How Inflation Affects Retirement Planning
Lately, there’s been one word on everyone’s mind: Inflation. With the prices of gas, groceries, and other regular expenses rising, the overall cost of living has increased, too.
In fact, it’s gone up quite a bit: In June 2022, U.S. inflation hit a 40-year high of 9.1%.1 While the start of 2023 has seen rates cool off slightly, prices are still trending upward faster than usual.2
Naturally, this period of rising inflation impacts everyone. However, it can be especially troubling for retirees with a fixed income or older adults close to retiring.
As such, inflation and retirement are inextricably linked. No matter where you are in your retirement planning, whether you are nearing retirement age, wondering what retirement planning for couples looks like, or have just started building a nest egg, you can benefit from taking high inflation into account.
How Inflation Erodes Purchasing Power
To put it simply, inflation causes the price of goods and services to increase over time. When products and services become more expensive, the same amount of money doesn’t go as far as it once did.
For example, let’s say a carton of eggs costs $5 today. If inflation causes that same carton of eggs to cost $6 next year, you’ll need to spend more to buy the same thing. In other words, your money isn’t as “strong” as it used to be. Economists call this reduced purchasing power, and it’s a hallmark of inflation.
Inflation can happen for various reasons, such as:3
- Increased consumer demand
- Supply chain issues that limit demand
- Excess money in circulation
- Rising production costs that businesses pass on to consumers
No matter the cause, inflation ultimately makes your money worth less and less each year. And in periods of high inflation rates, this devaluation happens quicker than usual.
The Impact of Inflation on Retirement Savings
So, how does inflation affect your retirement plan? Well, since retiring means leaving the workforce, your income as a retiree is fixed (or, at the very least, it isn’t growing the way it used to).
As a result, your retirement savings fund shrinks every year—even if you aren’t spending it. Though the number in your bank account won’t necessarily decrease, its purchasing power will.
Inflation also impacts retirement perks like Social Security benefits. For 2023, the Social Security Administration is increasing payments by 8.7% to address the rising cost of living.4 While this adjustment may provide short-term relief to retirees now, it may quicken the depletion of the Social Security fund, which would mean fewer benefits for future retirees.
How Should Retirees Respond to Inflation?
If all of this sounds a bit grim, don’t panic—there’s plenty you can do to combat inflation. Whether you’re currently retired or planning well in advance, these suggestions can help you enjoy a comfortable retirement, even in the face of inflation.
Budget and Spend Accordingly
One of the most immediate ways to address inflation is to change your lifestyle. By making smarter financial choices—such as cooking more at home, taking public transit, and cutting back on monthly subscriptions—you can stretch your retirement fund further.
To determine how much you can save and how much you should spend, consider making a monthly budget. If you already have a budget, it may be out of date; after all, prices for some staples have risen month after month. And if you don’t have a budget, now is a perfect time to build one.
Here are some expenses to consider when creating (or updating) your monthly budget:
- Rent or mortgage payments
- Utility bills
- Car and home insurance
- Phone and internet plans
Once you have a firm grasp on your expenses—with inflation factored in—you can confidently determine how much you can spend each month.
It’s also worth noting that the economy is cyclical, and what goes up mostly comes down. While inflation is normal, the extreme inflation of 2021–2023 is not.
Eventually, the inflation rate should return to around 2%—the target that policymakers believe is acceptable.5 If and when rates return to typical levels, you can reassess your budget and spending habits again. But for now, it may be wise to tighten your purse strings and hunker down while inflation is at its worst.
Invest in a Diverse Portfolio
Inflation usually affects some sectors more than others. For example, when looking at rising inflation from December 2021 to December 2022, grocery prices went up 11.8% while clothing costs only rose 2.9%.2
In the same way, various stocks and indexes will react to inflation differently; some investments may fall, but others could benefit from an uncertain economic climate.
With that in mind, diversifying your investment portfolio is one of the best ways to respond to inflation. A diverse investment strategy gives you inflation protection as it reduces the chance of your retirement savings plummeting due to inflation-based uncertainty.
Whether you’re already retired or not, you may want to rebalance your portfolio. A financial advisor can help you devise an investment strategy that addresses your needs and tolerance for inflation risk. Some of the recommendations a professional may make include:
- Buying stock in several publicly-traded companies
- Investing in a real estate investment trust (REIT)
- Adding index or bond funds to your portfolio
Another way to “beat” inflation is to increase your investment amounts. After all, the more you invest before you retire, the more you’ll have in your retirement savings when you stop working.
However, with the cost of goods and services also increasing, setting aside more money than before can be easier said than done. If you have to save and invest less to keep up with inflation, that’s okay—but try not to stop saving altogether. When you halt contributions to your retirement fund, inflation can devalue your savings even faster.
