Don’t Let Inflation Affect Your Retirement
Posted by: Joseph Kuo | July 16, 2021
As the cost of goods and services rises, the value and buying power of many retirement accounts diminish. If your retirement plan is highly dependent on a specific target rate of return, maintaining your desired savings and lifestyle in retirement becomes a challenge.
Luckily, there are different methods retirees can use to adjust for inflation and help protect the value of their retirement. Here 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 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 it’s actually not that simple. To properly account for inflation, retirement plans should consider the specific ways that inflation affects them.
Considering Individual Costs
Inflation affects each of us differently. For example, if you’re planning to do a great deal of retirement travel, the rising cost of gasoline would affect someone who travels across states more than someone who travels locally or stays at home.
Inflation also can vary depending on location. If you’re planning to relocate to a distant area, it’ll be important to research the price trends in that area versus the national average.
Retirement acts in a similar fashion, as it creates a lifestyle change that causes inflation to affect retirees differently. One of the quicker 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 You can use the CPI-E as a starting point to get a rough estimate of anticipated costs during your retirement.
However, the CPI-E is still just a generalization. The best way to determine the cost of inflation is to examine your personal lifestyle and make adjustments.
Adapting Your Retirement Plan to Manage 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.
Be sure to consult with your financial advisor before making any investment decisions.
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? This does not mean you need to give up on retirement goals. Rather, what can be adjusted to help you achieve them while maintaining your savings?
Continue to Let Your Money Work For You
Even as you’re making withdrawals during retirement, it’s important to keep your money invested, but in relatively safer investments. This will help mitigate inflation and will greatly help to slow the depletion rate of your retirement accounts.
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. Consult with your financial advisor to acquire a better understanding of how inflation will affect you, and what you can do to help protect your retirement savings.