What Does Inflation Do to Your Retirement Plans?

Resulting from fluctuations in supply and demand, increased production costs, an increased money supply, policy changes and other factors, inflation can particularly hurt Americans who are retirees. Since inflation involves prices for everyday purchases rising, it can make your retirement income run out faster, unless you plan ahead with an effective investment strategy. Before retirement, inflation can hurt your ability to regularly contribute enough and get a suitable return. Therefore, considering how inflation affects your retirement planning is crucial.

The Federal Reserve works toward a low typical inflation rate of ​2 percent​; however, it can run much higher, especially in times of crisis. You can look at the Consumer Price Index (CPI) on the U.S. Bureau of Labor Statistics website to understand current inflation rates. For example, the rate was ​7.9 percent​ in February 2022 due to the ongoing economic effects of the pandemic.

Inflation hurts your purchasing power since you’re able to buy less with the same amount of money as prices rise. Therefore, your cost of living goes up, and the financial strain causes challenges both now and far into the future. Considering that inflation is ongoing, you’ll find you need to save up a significantly higher amount of money to have the same purchasing power years away in retirement as you do now.

To see how years of inflation affect your retirement savings needs, consider you’re a 30-year-old professional who earns $60,000 a year, plans to retire at 65 and expects to live until age 85. You decide you need to replace 75 percent of your current income annually. Even with a low 2 percent estimated inflation rate, you’d need almost $90,000 to just replace your income in the first year of retirement; this rises to almost $134,000 for the year you reach 85.

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While your retirement savings goal depends on numerous factors, experts generally recommend stashing away at least 15 percent of your yearly earnings for this purpose. However, unless your employer provides sufficient cost-of-living adjustments to your income, you can have a harder time contributing this amount in times of higher inflation rates.

Since inflation involves prices for everyday purchases rising, it can make your retirement income run out faster unless you plan ahead with an effective investment strategy.

When you’re on a fixed income and experiencing rising costs for essentials such as housing, utilities, health care and food, you can have less money in your budget each month for savings. This means you can easily fall behind on your retirement savings goals and face the prospect of running out of money sooner when you do retire. You might also struggle later to try to make up for the shortage.

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Inflation affects the performance of your retirement investments since certain investments may not earn enough to keep up. This relates to the fact that high inflation rates usually occur alongside low interest rates – this is good for borrowers but bad for investors. When your nest egg doesn’t grow fast enough, this can result in insufficient cash to maintain your desired standard of living in retirement, even if you did keep up making regular contributions.

Generally, the less risky the investment, the lower the potential return and stronger the effects of inflation. For example, many bonds have low fixed rates that eventually lead to less purchasing power. However, there are some bond options such as Treasury Inflation-Protected Securities (TIPS) that offer some inflation protection through adjusting interest rates. On the other hand, savings accounts and certificates of deposits usually offer the lowest interest rates that don’t keep up even with mild inflation.

Going with riskier investments, however, can boost the chance of earning enough to beat inflation. For example, investing in large-cap stocks can yield a good rate of return in the long run despite the ups and downs of the stock market. Investing in real estate and other real assets that appreciate is another option to beat inflation. However, you’ll need to consider there’s no guarantee of sufficient earnings on these investments and that you can lose a lot of money as well.

When you do retire, you may be among the many Americans who rely heavily on Social Security benefits alongside their retirement savings. Your earnings during your working years will determine the monthly benefit amount, but this usually only replaces around 37 percent of your pre-retirement income. While you can expect regular cost-of-living adjustments from the Social Security Administration as inflation rises, these increases might not match or beat a high rate of inflation.

As a result, you’ll likely rely more on your retirement account and other investments like an annuity. Since inflation decreases how long your nest egg will ultimately last, handling rising prices on a fixed income can mean getting creative to find ways to cut costs so you can stretch out your savings. In addition, you’ll need to consider your portfolio’s performance since ups and downs in the market can also result in lost savings alongside lost purchasing power from inflation.

If you don’t end up saving enough for retirement to cover your expected costs in light of inflation, you might end up needing to wait a few years and change any plans for an early retirement. That way, you can continue to earn and contribute toward your eventual retirement.

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While inflation is inevitable and will affect your retirement plans in some way, you can help mitigate its harm to your retirement savings. This will involve taking action both while you’re still saving as well as when you start living off your retirement income. You can consider the following personal finance strategies:

• ​Know your savings goal​: To be successful in investing for retirement, you’ll need to know how much income you’ll need annually during retirement in light of ongoing inflation. You can find online calculators that take into account your age, intended lifestyle, savings strategies and types of post-retirement income alongside inflation. However, it’s worth speaking with a financial adviser to get personal advice. In any case, you can give yourself an advantage by saving more than you plan to need.
  
• ​Time your Social Security benefits wisely​: Although you might opt to start getting your monthly benefits when you’re 62, the SSA will offer you a higher monthly benefit the longer you wait to start your claim, up to age 70. This extra money can help you deal with rising prices, but there is the tradeoff that comes with working longer.
• ​Plan for reducing expenses​: Long before retirement, strategize on how to pay off major debts like a mortgage so your living expenses are lower in your older years. In addition, consider that health care costs like Medicare premiums and long-term care can eat up a lot of your retirement income, and inflation increases the effects. You might opt for a health savings account as a tax-advantaged way to prepare for such expenses.
• ​Allocate your portfolio strategically​: Considering risk and return in light of inflation, you’ll want to rebalance your portfolio at different stages of life to account for changes in your risk tolerance and savings needs. The brokerage Charles Schwab advises a portfolio mostly made of stocks for younger investors. That’s because this can yield a better long-term return that benefits you in times of inflation, and your investment horizon is longer the younger you are. Closer to retirement, you can rebalance to mostly bonds and cash investments.
• ​Consider still working​: There’s also the option to take on a part-time job in retirement or even start a side business to have an extra income stream in times of high inflation.

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