With prices rising at a record rate, many retirees or people
planning to retire soon may be increasingly worried about what sort of
lifestyle they can afford.
The good news is that the headline inflation number of 9.1%
from the Bureau of Labor Statistics represents an average rise in consumer
prices. Your own inflation rate may be different depending on what you buy and
where you buy it.
“Inflation is represented as a single number, but in
reality, it affects everyone differently depending on how they spend their
money,” says Brian Walsh, Senior Manager of Financial Planning at SoFi in Grand
Rapids, Michigan. “Generally, as you get older, you spend less on food,
transportation, clothing and entertainment but spend more on healthcare,
charitable contributions and services. Food, energy and transportation are
significant drivers of inflation so that some retirees may be less affected by
inflation compared to their working counterparts.”
The bad news, however, is that inflation still impacts you.
It could be worse than average, depending on where you live. Furthermore,
retirees often find themselves in a precarious position regarding inflation
based on several factors.
“Regardless of whether retirees’ expenses are more or less
affected by inflation than workers, higher expenses introduce additional risk
to a retirement plan,” says Walsh. “First, expenses may rise at a faster rate
than their fixed income. This creates the need to either reduce spending or
withdraw more money from investments during a bear market. Second, the Fed’s
response to high inflation has been to raise rates which may negatively impact
the value of existing fixed income investments that are owned more often by
retirees than workers. Third, high inflation and rising rates may create
additional volatility in the stock market which affects retirees more since
they are actively taking withdrawals from their investment accounts.”
If you’re retired, close to retirement or just thinking
about retirement, no doubt inflation has you wondering about your plans. The
questions below represent popular search engine requests. How similar are they
to reflecting your own worries?
What does inflation mean to retirees?
Inflation affects everyone, but you can be especially
vulnerable if you’re retired. Those who rely on the kind of income sources once
popular among previous generations can find themselves most at risk.
“Inflation harms retirees as they generally live on a fixed
income comprised of Social Security, pensions and withdrawals from their
retirement portfolios,” says Michael Fischer, Director and Wealth Advisor for
Round Table Wealth Management in Westfield, New Jersey. “Sustained inflation
over a number of years can drastically reduce your purchasing power, especially
without cost-of-living adjustments in pension payments or strong investment
markets to buoy retirement accounts.”
How does inflation affect the way you plan for
retirement?
Given the potential impact inflation can have, it’s
essential to adjust the way you plan for retirement. This represents something
new, as inflation has been relatively tame for more than a generation. Indeed,
no one expected this current bout of inflation to be anything but transitory
coming out of the pandemic. People are only now relearning how (and why) it
needs to be incorporated into retirement planning.
“Inflation reduces your purchasing power over time,” says
Rob Stevens, Retirement Income Specialist at TIAA in Charlotte, North Carolina.
“Over the past 30 years, inflation has averaged around 2.5% annually. That
means a 65-year-old retiree who needs ~$50,000 of income to cover today’s
expenses would need to spend about $80,000 in 20 years to maintain their
purchasing power. If inflation spikes sooner, though, retirees who want to
maintain the same lifestyle would also need to spend more money sooner.”
What rate of inflation should you use when calculating
how much you will need in retirement?
While it may seem that inflation was “unusually” low in
recent years, the fact is these low levels are consistent with the long-term
rate of inflation. Except for an extended period of high inflation from the
1970s through the 1990s, the “low” levels we’ve recently experienced were
similar to our historical average.
“Inflation averages 3% annually over time, but the recent
inflationary trends are at a 40-year high,” says Jody D’Agostini, a financial
advisor at Equitable in Morristown, New Jersey.
Even this average, however, is not without its consequences.
“Inflation is like high blood pressure,” says Lou Cannataro,
Founder & Partner of Cannataro Family Capital Partners in New York City.
“It’s a problem, and many may not see its true effects until it is too late.
You should have calculated how much you need each month to meet your expenses.
The problem is your monthly spending will increase not because you are
consuming or doing more, but because those goods or services simply cost more.
If retirees have done their long-range planning correctly, they will have
factored inflation into the calculation. However, high periods of inflation
should bring the retiree back to reconsider current spending and what tactics
need to be deployed (if any) to minimize the long-term effects on funding their
goals.”
How will inflation affect my 401k or IRA?
If you haven’t retired, and possibly even if you have
already retired, you may wonder what inflation will do to your retirement
savings. It is this portfolio that retirees rely on. How it reacts to inflation
can spell the difference between a comfortable retirement and getting a
part-time job during retirement.
“Inflation most acutely impacts retirees through diminishing
their purchasing power and thereby increasing lifestyle expenses funded through
investment portfolio distributions,” says Matthew Ruffalo, Head of Investment
Solutions at Clarfeld Citizens Private Wealth in Tarrytown, New York.
