Inflation has jumped several percentage points in the last year, prompting many to wonder—and worry—about the implications this can have on their retirement savings. Rather than fret, let’s cover just how inflation will or won’t disrupt your retirement strategy, and ways you can mitigate any further harm.

The Inflation Impact

Put simply, inflation refers to a general rise in the price of many consumer goods—such as food, gas, clothing, and so on. These price increases translate into less purchasing power for the consumer—your dollar goes less far for the same item than it did prior. Deflation, of course, is the opposite occurrence, with prevailing prices for goods declining.

One way to measure the impact of inflation is to understand Consumer Price Index (CPI) which The U.S Bureau of Labor Statistics defines as a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The Consumer Price Index for All Urban Consumers (CPI-U) charted inflation of 9.1% for a 12-month period ending in June 2022, which marks the largest increase in a period of this length since November 1981.

In other words, the cup of coffee you bought 12 months ago could be 9% more expensive now.

How Inflation Affects Retirees

Because retirees often live on a fixed income, inflation can be a significant burden, causing the prices for everyday goods to rise and reducing how far this fixed income goes. Retirees might see their purchasing power drastically reduced, being forced to live more leanly during these periods.

Understanding how the various income sources retirees depend on is important to comprehending how inflation will impact these income sources.

Social Security

Most retirees depend on their government-issued Social Security checks as a main source of retirement income. Each year, Social Security benefits are evaluated against price indexes; these price indexes exist to calculate the overall cost of living, though they are widely considered to be conservative in their calculations. The Senior Citizens League released a study in 2021 suggesting that seniors have lost 30% of their buying power since 2000. Some years, the cost-of-living adjustment has been so negligible that it has hardly made a difference; for example, in 2016 it was only .3%. Retirement advisors suggest waiting until you reach full retirement age to cash in on social security so you receive 100% of the benefit owed to you.

Pensions

More than 50% of retirees collect money from a pension. Because pensions are often tied to the last few years of a worker’s salary, inflation can negatively affect the pension amount if inflation happens during those last few years of work or after, as the pension will be based on pre-inflation calculations.

Some government pensions do adjust for inflation, but most private pensions do not. If you have the option to choose the best pension payout for your circumstances, check to see if there’s an option for indexed payouts, which adjust for inflation.

401(k) Plans

Your 401(k) could be affected, depending on what types of assets you have. Inflation can drive companies’ revenue up, but it also drives up the cost of manufacturing and products. If the government raises interest rates, bond prices drop, and commodity prices may rise in tandem. Your rate of return on your 401(k) should be higher than the rate of inflation for you to keep seeing positive returns; the best way to ensure this is to keep investments that rise with higher commodity prices.

Passive Income (E.g. Rental Income, Interest, or Dividends)

Passive income such as rental income, dividends, and interest generally follow inflation’s movement.

Rental income typically remains steady during higher periods of inflation, and interest rates are dictated by the government, which usually raises the rates to try and slow inflation. Dividends are a little more tricky: with high inflation, the Federal Reserve might raise the federal reserve rate. This makes it more difficult to obtain credit, in an attempt to slow down the economy until inflation cools off. If the economy feels slow, companies are at risk of generating less revenue, and thus less income for dividend pay-outs.

Wages or Self-Employment Income

Some retirees choose to pick up a side job after formally retiring to generate some extra spending money. Generally speaking, there is no requirement that wages adjust for cost of living increases; aside from minimum wage requirements, companies have free will to set salaries as they see fit. Government entities are the lone exception, as they have regulations set up to evaluate payroll.

Cash Savings

It's not a bad idea to keep a cash nest egg for emergency purposes, but for retirement—and how it responds to inflation—cash is a non-yield-producing asset. Every cash dollar you have today will invariably be worth much less in 10 or 20 years—just think about what $10 could buy you in 1990 compared to now.

How to Mitigate Inflation’s Effects On Your Retirement

The inflation rate is out of your control, but there are some steps you can take to curb any impact it will have on your nest egg and retirement plans.

Diversify Your Income

Consider ways to generate income from sources that make cost of living adjustments, and make sure there are multiple income sources for retirement funds. Choose fewer fixed-income sources.

Calculate Your Retirement Needs

Talk to a fiduciary advisor and discuss your retirement needs, so you can factor in inflation and ensure you’re saving enough to cover your lifestyle.

Lower Housing Costs

With inflation on the rise, it might be time to downsize and move into a smaller home, saving you money on property taxes, utilities, and more. You might also consider moving to a more retiree-friendly city.

Review Spending Patterns

Spend a weekend day reviewing all your spending from the last six months across your bank accounts and credit cards. Where can you cut back? What patterns do you see in terms of costs rising from inflation? Any surplus funds going forward can be put into your savings or to pay off debt.

Don’t Panic

It’s difficult to remain calm, cool, and collected knowing that inflation could have a major impact on your savings strategy, but do your best. Under pressure or stress, you might feel the urge to make rash or risky financial decisions, but slow, steady, and diversified is the way to go.

Frequently Asked Questions

Does Social Security Increase With Inflation?

Social Security does an annual cost-of-living adjustment (COLA), but generally speaking, it doesn’t always meet the needs of retirees. For instance, the 5.9% COLA increase that went into effect in January of 2022 won’t do much, as Medicare Part B premiums also jumped.

Will Inflation Hurt My 401(k) Investments?

Almost certainly, but it depends on which investments you have. Bonds will take a dip, but they’re still an important buttress when stocks are fluctuating in a shakier market; short-term bonds are considered more resilient to inflation than long-term bonds. Some commodities rise during inflation, which can positively affect your stocks—energy is one sector that tends to do well in inflationary periods. The key, of course, is to keep a diverse portfolio with the advice of a retirement planner.

Should I Save My Money During Inflation?

It’s always a good idea to evaluate your spending and savings, but especially so during inflation, when the costs of common goods are on the rise. Are you subscribed to magazines and newspapers you no longer read? What about streaming services you don’t watch? By cutting back in small ways, you may find that you have more cash leftover at the end of the month to put into your retirement savings or to pay off debt.

If you have any further questions, schedule a call with a Retirable Advisor today. We're here to help answer your toughest inflation questions and set you on a path to a fulfilling retirement.

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