How Does Inflation Affect Your Retirement Income?
As you save for retirement, it’s all too easy to ignore inflation. However, inflation can play a pivotal role in whether you have enough money to live the life you desire once you stop working.
By being mindful of inflation and understanding how it impacts retirement savings, you’ll be more likely to be able to continue living the quality of life you’ve been accustomed to. Let’s take a closer look at the various ways inflation affects retirement income and what you can do to prepare for it.
4 Ways Inflation Impacts Retirement Savings
You can think of inflation as a hidden fee that may gradually reduce the value of your nest egg. Here’s how it can take a toll on your finances if you don’t consider it in your retirement savings plan:
1. Reduced Purchasing Power
It goes without saying that inflation raises the cost of everything, and while its impact may be less significant for high-income earners or high-net-worth investors, it still has repercussions. As a result of inflation, housing, food, goods and services, transportation, and healthcare expenses are likely to rise in retirement – meaning the same amount of money buys less than it did before. You may find that after covering these basic needs, you have less disposable income than expected, affecting your ability to maintain your desired lifestyle.
2. Investment Returns
Inflation can diminish the real return on your investments. The real value of an item refers to its nominal value adjusted for inflation, which reflects the item’s purchasing power over time. While the nominal value is the face value or the amount stated without considering inflation, the real value accounts for changes in the price level.
Let’s say you have an investment in a stock portfolio that provides a nominal return of 8% over the course of a year. In the first year, your investment grows by 8%. However, inflation during that same year is 3%.
Nominal Return: Your investment grows by 8% in nominal terms, meaning if you started with $20,000, you’d have $21,600 by the end of the year.
Inflation Adjustment: To understand the real value of your investment return, you need to adjust for inflation. If inflation is 3%, the purchasing power of your $21, 600 is actually lower than its nominal value due to the increased cost of goods and services.
However, after accounting for inflation of 3%, the real return is approximately 4.85%, meaning the real value of your investment is $20,970.87.
So, while the nominal growth is $1,600, the inflation-adjusted growth in terms of purchasing power is only about $970.87.
So in summary, your investments are not going to provide what they could and instead are going to be cut a bit by inflation. Make sure to keep that in mind when it comes to your spending and expenses.
3. Social Security Benefits
The Social Security Administration (SSA) uses a (COLA) based on the Consumer Price Index (CPI-W) to help mitigate the impact of inflation on the benefits it provides. In 2024, for example, the COLA was 3.2%. While the COLA sounds great in theory, the purchasing power of Social Security has continued to erode. In fact, research has shown that the buying power of Social Security benefits has gone down by 33% since 2000. All of this information is important to consider if you plan to take advantage of Social Security in retirement.
4. Healthcare Costs
One of the most essential expenses to account for as you save for retirement is healthcare. Compared to the overall inflation rate, inflation for healthcare has increased at a far higher rate. According to the Kaiser Family Foundation, the per capita spending on medical costs will likely grow by 4.6% annually until 2028. Depending on your health status in retirement, you may need to spend a lot more than you’d like to manage acute and chronic conditions and maintain your overall health.
How to Safeguard Your Retirement Savings From Inflation
While you can’t stop inflation and predict inflation rates during your retirement years, you can take several steps to minimize risk. If your goal is to safeguard your substantial nest egg, these strategies should be on your radar.
Optimize Social Security
You can choose to collect your Social Security benefits early or later on. They’ll go up by about 7% annually between age 62 and your full retirement age. This figure will increase to approximately 8% between your full retirement age and 70. Therefore, if you wait to receive Social Security, you’ll get more bang for your buck.
Create a Budget
Think about the lifestyle you hope to live in retirement and budget for it accordingly. Maybe you want to take one international trip each year. Or perhaps you wish to donate a certain amount to your favorite charity every year. A budget can help you navigate inflation by prioritizing what’s important to you and where you’re willing to be flexible and potentially cut back.
Build an Emergency Fund
Inflation and unanticipated expenses go hand in hand. That’s where an emergency fund comes in. By pairing your retirement portfolio with an emergency fund you can pull from at any time, you’ll enjoy some extra cushion and peace of mind. Having a solid emergency fund, a car repair, a medical bill, or supporting a family member in need won’t derail your finances in retirement.
Diversify, Diversify, and Diversify
The saying “don’t put all your eggs in one basket” is key if you want to reduce the impact of inflation during retirement. It’s in your best interest to spread your money out so that it’s not all in one place. In addition to stocks, bonds, and mutual funds, you can invest in real estate, real estate investment trusts (REITs), commodities, and alternative investments such as startups or precious metals.
Work with a Fiduciary Financial Advisor at Olympic Wealth Management
You don’t have to figure out your retirement plan alone. With a trustworthy fiduciary financial advisor by your side, you can navigate inflation and ensure you live your best life in retirement. Eric Cumley of Olympic Wealth Management, a privately owned, independent Registered Investment Advisory (RIA) firm, is here to help. Schedule a consultation today for more information.