How Does Inflation Affect Retirement?

By Paulina Likos · March 03, 2022 · 7 minute read

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How Does Inflation Affect Retirement?

For retirees on a fixed income, inflation can have a significant influence on their ability to maintain their budget. That’s because as inflation rises over time, that fixed income will lose value.

That could mean that retirees need to scale back their spending or even make drastic changes to ensure that they don’t run out of money. Inflation spiked 7.5% in January 2022, the highest annual increase in 40 years.

Two-thirds of older Americans are worried that inflation will negatively impact their inflation, according to a survey by American Advisors Group . However, by planning ahead, it is possible to minimize some of the impact of inflation on your nest egg.

What Is Inflation?

Inflation is the rate at which prices of goods and services increase in an economy over a period of time. This can include daily costs of living including, such as gas for your car, groceries, home expenses, medical care and transportation. Inflation may occur in specific segments of the economy or across all segments at once.

There are multiple causes for inflation but economists typically recognize that inflation occurs when demand for goods and services exceeds supply. In an expanding economy where more consumers are spending more money, there tends to be higher demand for products or services which can exceed its supply, putting upward pressure on prices.

When inflation increases, the purchasing power of money, or its value, decreases. This means as the price of things in the economy goes up, the number of units of goods or services consumers can buy goes down.

When purchasing power declines, the value of your savings and investments goes down. While the dollar amount does not change, the amount of goods or services those dollars can buy falls. In retirement, inflation can be especially harmful, since retirees typically don’t have an income that goes up over time.

Concerns about inflation may even push back the age at which some people think they can afford to retire.

How Can Inflation Impact Retirement?

Inflation eats away at the value of each individual dollar, including savings and investments, so it’s important to keep in mind the inflation rate for retirement planning. There are several strategies you can use when investing during inflation.

For those saving for retirement, it’s important to keep in mind that the cost of living in the future will be higher than it is today. For example, if rent costs $1,000 today but next year if there’s inflation, that cost could rise to $1,100. Over a decade or more, that price could double or triple.

5 Ways to Minimize the Impact of Inflation on Retirement

While inflation can seem like a challenging or even scary part of retirement, there are several investment opportunities that may help you maintain purchasing power and reduce the risk of inflation.

1. Invest Your Savings in the Stock Market

Investing in stocks is a great way to fight inflation. A diversified portfolio that includes equities may generate long-term returns that are higher than long-term inflation. While past performance does not guarantee future returns, over the past 10 years, the average annualized return for the S&P 500 has been roughly 13%. Even when inflation is factored in, investors still have substantial returns when investing in stocks.

However, stocks are risk assets, which means they are sensitive to market volatility. These price swings may not feel comfortable to investors who are in retirement so retirees tend to allocate a smaller portion of their portfolio to equities to manage market risk.

One way to potentially determine the percentage of a retirement investment portfolio that should go towards stocks is to subtract your age from 100. For example, if you are 70 years old, a 30% allocation toward stocks may be suitable, but this can range depending on your risk tolerance and other sources of income.

2. Use Tax-Advantaged Retirement Vehicles

One of the ways retirees can increase their purchasing power is to reduce the amount of their money they need to pay in taxes. For example, a traditional 401(k) retirement account is not taxed until money is withdrawn from it.

Tax-advantaged retirement accounts are beneficial for retirees because the money grows tax-free. In 401(k)s and most Individual Retirement Account (IRA), you pay income tax on withdrawals in retirement, when you might be in a lower tax bracket. With Roth IRAs, you’ll pay taxes on the money you put into the account, but it will be tax-free in retirement.

3. Do Not Over- Allocate Long-Term Investments With a Low Rate of Return

Risk averse investors may be tempted to stay invested in securities that are not subject to major price swings, or even to keep their money in a savings account. However, theoretically, the lower risk investors take, the lower the reward. When factoring in fees and inflation, ultra-conservative investments may only break even or perhaps lose value over time.

While they offer a guaranteed return, for example high-yield savings accounts typically don’t earn enough interest to beat inflation in the long run. Since savings account rates are not higher than inflation rates, the buying power of your savings will continue to decline. That’s particularly important for retirees who are often living off their savings and investments, rather than off of an income that rises with inflation.

That’s why even retirees may want to keep a portion of their investments in the stock market.

4. Buy Inflation-Protected Securities

Treasury inflation-protected securities or TIPS are backed by the federal government and help protect investments against inflation. The principal value of the investment increases when inflation goes up and if there’s deflation the principal adjusts lower per the consumer price index.

TIPS have fixed coupon rates based on the principal value of the investment. When inflation increases, the value of the principal rises and the coupon payment will increase. Investors consider these bonds among the safest investments because they are issued by the U.S. Treasury and backed by the full faith of the U.S. government.

5. Buy Real Estate

Retirees may also consider investing in real assets. Real estate is often a good inflation hedge because it holds intrinsic value. During periods of inflation, real estate may not only be able to preserve its value, but it can also increase in value. One of the daily costs impacted by inflation is the cost of housing.

That’s why rental income from real estate historically has kept up with inflation. Investing in real estate as a real asset or even in real estate investment trusts (REITs), can be a great way for retirees to diversify their investment portfolio, reduce volatility, and add to their fixed-income.

Inflation Calculator for Retirement

It’s important to factor inflation into your plans as you’re saving for retirement. One way to do that is using a retirement calculator, like this one from the Department of Labor, which accounts for how inflation will impact your purchasing power in the future. That calculator uses a 3% inflation rate for retirement planning, but inflation fluctuates and could be higher or lower in any given year.

The Takeaway

While inflation can have an impact on a retirement portfolio, there are ways to protect the purchasing power of your money over time. Allocating a portion of your portfolio to stocks and other investments aimed at minimizing the impact of inflation can help. Another way to curb the impact of inflation during retirement is to reduce expenses, which allows the money that you have to go further.

With inflation rising, starting to save for retirement as early as possible can help you accrue the compounded returns necessary to counteract rising prices in the future. One way to get started is by opening an IRA account on the SoFi Invest® brokerage. Users can open a Roth or traditional IRA with SoFi Invest.


Is inflation good or bad for retirees?

A small amount of inflation each year is a normal part of the economic cycle. But over time, inflation eats away at the value of the dollar and purchasing power of your nest egg is diminished. This can have a negative effect on a retirement investment portfolio or savings.

How can I protect my retirement savings from inflation?

There are several Investing strategies you can use to protect retirement savings from inflation. These include diversifying your portfolio with inflation hedges including TIPS, real estate, and investments that provide a high rate of return. It’s important to keep saving for retirement even if you don’t have a 401(k).

Does your pension increase with inflation?

Some pensions have a cost of living adjustment on their monthly payments, so they increase over time. However, this is not the case for all pensions. When inflation increases this can affect your benefits.

Photo credit: iStock/RgStudio

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