“Inflation is one of the reasons why it’s important to invest in financial
markets.”
And by “financial markets,” Ruffalo refers to investments
beyond those you’d find at the neighborhood bank.
“Over longer periods of time, cash returns do not keep pace
with inflation,” says Ruffalo. “Therefore, the real value of an all-cash asset
base will decline. However, through building diversified investment portfolios
that utilize asset classes with historical returns that outpace inflation,
retirees can create asset bases that grow over time. Retirees can then rely
upon these portfolios to maintain the real principal value of their assets and
preserve requisite cash flow distributions to support increasing expenses over
time.”
Does inflation hurt retirement?
Why is it important to make sure you don’t get too
conservative in your retirement portfolio after you retire? That’s because you
don’t want inflation to hurt retirement. The failure to grow your retirement
assets beyond your retirement date is the number one reason inflation can
surprise you.
“Inflation hinders your purchasing power as the cost of most
everything you buy rises faster than the pace of your asset/retirement income
growth,” says Wes Moss, Managing Partner and Chief Investment Strategist at
Capital Investment Advisors in Atlanta. “For example, if inflation rises at 10%
and your income streams only increase by 3% per year, then everything is 7%
more expensive on a relative basis; hence, your purchasing power is 7% less.
Said another way, your ability to maintain the same standard of living can be
eroded in a significant way.”
How does inflation impact my retirement income needs?
The lack of investment growth is where inflation becomes a
real problem for retirees. Traditionally, retirees have relied on fixed income
instruments and/or plans to provide for their retirement income needs. Today,
most retirees have a significant equity portfolio to go along with fixed income
sources, be they bonds or Social Security. Without those equities, retirees
could be at risk given the current inflationary environment.
“Consumer prices in June have increased more than 9% over
the past 12 months,” says Ari Parker, Lead Medicare Advisor at Chapter in
Phoenix. “These price hikes have impacted everyday living costs, including the
prices of food, rent and even medical care. Retirees are especially vulnerable
to inflation because many of them are on a fixed income. For some, these rising
prices mean they have to dip into savings to pay for everyday items. Inflation
has resulted in a higher cost of living for those on a limited income,
especially for those who are not bringing in a steady income from an employer.”
How does inflation impact my retirement spending needs?
At the same time inflation influences your strategy when it
comes to investments, it will likely also change the way you spend your money.
It may not change the total amount you spend, but it may change what things you
spend it on. This is something you’re probably seeing right now.
“At the pace that inflation is currently rising, it
certainly will have an immediate impact on future expenses, for likely the next
year,” says Ted Wozniak, U.S. Head of Asset Management at SEI in Oaks,
Pennsylvania. “There is a chance it can cause an impact even further into the
future. This, coupled with a bear market, will certainly drive decisions around
future withdrawal rates for retirees.”
Will Social Security keep up with inflation?
Can you depend on Social Security to help? It certainly
isn’t “fixed” in the usual sense as the government does attempt to increase it
to reflect the current inflation rate. Sometimes, though, that doesn’t match
the real rate of inflation.
“Social Security did have a 5.9% increase this year,” says
D’Agostini, “but that has failed to keep pace with the 8-9% inflation we have
been seeing.”
More so, Social Security has its own set of problems that
will come to a head in the very near future. Inflation only makes these worse.
“For retirees that largely are on a fixed income, this can
be especially concerning,” says Matthew Benson, Owner of Sonmore Financial in
Phoenix. “Social Security does have a cost-of-living adjustment (COLA), which
was 5.9% for 2022, but it is well known that the Social Security trust fund is
underfunded. At its current rate, experts estimate they will have to reduce payments
at some point in the next 10 to 15 years. There are several solutions to extend
the life of the Social Security trust fund, one of which could be reducing or
eliminating the COLA. The intention of Social Security payments is to replace
about 40% of someone’s retirement income.”
How much do I need to retire with inflation?
This, then, is the bottom line. Unfortunately, this number
was a mystery even before factoring in inflation. Actually, including this
additional variable isn’t as hard as it seems. Any financial professional can
demonstrate this for you if you’re less confident in those omnipresent “free”
online retirement calculators. Don’t be surprised by the results.
“The cost of retirement often exceeds a retiree’s
expectations,” says Christian Mills, Head of Finance Relations and Home Equity
with Reverse Mortgage Funding, LLC in Denver. “It can be challenging for many
people to transition from living on a salary to living on a fixed income,
especially if they haven’t planned for certain significant expenses. Many of us
were told that $1M in retirement funds is the magic number for a successful
retirement. However, a recent study found that Americans will now need close
to $2M to fund their retirement.”
Again, that’s only an average. And like the average rate of
inflation, the average retirement target doesn’t help you. It all depends on
where you plan to live and how you plan to live.
Just don’t forget to include inflation in your calculations.
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