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Managing Inflation in Retirement

Inflation can significantly impact your retirement income. Learn why this is and what you can do about it in this article.

Inflation impacts every part of our lives, from grocery bills to filling up at the gas pump. However, it’s also a key factor that those planning for retirement or current retirees need to watch out for. Even if you’ve saved up a ton by the time you stop working, rising costs can drastically impact your purchasing power and, as a result, your financial well-being.

Because inflation is such a big obstacle to one’s retirement, it’s important that you know how it works. You’ll also want to know how you can protect your hard-earned money from it. This article will help you gain a basic understanding of the concept, as well as offer common solutions. We’ll also explain why a financial advisor can be invaluable in this situation.

Understanding Inflation

Inflation is a consistent rise in the price of goods and services over time. Because of this, consumers aren’t able to buy as much with the same amount of money. This phenomenon is often referred to as a loss of purchasing power.

Rising costs are often caused because of supply and demand issues throughout the market. When the demand for a given service or good rises above the supply, the price goes up. Global events that disrupt supply can be a common cause, as does a general increase in consumer spending over time.

In the U.S., inflation is tracked by using the Bureau of Labor Statistics’ (BLS’s) Consumer Price Index (CPI). It presents price increases as a single percentage that can fluctuate throughout the year. In September 2023, this number sat at about 3.7%. However, back in June 2022, the CPI percentage rose to 9.1%.

How Inflation Affects Retirement

When you retire, it’s likely you’ll rely on a combination of fixed-income sources and investments to sustain your lifestyle. However, rising costs of goods and services can severely impact your financial stability once you stop working. Tyler Meyer, CFP and RICP, likens inflation to a “slow leak in your boat,” which can seriously impact your purchasing power over time.

Because of inflation, “your fixed income may not stretch as far as it used to,” explains Meyer. This makes it more difficult to sustain your preferred lifestyle once you retire. This can apply to any fixed-income security, such as bonds, CDs, and “even some pension plans.” Per Meyer, “Their value likely won’t keep up with rising costs, and suddenly, your budget doesn’t cover as much as it used to.”

Dominic Murray, a financial advisor at Cameron James, explains that pensions for public sector employees “usually adjust with the full CPI percentage, offering some inflation protection.” However, while this is true, private sector employees may not have the same safeguard from price increases. So, if you’re an employee with a pension plan, be sure you know if it’s protected from rising costs. Otherwise, you may have to account for it in your retirement plan.

Income from securities like stocks and mutual funds can also take a hit because of rising costs. For instance, if your return on investment (ROI) for a stock is 6%, but the CPI rate is 4%, your inflation-adjusted return is 2%. This means that, during times of high inflation, your returns can be significantly cut down if you decide to sell.

You should also keep in mind that health insurance can be drastically affected by inflation. It can result in higher rates due to increased spending by insurers per claim. This is also something you should account for during your retirement planning process.

Ways to Curb Inflation’s Impact

While inflation can be a thorn in a retiree’s side, there are several ways to mitigate the impact on your bottom line. Primarily, this involves adjusting your investment strategy to account for rising costs over time. It’s also important to ensure you have several diverse streams of income once you retire.

Here are the most common ways you can lessen the effects of inflation:

Plan for Rising Costs Ahead of Time

It’s crucial to start accounting for inflation as soon as you can. As you begin planning for retirement, you’ll want to think about what you can do now to mitigate the impact later. This may involve saving extra, as well as investing in assets like real estate or mutual funds, which are generally safer from rising costs than fixed-income securities.

You should also consider that key expenses that you may fit into your retirement, like travel, medical expenses, and even food, can and likely will cost more because of inflation. For this reason, you may want to allocate more for these than you originally planned.

Purchase Treasury Inflation-Protected Securities (TIPS)

TIPS are a smart way to protect yourself against inflation, while also ensuring portfolio growth over time. These are U.S. Treasury Bonds that adjust their principal value based on CPI percentage fluctuations. Typically, these can be set for a term of 5, 10, or 30 years. You can buy these through TreasuryDirect, the U.S. Treasury’s marketplace.

Diversify Your Investments and Income

How you invest plays a crucial role in defending against inflation after you retire. Meyer recommends you stick to securities like “real estate or stocks, which historically have shown great resistance to inflation.” In particular, real estate can be a great hedge against rising costs, because “property value and rents” typically increase along with them, explains Murray.

Also keep in mind that, even though fixed-income sources will see some hit from inflation, you should still include them in your plan as well. A well-rounded retirement strategy includes several income streams to help supplement your lifestyle. Other securities, like the ones mentioned above, help to offset the impact of rising costs.

Annuities are another option you can take advantage of to diversify your income. These are where you pay an insurer ahead of time, so that you may receive a series of payments later. Some are inflation-adjusted, which can lessen its blow on your retirement income.

Maximizing Social Security

Your social security benefits will likely be one of your primary income sources upon retirement. Each year, the Social Security Administration (SSA) makes a cost-of-living adjustment (COLA) based on the CPI. As of October 2023, the SSA increased everyone’s benefits by 3.2%.

Although social security is adjusted for inflation, you should make every effort to maximize payments. This usually means delaying receiving benefits until you reach full retirement age (FRA). You may also want to claim spousal benefits, which refers to electing to receive the higher between 50% of your spouse’s payments or your own.

How a Financial Advisor Can Help

Retirement planning has many angles to it, such as the impact of inflation, which can make it tough for the average person to navigate. For this reason, having a financial advisor on your side can take a great weight off of your shoulders. Hiring the right professional can help you significantly mitigate the impact of increasing costs on your post-career income.

Tyler Meyer, an experienced finance expert, says that “an advisor’s first role is to create an investment strategy that has a baked-in plan to help hedge against long-term inflation.” He adds that they also need to “help account for a withdrawal strategy.” This includes ones like the “4% rule or the Guyton-Klinger (Guardrails) method.” Ultimately, a professional is able to leverage their expertise to help you keep more of what you’ve saved and invested for retirement.

As you search for a financial advisor to help with your retirement strategy, you should aim to seek out a financial planner. In particular, look for those with prestigious designations like Certified Financial Planner (CFP) and Chartered Financial Consultant (ChFC). Experts with these must adhere to a fiduciary duty and have years of experience. If you need help finding one near you, we recommend using a free matching tool, which will present you with up to three vetted local options.

Frequently Asked Questions

Are retired people going back to work because of inflation?

About 45% of retirees who return to work cite inflation as a key reason. Situations vary from person to person, but it’s possible that many who feel the need to go back to work either lack a retirement plan that accounts for it or have insufficient diversification of investments and income sources.

Be aware that if you do decide to return to work, it can impact your social security benefits. With more income from a job, your government payments may be subject to federal income taxes.

What is the 4% rule for retirement?

This is a withdrawal strategy for retirees that suggests that one should only take out 4% of their savings each year. Its purpose is to prevent you from running out of money throughout your retirement. To prevent a loss in purchasing power, you would manually adjust the amount you withdraw each year according to inflation.

Is social security inflation-adjusted?

Yes, your social security benefits are adjusted each year for inflation. This is because, each year, the SSA makes a cost-of-living adjustment (COLA) which takes changes to the CPI into account.