Could Inflation Affect Your Retirement Plans?

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. For some retirees, this means 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.

On average, the U.S. experiences an inflation rate of roughly three percent. This percentage and the percentage expressed by the CPI are helpful for understanding inflation across multiple markets. Keep in mind, these values should be understood as a general approach. The real impact of inflation will depend on the individual.

For example, we might assume that a retiree may 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.  For example, if you travel more during retirement, inflation would affect you differently than if you were more apt to stay home. Higher inflation may cause you to shorten trips or take less trips or keep them domestic versus international travel.

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 aged 62 and above.

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 adjust accordingly.

Managing the Effects of Inflation

With the above in mind, here are some ways to help offset inflation during retirement.

Social Security

The Social Security Administration provides the Cost-of-Living-Adjustment (COLA) to offset some of the effects of inflation by raising Social Security benefits. 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.

Investments that Adjust with Inflation

Certain investments can adjust with inflation.  One example is Treasury Inflation Protected Securities, or TIPS for short.  These are marketable Treasury securities that have their principal and interest payments adjusted for inflation.  Investments in equities, such as stocks, typically outpace inflation, with the annual inflation-adjusted return of the S&P 500 being 6.4%. That increased return does, however, come at the cost of higher volatility. Dividend-paying stocks offer a solution here, with growth outpacing treasury bonds, volatility lower than non-dividend-paying stocks, and the ability to generate income without selling the assets. 

However, any investment comes with risk, something that should always be considered during retirement. Be sure to consult with your HCM Advisor before making any investment decisions.

A Change in Lifestyle

Consider your retirement goals and overall lifestyle. Is there something you can trim back 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? Some potential cost-cutting options include cooking more meals at home, cancelling unused subscriptions, and reducing housing costs. 

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.