How does inflation affect retirement?

Imagine that after diligently saving for retirement for decades and finally reaching your goal, you find that your living expenses are all more expensive than you had planned for. Gardening tools? Plane tickets? That piccolo you were hoping to learn to play? They all cost much more than when you started saving.

This is the lingering power of inflation and its effects on your savings. And it’s something you and your financial advisor should plan for when defining your retirement goals. 

“Without taking into account the likely impact of inflation over time, your planned retirement savings goal might not be enough to support you in the future,” says Amy Blacklock, co-founder of a personal finance blog.

Inflation and retirement don’t need to be a bad combination. Everyone from young savers to retirees should understand how inflation affects retirement. You can plan accordingly with these tips from the experts.  

Why retirement planning must consider inflation

When inflation strikes, even routine trips to the grocery store can get stressful. For example, by December 2022, grocery prices had increased by at least 11.9% from the year before, according to the Bureau of Labor Statistics’ Consumer Price Index.

“Inflation reduces your money’s purchasing power, so you can’t buy as much with the same dollar amount over time,” says Alana Benson, a writer focusing on investment topics. 

For younger people, inflation can make it harder to sock away retirement funds, whether in a Traditional or Roth IRA or a 401(k) provided through an employer.

“Younger investors should try to make space in their budget to invest for retirement even as inflation pushes the price of everyday goods higher,” Benson adds. If that’s not possible now, don’t let it deter you from setting goals for when to start saving. Stay focused on the future: “If you’re just starting out in your career, it’s likely that your income will rise over time and allow you to start saving for retirement.” She suggests increasing contributions little by little with each pay raise or job change.

Remember: Prices are always in flux, but inflation trends up over time. “Over the years, inflation can significantly erode the purchasing power of your money, making it more difficult to cover even basic living expenses,” Blacklock says. She notes that inflation should factor into the retirement plans of people of all ages. 

Luckily, there are ways to factor inflation into retirement planning, no matter what stage of life you’re at.

How to factor inflation into retirement planning 

When considering inflation and retirement, Blacklock recommends using a retirement calculator with inflation factored in. This will allow you to adjust your inflation and spending assumptions for different scenarios. “Calculators that allow for a wide range of assumptions are excellent tools for planning out a pleasant retirement and keeping you on track to save enough money each year to reach your future goals,” she says.

With a retirement calculator, you can pressure-test your savings plan for unexpected inflationary spikes. According to Bankrate, inflation ascended to 12.2% in 1974, 14.6% in 1980, and 9.1% in 2022. Between 1986 and 2020, Bankrate notes that inflationary spikes weren’t as common, and the average annual inflation rate was about 2.5%. Even if inflation seems to be under control, Blacklock encourages you to factor double-digit inflation rates into a retirement calculator to see if your savings could still allow you to cover the added costs in living expenses.

But using a retirement calculator with inflation factored in is just one tool of many that you’ll need, Benson says. It’s also important to consider personal spending, income, existing investments, and any personalized advice from a financial advisor as well.

How to protect your retirement savings against inflation

Saving for retirement is a long journey. To future-proof your financial security along the way, Blacklock recommends these practical steps to ensure inflation is front of mind when retirement planning:

• Know how much you spend on goods and services today and project your future costs using a retirement calculator with inflation factored in. 
  “This will help you set realistic goals for retirement savings to maintain your current lifestyle,” Blacklock says. 

• Save and invest early and often to give your money time to grow. 
  “While compounding isn’t magic, you may be surprised that time in the market may matter more than how much you invest,” she notes.

• Utilize tax-advantaged accounts. 
  “These accounts include Roth IRAs, 401(k)s, HSAs, and 529 plans that can help you shield your funds from inflation’s bite over time,” Blacklock explains. 

• Choose investments that have historically kept up with or exceeded the inflation rate. 
  “These investments may include real estate, stocks, bonds, commodities, or collectibles with a good resale value,” she says.¹ Blacklock also recommends looking into government-issued Treasury Inflation-Protected Securities (TIPS), which are designed to reduce the impact of inflation on your investments.

• Be mindful of interest rates, fees, and expenses associated with different investment products. 
  Blacklock points out that online banks typically provide savings products that feature higher interest rates than traditional banks do. (Compare the annual percentage yield and no account fees of the Discover^® Online Savings Account to what other banks offer to see for yourself.) “The account fees that some banks charge may eat away at your earned interest, so it’s important to be strategic about where you put your money,” she adds.

These tips can help you mitigate the effects of inflation on your retirement plans at any stage of your savings journey. Still, Blacklock and Benson agree that the inflation risk gets especially critical the closer you get to retirement.

