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Retirement

Retirement Planning

How to Inflation-Proof Your Retirement as Prices Continue to Rise

A retiree's beach chair that is in the shape of an upward arrow (representing inflation)

Kiersten Essenpreis for Money

The cost of everything is rising, from groceries to gas.

The reopening of the economy means that consumers are finally spending more money on goods and services, driving inflation up to 5.3% in August compared to a year earlier. In late August, the Office of Management and Budget said it expected consumer prices to jump 4.8% in the fourth quarter from a year earlier, more than double the Biden administration's May forecast.

These high numbers mean Social Security recipients can expect a bigger-than-average boost to their benefit next year. The Senior Citizens League is predicting a 6.0% to 6.1% cost-of-living adjustment for 2022, and while that might come as welcome news, it's too late to help the millions of retirees who have been coping with this year's price increases on the meager, 1.3% raise they got for 2021.

If you’re planning to retire soon, all this inflation talk could have you spooked. Here’s what you need to know.

Is inflation here to stay?

Some Republican lawmakers blamed the Biden administration for the rising prices, saying that high government spending under President Joe Biden and Democrats led to the surge in inflation. But economists and Federal Reserve Chair Jerome Powell pushed back, arguing that high prices were due to supply chain issues that will eventually be resolved. What's more, since prices in categories like travel fell so much when the pandemic hit, the inflation figures in those categories look disproportionately larger now that they've rebounded with the economy.

But some experts say that while inflation might not continue at the heightened levels we've seen in recent months, the Fed may be downplaying the situation.

Prices continue to rise and inflation may be here to stay, due to a combination of the federal government's increased use of printing money to pay for what it spends over the years, and its growing deficit, says Laurence Kotlikoff, professor of economics at Boston University. (More money means more demand from consumers, and when there isn’t the supply to match that demand, prices go up.)

While the transitory components that are bumping up inflation currently may dissipate, we will unlikely go back to the 1% to 2% levels we've been seeing, says Shang-Jin Wei, a professor of finance and economics at Columbia Business School. The likely scenario, he says, is closer to 2% to 4%.

But even thinking about inflation, or worrying about it, may be new to some people, thanks to the low rate we've enjoyed for years.

"Inflation has been such a non-issue for so long until recently that people just aren't used to really dealing with it, so even if inflation isn't extremely high, but just higher than it has been in the recent past, it's something investors will have to pay closer attention to," says Amy Arnott, a portfolio strategist for Morningstar.

Retirees, especially. Over the last 30 years, retirement savers have enjoyed tailwinds because market returns have been so strong and inflation has been low, Arnott adds.

But even if the inflation isn't as drastic as what we've seen this year, prices do inevitably go up. If you’re nearing retirement, you need to be prepared.

What does inflation mean for retirees?

Yes, higher inflation means higher costs in retirement, a time during which your income will likely decline. But the problem may be more dire than just a bigger bill at the grocery store or gas pump each week. It's the fact that your income might not keep pace with these increases.

Social Security benefits have lost more than 30% of their buying power since 2000, according to a study by The Senior Citizens League’s (TSCL). The Social Security Administration (SSA) increases benefits each year based on cost of living, and in 2020, that adjustment was just 1.3%.

But the way the cost-of-living adjustment (COLA) is calculated doesn’t take into account the rising prices specific to older Americans, according to TSCL. COLA adjustments are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which specifically excludes retirees. Older adults, however, spend money differently. For example, health care is expected to be one of your largest expenses in retirement, with an average 65-year-old retired couple needing approximately $300,000 after tax to cover health care expenses, according to Fidelity. Health spending was around $1.4 trillion in 2000 and by 2019 had more than doubled to $3.8 trillion, and tends to grow at a faster rate than general inflation, according to a study from the Peterson Center on Healthcare and Kaiser Family Foundation.

CPI-W does not include many of the fastest growing costs of people over age 62, says Mary Johnson, a Social Security and Medicare policy analyst at TSCL. “That is a very big area of weakness in the COLA using the CPI-W," Johnson adds.

A bill titled “Fair COLA for Seniors Act of 2021,” introduced to the House of Representatives in July, would require that COLA calculations be based on the Consumer Price Index for the Elderly (CPI-E), which advocates say would more accurately reflect the actual costs older Americans face.

But, for now — and likely even if this legislation is passed, since most retirees can’t make ends meet on Social Security income and Medicare alone — you have to budget for rising prices on your own.

What should you do if you’re planning to retire soon?

Invest properly

Investors nearing retirement may find it tough to balance taking risk off the table, while still making enough money from their stock investments to be able to battle inflation in this low-rate environment. While specific adjustments to your portfolio should be made with your specific situation, goals and risk tolerance in mind, you want to ensure you have the right mix of bonds in your portfolio, and that you’re diversified into other areas like commodities and real estate investment trusts (REITs), says Calvin Williams Jr., CEO and founder of financial planning firm Freeman Capital.

Therefore, your bond allocation doesn't need to be as large as previous generations'. While a portfolio of 60% stocks and 40% bonds has long been a go-to investing strategy, with today's bond worries, that 40% in bonds may not be as safe as you think. Some near-retirees should have 50% or less of their portfolios in stocks, while others should have much more aggressive portfolios — and it all depends on your needs, writes Christine Benz, Morningstar's director of personal finance. If you're looking to trade out some of your bonds, experts recommend dividend stocks and pass-through securities (a pool of fixed-income securities) as ways to live off your savings in low-yield environments.

Consider allocating some of your fixed income holdings to Treasury Inflation-Protected Securities, or TIPS, Arnott says. TIPS are treasury bonds that protect against inflation.

Work as long as you can

Working will of course increase your income, helping you keep up with inflation, but it also impacts your Social Security benefits. While you can begin receiving your retirement benefit as early as age 62, your benefit amount will be reduced if you don’t wait until your full retirement age, which is now 67 for those born in 1960 or after. For example, if you were born in 1960, your retirement benefit will be reduced to 70% of your full amount if you start receiving the money at age 62. You'll get more if you wait: That figure goes up to nearly 87% if you wait until age 65 and 100% if you wait until age 67. You can calculate how much your benefit will be reduced if you retire early, via the SSA’s website. Working longer also allows your retirement savings to grow, since you're living off wages, not portfolio income.

Budget for higher costs

Many people know to factor in the likelihood of additional health care costs as you age, but don't forget that the costs you pay service providers for fixes like home repairs may also become higher than you’re even used to paying today, Johnson says. Experts suggest to expect between 1% and 4% of your home's value for maintenance costs annually.

And always have a cushion for when the unexpected happens, like your car breaks down or a tree falls on your house.

“Have enough money set aside that's liquid that you will be able to meet emergencies or necessary expenditures even when there is an inflationary period going on,” Johnson says.

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