Relocate to a More Affordable Area
Moving may be a more extreme reaction to rising prices, but it can stretch your retirement dollars. Relocating is an increasingly popular choice, too: A 2022 survey found that around 15% of American workers already plan to retire abroad.6
Although there’s no escaping the global phenomenon of inflation,7 moving to a lower-cost-of-living country means your money goes further than it would back home. When your food, rent, and entertainment costs are much lower, you can enjoy a higher quality of life.
Some of the most popular international destinations for U.S. retirees include:8
- Dominican Republic
Many of these countries are warm, inviting destinations with delicious cuisine, gorgeous architecture, and endless activities. Some even use the U.S. dollar, which makes the transition a math-free breeze.
Of course, you don’t have to move around the world to enjoy a higher quality of life for less. Sometimes, all it takes is moving to a different part of the country or state. Leaving a higher-cost-of-living city for a more rural lifestyle can help you stretch your retirement fund further. Even moving to a new neighborhood or downsizing for retirement can improve your financial situation.
No matter where you want to go, if you plan to buy a home elsewhere, more liquidity can help you make a better offer. With EasyKnock, you can convert your home equity to cash before making an offer on your next place.
In fact, a high inflationary period may be the best time to sell your house, since housing prices tend to rise alongside other goods.9
Secure Several Sources of Income
A diverse portfolio can help you come out of inflationary periods more or less unscathed, but investments shouldn’t be your only source of income. Ideally, you’ll be able to fund your retirement with money from some or all of these sources:
- Social Security benefits – If you’ve lived and worked in the U.S. for most of your life, you’ll most likely receive Social Security payments after retiring. Social Security ensures that workers without a private employer pension can still afford to retire.
- Investments – Aside from stocks and bonds, you may also find it worthwhile to invest in real estate, collectibles, or even cryptocurrency. Options like 401(k) plans or a Roth IRA can also help you grow your money and retire comfortably. As always, a financial advisor can point you in the right direction.
- Rental income – Maybe you have a basement suite you can rent out. Maybe you have an investment property. Or maybe you can lease out your otherwise empty home while you travel the world. No matter your situation, rent can be a welcome source of passive income.
- Part-time work – It may not be ideal, but continuing to work part-time throughout your retirement—even for the first few years—can further boost your savings. These extra years of work may offset the effects of inflation.
Prepare for Retirement with a Sale-Leaseback
Like taxes and change, inflation is an inevitable part of life. If you don’t want inflation to affect your retirement fund, taking action now can help you live comfortably later.
With a residential sale-leaseback, you can convert your home equity into cash by selling your house and living in it as a renter. With cash in hand, you can invest in a diverse portfolio, move abroad, or downsize—the world becomes your oyster, and inflation becomes a background thought.
Because retirees rely on a relatively fixed income, inflation and retirement are intertwined. When retirement planning, it’s worth thinking about the short- and long-term effects of inflation. To best prepare for retirement in the face of inflation, you can:
- Follow a more stringent budget
- Diversify your investments
- Relocate to a lower-cost-of-living destination
- Use a residential sale-leaseback program to sell your house and continue living in it as a renter
- Ensure you have several sources of income
- Save more at an earlier age
- CNN. US inflation hit 40-year high in June, driven by record gas prices. https://www.cnn.com/2022/07/13/economy/cpi-inflation-june/index.html
- U.S. Bureau of Labor Statistics. Consumer Price Index. https://www.bls.gov/cpi/
- Harvard Business Review. What Causes Inflation? https://hbr.org/2022/12/what-causes-inflation
- CNBC. Retirees will receive more in Social Security benefits in 2023: What to know about the inflation adjustment. https://www.cnbc.com/select/social-security-benefits-increase
- U.S. Federal Reserve. Why does the Federal Reserve aim for inflation of 2 percent over the longer run? https://www.federalreserve.gov/faqs/economy_14400.htm
- CNBC. You can retire abroad for less than $2,000 a month in Tokyo, Berlin and these other 8 cities. https://www.cnbc.com/2022/11/02/retire-abroad-in-these-10-cities-for-less-than-2000-dollars-per-month.html
- Economic Policy Institute. Rising inflation is a global problem. https://www.epi.org/blog/rising-inflation-is-a-global-problem-u-s-policy-choices-are-not-to-blame/
- U.S. News. The Best Affordable Places to Retire Overseas in 2022. https://money.usnews.com/money/retirement/baby-boomers/slideshows/the-best-affordable-places-to-retire-overseas?onepage
- Forbes. How Rising Interest Rates And Inflation Impact Real Estate Investments. https://www.forbes.com/sites/forbesbusinesscouncil/2022/02/24/how-rising-interest-rates-and-inflation-impact-real-estate-investments/