“Those who are close to retirement have a lot to lose from high inflation,” Benson says. “Since inflation erodes their money’s purchasing power, all the money they’ve saved for years can suddenly buy less than it could a year ago.”

To protect your retirement savings from inflation, Benson suggests working with a financial advisor who can ensure you’re invested in a well-diversified portfolio. “This can help buoy your portfolio during turbulent markets,” she says. 

You can also look into assets that may protect against inflation, she adds. “For example, Series I savings bonds, commonly referred to as ‘I bonds,’ are bonds backed by the federal government,” she says. Benson notes that I bonds have a lot of specifications and fine print, so it’s worth speaking with a financial advisor to see if they’re suitable for your financial goals. 

If you’re nearing retirement, Blacklock adds that it’s also a good idea to consult with a financial advisor about investing in index funds or exchange traded funds (ETFs) if you aren’t already. “Index funds and ETFs track broader markets and may be less risky than individual stocks or bonds,” she says. 

One more tip from Blacklock: Have some cash and liquid investments on hand that you can use to cover rising expenses in retirement if inflation hits. “This allows you to avoid the unplanned selling of other assets in a down market,” she says.

Taking these steps can help shield you from how inflation affects retirement. But even after you retire, inflation still needs to be accounted for.

How to protect your savings against inflation while living in retirement 

Retirement means it’s time to relax—not worry about inflation. Unfortunately, prices can suddenly jump, so it’s wise to be financially prepared. 

So, why are retired people hurt by inflation?

“Retirees don’t necessarily have income, meaning they need to make that lump sum last as long as possible, and high inflation erodes those savings,” Benson says. “If you have a lump sum of money that could provide a year’s worth of groceries, with high inflation, it may only be able to buy a few months’ worth.”

Who’s most at risk? Income sources and lifestyle can determine your inflation exposure, Blacklock says. For example, people relying on Social Security could find that their purchasing power is reduced because their monthly checks don’t increase with inflation. 

“Retirees who are living off their investments, on the other hand, may benefit from inflation in some cases and be hurt in others,” Blacklock says. Rising prices may make investments more valuable, but having to sell stocks in down markets to cover rising expenses can be detrimental. “This is why it’s essential to monitor inflation and adjust financial strategies accordingly,” she adds.

It’s time to ask yourself: “How long will my retirement savings last with inflation?” One of the best ways to get an answer is to look at your income and current spending (reflective of higher prices) to see how long your savings will last if inflation remains high, Blacklock says. 

“This means reevaluating your basic living costs, as well as any other expenses, such as medical bills or emergency expenditures, and then revisiting inflation and retirement calculators,” she says. You may find that you need to cut back on unnecessary spending and/or add income sources where possible to stretch or bolster your retirement savings.  

Want to limit the impact of inflation during retirement? Take these actions, Blacklock says:

• Utilize budgeting and expense tracking tools. 
  There are a lot of apps that can connect to your bank accounts to make it easy. 

• Save where you can. 
  Cut costs where possible, stock up during sales, and apply discounts and coupons. Free or reduced-cost local or government services may also provide a boost.

• Maintain investments in assets that tend to increase when inflation rises. 
  These can include stocks, bonds, real estate, and some commodities. 

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• Allocate money to accounts that still yield interest. 
  Blacklock suggests retirees should set aside enough cash in a high-yield savings account or money market account and consider laddering Certificates of Deposit (CDs) or bonds to cover basic essentials like food and housing during rising inflation and volatile markets.

• Consider additional streams of income. 
  Taking on a part-time job or side hustle can help ease the financial burden or rising costs due to inflation.

• Review your housing expenses and consider the benefits of downsizing or relocating if necessary. 
  Consider options to reduce expenses such as downsizing by selling things you no longer use or need, moving to an area with a lower cost of living, or even merging households with a loved one.

Of course, before you make any significant financial moves in retirement, speak with a financial advisor first, Benson says. “They can help you calculate your living expenses and figure out how inflation will impact your bottom line,” she says.

Don’t let inflation get in the way of a stress-free retirement

Inflation is inevitable. But with proper planning, how inflation affects retirement is largely up to you, Blacklock says. 

Benson agrees: “The big-picture view is that high inflation does not last forever. It certainly should not keep you up at night, especially if you have an emergency fund and a well-diversified portfolio. If you don’t have those things, it’s not the end of the world. Focus on saving between three and six months’ worth of living expenses and go from there.”

Looking for a safe, tax-advantaged place to keep your retirement savings? Learn about an IRA savings account and how it can work for you. 

*The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.

¹ Discover Bank does not sell non-deposit investment products (“NDIP”) or provide recommendations regarding NDIP. NDIP are NOT FDIC insured.

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