What is Inflation?

How Inflation Affects Your Retirement Savings

Inflation happens when prices go up over time, so your money won't go as far in the future as it does today. In other words, things may cost more down the road. 

Imagine: you’ve saved $100,000 in your 401(k) or IRA. Now let’s imagine inflation increases prices consistently by 3% each year until you retire. In 20 years your $100,000 savings would only buy what about $55,000 would buy today!

That’s why it is so important to factor Inflation into your retirement planning because:

• Most people spend about 20 years in retirement
• Some retirement costs, like healthcare, tend to rise at a faster rate compared to general inflation
• Social Security isn’t guaranteed to keep pace with inflation

‍

What Inflation Rate Should You Use For Retirement Planning?

Most financial experts say to account for a 2-3% inflation rate when planning your retirement. As well as being historically on point, this range aligns with the Federal Reserve’s inflation target of 2%.

While this estimate is reasonable, future inflation rates cannot be predicted with 100% certainty. In the US, inflation averaged around 3% per year over the last 50 years. But when we zoom in, we see that in some years inflation was as high as 7% (2021) and as low as 0.1% (2008).

Using a higher inflation rate in your retirement calculation, like 5%, might feel like playing it safe, but it could actually mean saving more than what feels comfortable for you right now. On the flip side, using a lower rate, like 1%, might leave you with not enough savings. That’s why most investors go with a rate around 2-3%.

How to Protect Your Retirement from Inflation

The last time prices didn’t go up was in 1954, over 70 years ago. Since then, inflation has been constant, gradually increasing the cost of goods and services, which is why it's important to factor it into long-term financial planning. However, this doesn’t mean your retirement savings are destined to lose value over time.

Here are a few ways to protect your retirement savings against losing purchasing power:

• Build a Diverse Investment Portfolio: Various investment products offer diverse asset exposure, with exchange-traded funds (ETFs) becoming a popular choice. ETFs can focus on real estate, commodities like gold, and other sectors that often rise with inflation.

• Delay Claiming Social Security: Each year you delay claiming Social Security benefits (up to age 70), your monthly payment increases. This can give you a larger income stream to put towards higher prices.

• Adjust Your Withdrawals During Retirement: You don’t always have to take out the same amount. Withdrawing less during periods of high inflation can help your savings last longer.

‍

Take Control with PensionBee

Inflation can reduce your buying power over time, so it’s important to have a retirement plan that helps your savings grow faster than prices. PensionBee simplifies retirement planning by helping you consolidate all your retirement savings into a one, easy-to-manage PensionBee Individual Retirement Account (IRA). Explore our award-winning app and use our retirement calculator to see how inflation might affect your savings. We offer a variety of investment portfolios, powered by State Street ETFs, designed to fit a range of retirement goals.

Frequently Asked Questions (FAQs)

How Does the 4% Rule Work With Inflation?

The 4% rule suggests withdrawing 4% of your retirement savings in the first year and then adjusting that amount for inflation each subsequent year, helping to ensure your funds last at least 30 years. This approach already takes inflation into account, making it a simple way to maintain your purchasing power over time.

Does Inflation Hurt Retirement Accounts?

Inflation makes your money worth less over time. Retirement accounts invested in a mix of assets, for example through ETFs, have historically grown faster than inflation over the long term. So while inflation will increase your expenses, your investments, properly invested, should grow enough that you can still afford those higher expenses when you retire.

How Long Will My Retirement Savings Last With Inflation?

Without accounting for inflation, $1 million in retirement savings with 4% yearly withdrawals would last 25 years. But if we factor in 3% yearly inflation and a 5% average return on investment, those same withdrawals would use up your savings in less than 20 years. Since the average retirement length is around 20-30 years, inflation could cause your savings to run out before the end of retirement.

(Note: These calculations are based on assumptions of a retirement age of 65, a constant 5% per annum return on investment, and a constant 3% annual rate of inflation. Actual outcomes may vary depending on individual circumstances and market performance.)

Is High Inflation Good for Retirees?

No. High inflation is bad for retirees with fixed incomes. Although Social Security benefits do get cost-of-living adjustments, these often don’t keep up with inflation rates. Plus, some retirement plans don’t adjust for inflation at all, meaning their value can get eroded away quickly during periods of high inflation.