How Inflation Impacts Your Retirement Plan

School of Financial Wellness

A twenty-dollar bill has the number 20 scratched out in red and replaced with a 19 to indicate the loss of purchasing power associated with inflation.

It’s no secret that effective planning for retirement requires some in-depth financial knowledge that most people don’t acquire through normal life. In particular, it can be a daunting task to project the amount of income you will need for retirement – especially without the help of an experienced financial advisor. To complicate matters further, inflation is constantly changing the value of the dollar, and in turn, impacting the amount of spending power your savings will have in retirement.

Inflation’s Impact on Retirees and Fixed Incomes

It is common knowledge that prices tend to increase over time for most goods and services, and that is the basic principle of inflation. While uncomfortable to experience, inflation in moderation is seen as a positive for an economy, because it shows that consumers have more money to spend and are willing to pay more for goods and services.

Due to its positive effects on the economy, the Federal Reserve [Fed] attempts to maintain 2% annual inflation over the long term. They work to meet this goal by adjusting monetary policy, which includes things like changing the Fed Funds target rate and buying or selling securities to impact rates in other debt markets.

For retirees and others on a fixed income, excessive inflation can be a challenge to overcome. This is especially true because prices for essential services that retirees need most, like housing and medical care, have exceeded general inflation in recent years and are often excluded from measures that leaders use to monitor prices and adjust cost of living calculations. For example, Barron’s reported that in the period from January 2000 to January 2020 prices for housing and medical care increased by 156% and 194%, respectively. Compare that to all items which increased by 144% and you begin to understand the complications for retirees.

In addition to outpacing inflation, housing and medical care costs take up more of the budget of retirees than they do for the average citizen, so inflation in these areas hits them even harder. According to the same Barron’s data cited above, people over 62 spend 38.6% more on medical care than the overall population and 9.9% more on housing. These two particular areas have an especially large impact on retirement planning because they are essential – people must have both medical care and housing to survive comfortably.

Social Security Assistance in Retirement

Many Americans rely on Social Security for a portion of their retirement income. As such, approximately 40% of retiree’s income during retirement is provided by Social Security. That’s why Social Security benefits are reviewed annually and can be increased for inflation and a variation of the Consumer Price Index [CPI] is used to make the determination.

These increases in Social Security payments are called Cost of Living Adjustments [COLA], and the most recent increase was a 1.3% COLA for 2021. COLAs are based on a formula which tracks increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), and this method has some glaring flaws. The most important being that basing increases in Social Security payments on the prices noted by workers doesn’t align perfectly with population as most of those who are receiving Social Security payments are not currently working. This discrepancy has led to retirees seeing their expenses rise more quickly than the increases in their Social Security payments.

Combatting Inflation in Your Retirement Plan

There are some easy ways to combat inflation in your retirement plan and make your retirement savings last longer. While there are trade offs to these strategies, implementing them can help you stretch your nest egg.

Take Social Security at the Optimal Time

One strategy for increasing monthly income later in retirement is to delay taking Social Security benefits until your full retirement age or later. Beginning Social Security payments before your full retirement age results in a reduction in your monthly benefits for life.

On the other hand, delaying your Social Security payments past your full retirement age, up to age 70, boosts your monthly benefits for life. Choosing when to begin Social Security payments is unique to your situation and should be carefully considered with your financial planner.

Properly Manage Your Retirement Accounts

In addition to Social Security, many people rely on some type of savings, usually in some type of retirement account, to provide income during retirement. These retirement accounts have vastly different rules, taxation and penalties for withdrawals, so there are many opportunities to optimize these accounts, so they provide more benefits in the future.

To combat inflation, investors can choose an effective mix of stocks, bonds or mutual funds whose long-run returns have historically outpaced inflation. Especially in the early years of retirement planning, investors can take more risk and hope to earn a larger return that can compound throughout the rest of their working years. But, be careful, because it’s critically important for retirees to know when to shift their retirement strategy from offense to defense. That’s because taking too much risk as you near retirement can be disastrous if the markets collapse as they did in 2009 – or even worse in 1929.

Plan for Inflation and Secure Your Retirement™ with Financial Fingerprint™

Striking the balance between planning for long-term growth that will outpace inflation and keeping enough liquid assets to cover day to day expenses in retirement is a major challenge that retirees and financial advisors continually face.

This has led our company, Meld Financial, to develop a metric that pinpoints the return you need to achieve on your retirement savings to meet your goals – and we call it your Required Rate of Return™ [RRoR™]. Your RRoR™ is a key component in our proprietary system, developed during more than 30 years of managing our clients’ wealth, called your Financial Fingerprint™. Your Financial Fingerprint™ is a comprehensive wealth management plan that is quick to assemble, easy to understand, and simple to modify as your circumstances change.

At Meld Financial, our team of financial, legal and tax professionals will help you develop a retirement strategy that takes inflation into account, minimizes tax burden and aims to meet your goals. In about an hour, we can determine your Required Rate of Return™ [RRoR™] by building your FINANCIAL FINGERPRINT™ and give you confidence that you are on track for a happy retirement. It’s never too late to start planning for retirement, so contact a member of the Meld Financial team today to get started on your Financial Fingerprint™.

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Why Meld Financial?

Meld Financial, Inc. is an independent wealth management firm located in Birmingham, AL.

We specialize in financial planning, investment management, employee benefits and executive benefits for individuals, families, trusts, foundations and institutions.

We provide independent and objective services melded with customer-driven financial goals.

Mark McGarvey - Founder - Meld Financial

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-Mark McGarvey, Founder