Retirees are often aware of the detrimental effects of inflation on their retirement savings. As the cost of goods rises, the value and buying power of many retirement accounts diminish. And for some retirees, maintaining their savings and lifestyle becomes a challenge. Luckily, there are different methods retirees can use to adjust for inflation and help protect the value of their retirement. Below are some of the ways inflation affects retirement and how you can prepare.
How Is Yearly Inflation Calculated?
Inflation is calculated using the Consumer Price Index (CPI) which calculates inflation across major categories before determining a yearly inflation rate expressed as a percentage.1 On average, the U.S. experiences an inflation rate of roughly three percent.2 However, U.S. inflation came in at 7% in December on an annual basis, according to new figures published on Wednesday Jan 13, 2021, its highest print since 1982. Meanwhile, consumer price rises in the U.K., Europe and elsewhere also hit multi-decade highs in recent months, prompting most central banks to begin guiding the market towards a tightening of monetary policy, with the exception of the European Central Bank.This percentage and the percentage expressed by the CPI are helpful for understanding inflation across multiple markets. But these values should also be understood as a general approach, meaning the real impact of inflation will depend on the individual. For example, we might assume that a retiree might need to withdraw an additional three percent from their savings each year in order to adjust for inflation. But this isn’t the whole picture. Instead, this retiree should consider the specific ways that inflation affects them.
Considering Individual Costs
Inflation affects each of us differently. For example, the rising cost of gasoline would affect someone that drives long distances more than someone without a vehicle. Retirement acts in a similar fashion, as it creates a lifestyle change that causes inflation to affect retirees differently. One of the better ways to measure this difference is through the Consumer Price Index for the Elderly (CPI-E), which shows inflation rates for households with individuals age 62 and above.3 However, this is still a generalization, though of a specific population. The best way to determine the cost of inflation is to examine your personal lifestyle and make adjustments.
Managing the Effects of Inflation
With the above in mind, here are some ways to help offset inflation during retirement.
The Social Security Administration provides the Cost-of-Living-Adjustment (COLA) to offset some of the effects of inflation by raising Social Security benefits.4 This can be an important source of income during retirement. However, the COLA is also based on the CPI-W, meaning some individuals may not be able to rely on adjustments from Social Security to make up for all cost increases.4
Investments that Adjust with Inflation
Certain investments can adjust with inflation. However, any investment comes with risk, something that should always be considered during retirement.
When investing, consider the Rule of 72.
The Rule of 72: Years to Double Your Money = 72/Interest Rate
If your cash at the bank is getting you .01%, it will take approximately 7200 years to double your money. If inflation is 7%, it will take 10.2 years for your expenses to double. If your investments are also making 7%, that money would double in the same amount of time. How are you BALANCING saving for emergencies and investing to be able to compete with the rising cost of goods and services over time? This is truly where a financial planner can help.
A Change in Lifestyle
Consider your retirement goals and overall lifestyle. Is there something you can trim back on to save on the cost of inflation? Are you holding TOO much in emergency cash at this time? What can be adjusted to help you achieve your financial goals while maintaining your emergency savings? This is by no means a comprehensive list of ways to protect your retirement savings against inflation. Rather, it is intended to demonstrate some of the options available to you. Here are some free calculators available as a resource for you. In addition, you should consult with your financial planner to acquire a better understanding of how inflation will impact you personally, and what you can do to help protect your retirement savings.
This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.