Is Inflation Costing You More as a Retiree?

Higher prices can sting retirees harder than others for a number of reasons, but there are a few specific types of investments that can help ease the pain.

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Inflation hurts everyone. It seems to reach every sector, product and business in one way or another, whether it raises the cost of heating your home, lunches or road trips. But if you’re a retiree, you may be particularly worried about inflation because your spending habits and income sources might be disproportionately exposed to inflation. This means that changes to the dollar’s purchasing power may have a considerable impact on your ability to cover costs of living and maintain your quality of life.

1. Why Inflation Can Hurt Retirees Disproportionately

Inflation affects people differently, and there are many who may not feel the effects of inflation as much as others. But retirees tend to spend larger portions of their income on items highly affected by inflation. You may spend a large part of your income on housing, food, gas and health care, all of which are seeing the full effect of inflation. In addition, inflation hurts those who are living off their savings and have limited market exposure that could otherwise provide higher yields. Retirees are much more likely to be dependent on their savings than a working person, who may receive cost of living increases to their salary or consistent raises.

As a retiree, when markets are volatile and inflation is at your door, the task of making your money last for the rest of your life can seem daunting. In that respect, inflation is the silent killer of retirement planning. To put it in perspective, there is a commonly used calculation that is used to determine how inflation may affect your money. The rule of 72 is a simple calculation used to assess the effects of inflation on an individual’s assets over time – it goes like this: Divide 72 by the inflation rate, and the result is how many years of that inflation rate it would take for the value of your money to halve.

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The recent rise of inflation leaves many retirees with difficult decisions on how to protect their retirement savings while covering their costs of living. For example, if you’re exposed to markets, you’ve seen your portfolio fluctuate in value and may suffer what’s known as “sequence of returns risk,” where you’ve essentially sold your holdings at market lows, leaving less for an eventual bounce-back. On the other hand, if you’ve played it safe and held your savings in bank accounts yielding little to no interest, you’re looking at high rates of erosion from inflation.

2. The Cost of Inflation

Retirees’ sources of income tend to be vulnerable to large inflation spikes. Employees can at least make the case for inflation-based raises, but retirees don’t have that option. If you’re a retiree, most of your income is likely either tied to markets or is in fixed income, two sources that are highly affected by inflation.

Pensions are a mainstay of retirement income for many. But this source of income is struggling to match pace with inflation. Most private pensions don’t offer cost of living adjustments, or COLAs, which means that if you’re a retiree relying on pension income, you’ll receive the same payments regardless of their diminishing value.

While Social Security does offer COLAs, the last increase was 5.9%, which falls short of the 8% to 9% increase in prices we’ve seen over the past 12 months, according to the CPI (opens in new tab). Because of this, retirees relying on Social Security could see insufficient income for the rest of 2022.

Retirees often turn to their savings to get them through retirement. But when inflation occurs, the purchasing power of your savings diminishes, leaving you to withdraw larger amounts of savings to cover your costs of living, effectively shrinking the lifespan of your retirement savings. Similarly, many retirees also utilize certificates of deposits (CDs), which lock up their funds for a fixed amount of time in exchange for interest payments. Many turn to CDs as a safe, market-neutral investment, but some CD arrangements can last many years, tying up funds you may need to get you through this inflationary period and offering fixed rates that don’t match inflation. Plus, withdrawing these funds prematurely can leave you paying hefty penalty fees.

But on the other hand, inflationary periods can sometimes coincide with market volatility and downturns. The S&P 500 saw roughly a 20% decline from Jan. 3, 2022, to July 1, 2022. If you were relying on IRA distributions within that period, they may have left you taking larger distributions when markets were at relative lows, meaning you withdrew a larger percentage of your portfolio. This phenomenon, known as sequence of returns risk, leaves less of your principal amount to benefit from an eventual market rebound, ultimately shortening the lifespan of your IRA.

Ensuring that your income keeps pace with inflation is a must. But it’s also important to consider whether inflation will mean paying more in taxes. If you’ve opted for inflation-protected securities that yield you higher income, more income means more taxes, and in some cases, a higher tax bracket. Unfortunately, tax brackets don’t adjust in real time, so there may be a period in which your income is taxed at higher rates, despite it covering less of your expenses. Paying more in taxes can be another hidden cost of inflation.

3. Inflation Hedges to Protect Yourself

As mentioned, inflation-protected securities can be a way to keep your income on pace with inflation. Treasury Inflation-Protected Securities, commonly known as TIPS, offer an interest distribution rate that keeps pace with the CPI inflation rates. This investment vehicle has helped retirees mitigate inflation and maintain their quality of life through retirement without worrying about outliving their savings.

However, inflation-protected bonds aren’t for everyone. If you seek wealth preservation as opposed to increased income, there are other asset strategies that will achieve those goals without income taxes. Consider including in your portfolio certain stocks and sectors related to precious metals, mining, commodities and commodity production, such as food, oil and gas. Holding your assets in these sectors has historically provided wealth protection without increased taxable income through inflationary periods.

Annuities, an insurance product for retirement savings, are another option that can provide you with inflation protection without sacrificing market exposure or sequence of returns risk. Annuities are often customizable based on what your personal risks are as well as what you’re concerned about in the market.

The Bottom Line

Retirees and their savings face a tough road ahead due to inflation. Income sources for retirees are largely inflation-exposed, and their spending habits tend to be on products and services impacted by inflation. But there are plenty of strategies out there that can keep your retirement on track, whether you’re looking to protect your wealth from the erosion of inflation or increase your income to keep pace with it.

Investing in inflation-protected securities, asset sectors that are historically inflation-resistant and financial insurance products, such as annuities, are all potential strategies that could help you weather the storm of inflation.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Rick Barnett, Certified Estate Planning Professional
Founder & CEO, Barnett Financial and Tax

Rick Barnett is president and founder of Barnett Financial & Tax, a one-stop financial hub for clients in Michigan and beyond. He hosts the "Barnett Financial Hour" radio show and often serves as a source on local TV news stations. His professional designations include Certified Estate Planning Professional (CEPP), Masters of Estate Preservation (MEP) and Christian Financial Consultant and Advisor (CFCA).