Most Americans recognize the impact of inflation in the short term, like when they go to the grocery store or fill up their car. However, inflation is much more than just a temporary inconvenience. Increasing inflation affects long-term financial plans, especially in retirement. Over time, rising prices can seriously erode the value of your savings and income, reducing your purchasing power just when you need it most.
The challenge of long-term inflation.
Although inflation has cooled down from its peak of 9.1% in June 2022, it’s still of concern to retirees and those hoping to retire within the next decade. During the 12-month period ending in May 2024, the Consumer Price Index (CPI) rose by 3.3%. While projected inflation rates for the next five to ten years are around 2.2% and 2.3%—close to historical averages—retirees still face the cumulative effects of past inflation surges.
The CPI has climbed about 22.5% over the past three years, meaning retirees today are spending significantly more for the same goods and services they bought just a few years ago. For instance, if a retiree needed $50,000 a year to cover expenses before inflation spiked, they would now need closer to $59,000. As a result, even a well-designed $1 million retirement portfolio may not stretch as far as planned.
Inflation has a direct negative impact on retirees’ savings and income, making long-term planning essential.
What are the common sources of retirement income, and how do they fare when inflation runs amok?
Understanding the sources of income retirees rely on is crucial when considering inflation. Some income streams are better able to handle inflationary pressures than others. Let’s examine a few of the most popular income streams in retirement.
Social Security
Around 79% of all retirees in the U.S. depend on Social Security benefits, with that number increasing to 93% for those aged 65 and older. One of Social Security’s best-known features is its annual inflation adjustment, known as the cost-of-living adjustment, or COLA. COLA helps protect against the loss of purchasing power by adjusting benefits to match rising prices.
However, many economists criticize COLA for not keeping up with inflation entirely. According to estimates from senior advocacy groups, Social Security benefits have lost about one-third of their purchasing power since 2000. Relying entirely on Social Security can leave you vulnerable to the ravages of inflation.
Other income sources.
Some retirees are fortunate enough to have pensions. However, not all pensions adjust for inflation. Many private companies have internal policies that may or may not include cost-of-living adjustments (COLAs) for retirees. Other income sources, such as personal savings, 401(k)s, and IRAs, may lack automatic inflation adjustments. In the absence of such adjustments, retirees need to find ways to protect their nest eggs from inflation and help them continue to grow, even after they stop working.
Inflation risk isn’t necessarily an intractable problem. Retirees can use a few simple strategies to combat rising costs. One option is to delay retirement by a few years. Delaying retirement has numerous benefits, including giving you time to save more and putting off the need to begin drawing down your savings. Staying longer at your job can also provide you with time to acquire new skills you might use later to supplement your retirement income. If you enjoy what you do, then staying at your present job can have a positive impact on your mental health and happiness. Similarly, getting a part-time job can be fulfilling and financially rewarding as well.
But what if you can’t keep working for health reasons or you simply don’t want to continue to work? If you aren’t thrilled at the prospect of extending your working years, then you’ll need a clear, realistic picture of how much money you will need to achieve your preferred lifestyle. As you might imagine, there is often a profound disconnect between what retirees think their expenses will be in the future and what they will actually need to meet essential costs of living. Working with a financial life designer can help you come up with an honest assessment of your spending habits and future expenses so that your estimates will be more realistic.
Many factors influence the estimation of future expenses, and every retiree’s situation is different. For instance, housing costs have risen steeply, but homeowners with paid-off mortgages haven’t felt the same pressure as renters. If your mortgage is paid off when you enter retirement, you may not need as much income to realize your dream retirement.
A flexible approach to withdrawals can also make a significant difference. Some retirees start with a 4% withdrawal rate, adjusting for inflation each year. However, more adaptive methods, like the “guardrails” approach, can provide greater flexibility, allowing for higher initial withdrawals, which may help with immediate inflationary pressures.
How can annuities help offset the negative impacts of inflation?
Annuities can give retirees a steady, reliable income stream and a degree of inflation protection. An annuity is often an attractive option for those concerned about outliving their savings or losing purchasing power due to inflation.
Fixed indexed annuities, in particular, are known for their ability to combine principal protection with growth potential. These “safe money” products link to market indices, which means they may benefit from inflation-driven market gains. Unlike bonds, where rising interest rates often decrease value, annuities can still accumulate value even as inflation drives rates higher.
Annuities also offer other key benefits: principal protection, guaranteed lifetime income, and, in some cases, inflation-adjusted payouts. Including an annuity in your retirement matrix can make a lot of sense, especially if you are facing rising healthcare costs or if other necessities become more expensive during inflationary periods.
Planning for Inflation with Annuities
For retirees worried about inflation, working with a financial professional to integrate annuities into their retirement strategy often gives them peace of mind. Since inflation impacts each person differently, a safe money specialist can help determine which type of annuity fits best, considering an individual’s comfort level with inflation risk and financial goals.
Annuities provide flexibility in adjusting to inflation in two critical ways. First, they can help retirees withdraw larger dollar amounts as needed to cover rising costs. Second, annuities reduce the pressure on a retiree’s savings, ensuring that their portfolio isn’t depleted prematurely due to unexpected inflation spikes.
What about future inflation?
Past inflation has already eroded some of your purchasing power. Future inflation is perhaps even more of a threat, particularly if you have already retired. For those who rely the most on income generated by their retirement investment portfolios, adding inflation-protected investments like Treasury Inflation-Protected Securities (TIPS), along with the right kind of annuity, might be a helpful approach.
In addition, adopting a flexible mindset regarding retirement withdrawals and incorporating annuities into a broader retirement strategy can give you stability when faced with economic uncertainty. The tried and true “4% Rule,” may no longer work for many retirees. If you’re worried about running out of money in retirement, then having additional income is crucial.
To sum it up:
Inflation can significantly impact your retirement income, eroding your purchasing power over time. However, with careful planning, flexible withdrawal strategies, and products like annuities that provide inflation protection, you can safeguard your financial future. Staying informed and working with financial professionals trained in the spend-down phase, retirees can confidently navigate rising costs and ensure their savings last throughout their entire retirement.
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