Inflation is a significant risk for retirees. Inflation can erode the purchasing power of retirement savings and reduce the standard of living in retirement. In this blog post, we will discuss what inflation risk is, how it can impact your retirement, and some strategies you can use to mitigate this risk.
Inflation Risk Explained
Inflation is an overall increase in the prices of goods and services. When prices rise, each dollar buys fewer goods and services. Inflation equates to a decrease in the purchasing power of your dollars in the future.
Inflation risk is the risk that the value of money will decrease over time due to inflation. Inflation can have a significant impact on retirement savings, as it reduces the purchasing power of money over time.
Inflation’s Impact Retirement
Inflation is a massive headwind for your retirement savings. If your retirement savings do not keep pace with inflation, you may find that your standard of living decreases over time. For example, if you retire with $1 million in savings and inflation averages 3% per year, after 20 years, the purchasing power of your savings would be reduced to $540,000.
Inflation can also impact the cost of healthcare in retirement. Healthcare costs tend to increase at a faster rate than the general rate of inflation, which can put a significant strain on retirement savings.
Mitigate Inflation Risk in Retirement
Adjust your investing with inflation in mind. Keep your portfolio invested such that your returns are keeping pace with inflation at a minimum. One strategy to mitigate inflation risk in retirement is to invest in assets that tend to increase in value with inflation. One such asset is existing real estate. Also, raw materials and precious metals (collectively, “commodities”) generally increase in value during inflationary times.
Certain assets are designed with inflation protection, such as Treasury Inflation-Protected Securities (TIPS). TIPS are a type of U.S. Treasury bond that is indexed to inflation, so the principal value increases with inflation.
Another strategy is to consider delaying Social Security benefits. Delaying Social Security benefits can increase your monthly benefit amount, and the benefits are adjusted annually for inflation, providing some protection against inflation risk.
Consider creating a retirement budget that includes a cushion for inflation. Your budgeting does not need to be strict. Rather, a general awareness of how your money is spent should be enough to keep your retirement on track.
You may want to consider creating a retirement account withdrawal plan. By having a plan, and committing to it, you can protect yourself from over-spending. A set withdrawal amount may encourage discipline in your spending. A withdrawal plan, in concert with a budget, will help ensure that your retirement savings sustain you in retirement.
Inflation risk is an important consideration for retirees. By understanding this risk and implementing strategies to mitigate it, you can help ensure the longevity of your retirement savings and maintain your standard of living in retirement. Talk to a financial professional about whether your current savings rate and/or retirement plan meet your needs. It is advisable to seek professional counsel before investing in anything, especially in commodities.