Inflation Risks

Inflation means your savings and fixed income lose purchasing power as time passes and the cost of goods and services goes up. Inflation can affect your standard of living and is especially problematic for retirees who may find they haven’t saved enough to support their lifestyle when prices increase.

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    Jennifer Schell

    Jennifer Schell

    Financial Writer

    Jennifer Schell is a professional writer focused on demystifying annuities and other financial topics including banking, financial advising and insurance. She is proud to be a member of the National Association for Fixed Annuities (NAFA) as well as the National Association of Insurance and Financial Advisors (NAIFA).

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    Stephen Kates is a Certified Financial Planner™ and personal finance expert specializing in financial planning and education. Stephen has expertise in wealth management, personal finance, investing and retirement planning.

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  • Updated: August 21, 2023
  • 7 min read time
  • This page features 12 Cited Research Articles
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What Is Inflation Risk?

During your retirement years, your money will not stretch as far as it did when you first left the workforce. This is due to inflation: the economic phenomenon that describes how prices of goods and services increase over time.

Using the Bureau of Labor Statistics’ inflation calculator, you can determine how far your money could go from year to year based on historical inflation rates. Although the calculator can’t predict the future, it’s useful to see how the value of money has changed in the past when estimating how much income you are likely to need in the future.

Plugging numbers into the CPI calculator shows you that you would need $903.76 to have the same buying power in June 2023 as you had with $500 in January 2000.

To translate this example into retirement, let’s say you plan to live off of $50,000 a year when you retire. If we assume a regular inflation rate of 3% per year, you’ll need $77,898.37 to match the purchasing power of that $50,000 after 15 years.

Because the cost of living will increase each year after you leave the workforce, you must account for this inflation when you’re planning and saving for your retirement.

“Inflation is one of many financial risks which can never be completely avoided, only managed. Like most risks of investing (or not investing), a balanced strategy can control the severity of the impact to your finances.”

How Can Inflation Impact Your Finances in Retirement?

Inflation soared from 2021 to 2022 with consumer prices spiking at 9.1%, according to a report from the U.S. Bureau of Labor Statistics. This increase marked the largest 12-month increase in consumer prices in over 40 years.

However, since then, inflation levels have started to gradually decrease. The current inflation rate is down to 2.97% as of June 2023.

Even a low rate of inflation can significantly erode purchasing power in the long run, and retirees experience inflation at higher rates than other consumers. Retirees tend to spend more of their money on services and products heavily impacted by inflation, such as healthcare, housing and food. expert contributor Thomas Brock said there’s another factor that complicates inflation for retirees. “The problem is most significant for people living on fixed incomes, which is typically the case for retirees. Over time, inflationary pressure can diminish the purchasing power of their income.”

Inflation in the 12 months from June 2022 to June 2023 has averaged about 2.97%, according to the most recent data from the Bureau of Labor Statistics. Viewed in terms of the purchasing power of the dollar, this means that $100 last year is now worth $102.97.

However, if a high rate of inflation returns, the purchasing power of retirement savings could begin to erode.

The Effects of Inflation on Retirement Savings

Health care spending for seniors is estimated to be three times higher than for working adults and five times higher than for children.

In addition, retirees spend higher portions of their income on housing, which rises in cost at a slightly faster pace than other goods and services.

Inflation and Your Savings

When you’re putting money away for a long time — such as saving for retirement — you must account for how the purchasing power of your money will decrease due to inflation.

Putting money into a savings vehicle like a savings account or a certificate of deposit (CD), your money earns interest for as long as it remains in that account. The longer you keep the money in the account without withdrawing it, the more interest your savings will earn.

However, interest rates for these bank products are often too low to keep pace with inflation. The average interest rate on savings accounts as of June 2023 is 0.42%, which is an increase from May’s average of 0.36%. The average interest rate on a one-year CD sits at 1.63% as of June 2023. Although these numbers are higher than recent rates from 2022, they are still significantly lower than the current rate of inflation.

Meaning that in these accounts, your savings won’t grow nearly as fast as inflation, resulting in a significant reduction in purchasing power.

Planning for Retirement With Inflation in Mind

The good news is that most retirees don’t have their savings stuffed in low-yield savings accounts. The money likely is invested in a way that allows it to grow so that it may be keeping up with inflation already, thereby mitigating one of the most significant risks in retirement.

However, inflation doesn’t stay the same from year to year, and it’s impossible to predict when prices might spike dramatically as they did in 2021 and 2022. It’s worth considering how you might better prepare your retirement savings for the effects of unusually high inflation.

How To Track Inflation Rates

Although inflation has increased at an unusually brisk pace in recent years, financial advisors generally suggest assuming an annual 3% inflation rate when planning for retirement. Prior to the pandemic, this was a slightly higher rate than what the government typically calculated as the actual inflation rate each year.

The Bureau of Labor Statistics (BLS) tracks monthly average prices of consumer goods to establish the current Consumer Price Index (CPI), which the bureau defines as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”

The change in the CPI from one period to another is what determines the rate of inflation. The BLS traditionally tracks the CPI of one population group, urban wage earners and clerical workers, as a measure known as the CPI-W.

CPI-W measurements are used to dictate the cost-of-living adjustments (COLA) made by the Social Security Administration. But, because their spending is more centered on goods and services with more rapidly increasing costs — primarily health care and housing — retirees face cost-of-living increases that tend to exceed the national averages reflected by the CPI-W.

Because of this, the BLS created an unpublished, experimental inflation measure specifically for older Americans, known as the CPI-E. The CPI-E reflects estimated spending patterns of Americans ages 62 and older from December 1982 to the present and varies slightly from the CPI-W.

Historical Average Annual Rate of Inflation: CPI-W vs. CPI-E

2022 (1st Half) 9.0% 7.6%
2021 5.3% 4.3%
2020 1.2% 1.4%
2019 1.9% 1.9%
Source: U.S. Department of Labor

Investment Options

One way to keep inflation from affecting your ability to maintain your lifestyle in retirement is to invest in assets that keep pace with inflation or even surpass it in growth.

But there is usually a cost associated with any investment that has the potential for higher returns. It might be the fact that the investments, such as stocks, carry higher risks of losing value. Or it could be that the cost of the investment is higher than the same investment without inflation protection.

Examples of investments that may protect against inflation include annuities, inflation-protected treasury securities, Series I Savings Bonds and real estate.

Annuities are an insurance product that converts a lump sum premium into a stream of income payments. Some annuities are inflation-adjusted, which means their payment amounts will increase according to increases in the CPI. Most inflation-adjusted annuities have a limit on how much the amount can increase each year, known as a cap.

Treasury Inflation-Protected Securities (TIPS) are issued by the federal government. Payouts rise with inflation as measured by the Consumer Price Index. These bonds pay interest at a fixed rate two times each year. The principal may be increased if the CPI warrants it, with the interest rate applied to the higher principal.

Besides TIPS, the Treasury’s Series I Savings Bonds are another great product to invest in for inflation protection. “Essentially, we’re talking about a completely risk-free investment issued directly by the U.S. Treasury Department,” said Brock. “You can’t lose your principal investment on these bonds, and you are hedged against inflation. All things considered, there is no other investment in the world that currently offers a comparable risk-adjusted return.”

According to an article from EquityMultiple, experts say real estate investing can be a hedge against inflation because the scarcity of real estate gives it intrinsic value. Demand for real estate doesn’t decrease as inflation increases, and the ability to generate rental income from the property also increases at a rate that compensates for inflation. For these reasons, real estate has proven to be a reliable hedge through historic periods of inflation.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: August 21, 2023

12 Cited Research Articles writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.

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