risk option short of buying Treasury bonds. However, it also exposes your money to near-constant erosion. This feels like the safe option, but keeping all your money in the bank is a good way to effectively lost it little by little rather than all at once.
  • Low-Risk Investments: Low-risk investments tend to include assets like bonds and annuities. These are the middle ground between growth and safety. You want some growth but are willing to sacrifice potential gains for the confidence that you’ll get your money back. These are a mixed bag when it comes to long-term inflation management. The biggest problem is that low-risk investments often define their gains up-front.
  • Higher-Reward Investments: The most common footprint for a high-reward investment in stocks is either buying shares of an individual company or buying into industry or index funds. These are the growth end of the risk-reward balance. You will get the strongest returns but with the most risk. High-reward investments are the best way to manage inflation in the long run, since strong returns are the best way to keep your investments current with rising prices.
  • Social Security: Finally, most retiree households depend on Social Security to one degree or another. When it comes to inflation, this is the good news. Each year the Social Security Administration issues its annual COLA or “Cost of Living Adjustment.” This increases the monthly benefits issued to all recipients based on the government’s benchmark inflation rate. The COLA is based on national inflation figures. When prices go up, they tend to increase more in some areas than in others.

How To Address Inflation

So this is what inflation does. It tends to erode the value of low-growth assets and income as prices increase faster than the value of investments. Here are two things you can do to address inflation.

1. Manage Investments

The best way to address inflation in your retirement is to plan for it upfront. Specifically, build your retirement portfolio with inflation in mind. This can mean a few different things, such as investing in:

All of these assets tend to be sensitive to inflation. Stocks and REITs tend to grow with the value of the market, as companies increase their prices to keep pace with inflation. Short-term bonds, meanwhile, mature every few years, allowing you to reinvest in new assets that may better reflect current pricing. And some annuities offer an inflation-adjusted payment schedule, allowing you to plan for long-term growth in your returns.

2. Manage Costs

The biggest issue here is housing. The cost of housing has soared in recent decades and that fever shows no serious signs of breaking. This is most prominent in the rental market. Buying a home before you enter retirement, even if that means downsizing from your apartment, can help you secure your housing costs going forward.

If you own a paid-off home, you won’t have to plan for housing payments. If you start a mortgage prior to retirement, you will at least have fixed rather than escalating costs. Beyond that, prepare a good cash reserve for the wide fluctuations common to the energy and food sectors. These two areas are most prone to volatile price swings, both up and down, during periods of inflation.

The Bottom Line

how does inflation affect retirement

Inflation can significantly eat away at your retirement savings. It’s important to build a retirement plan that anticipates enough growth to offset this, otherwise, you can see your quality of life decline as your bills get more expensive year after year. It’s important to take the necessary steps to protect your retirement savings.

Inflation Management Tips

  • The other best way to make plans is with good, solid help. A financial advisor can help you determine how inflation will impact your ability to save what you will need for retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • The best way to make plans is with hard, solid numbers. Run your retirement plans through our inflation calculator to get a sense of whether you’re on the right track.

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