There are a number of factors that are taken into consideration while planning for retirement. These factors include your annual income, age, present and future goals, health, life expectancy, number of dependents, family’s needs, debt, and more which play a critical role in devising a retirement plan suited to your needs. That said, you also need to account for inflation as it can severely impact your corpus if left unchecked. Due to the continuously rising prices and the depreciating value of the dollar, inflation is affecting the financial plans of people saving for retirement. Be it the cost of housing, gas, beef, or healthcare expenses, everything is becoming more expensive. The COVID-19 pandemic did not help matters either. The inflation rate touched a high of 9.1% back in June ‘22 and averaged 8% over the last year until October 2022. A high inflation rate is detrimental not only to investors, but also to retirees as they have fewer means of earning money. It is advised that you reach out to a professional financial advisor who can offer you the right retirement planning tips to safeguard your retirement corpus from high inflation.
This article discusses the impact of inflation on retirement planning and what steps you can take to protect your retirement savings from inflation.
What effect does inflation have on retirement planning?
Inflation not only eats up your savings and reduces the value of your income but it also causes your expenses to shoot up. These factors can have an adverse effect on your retirement planning in the following ways:
1. Lowers your retirement plan contributions:
As the prices of goods and services rise due to inflation, your monthly budget also increases forcing you to reduce your other costs, such as savings and investments. While you may be able to lower your discretionary expenses such as eating out, travel, etc., you may not be able to do so with your non-discretionary expenses like rent, water, groceries, gas, electricity, etc. Due to this, you may have to skip contributing to your retirement plan, lower the contribution amount, or exit the investment prematurely. This may be a temporary measure but can have a significant impact on your overall returns at the time of maturity.
2. Adversely affects your net income:
Inflation reduces the value of money over time which causes an increase in your monthly expenditure. Your salary may remain the same but your spending power decreases. In addition, it is unlikely that an employer would offer a bonus or hike during a period of high inflation. In fact, there is a higher probability that you may end up losing your job. Several tech giants such as Amazon, Twitter, Meta, and more are laying off employees to reduce their costs. This scenario can affect self-employed individuals even more as they do not have any formal cost of living adjustment.
3. Reduces your investment returns:
To combat the impact of inflation, the Federal Reserve hikes the Federal Reserve rate to protect the economy. The subsequent rate hike has a negative impact on companies and their earnings. This means that companies earn lesser revenues, which reduces their profit margins and, thereby, have less money to offer as dividends. In the end, you earn diminished investment returns due to a rise in inflation.
4. Affects your Social Security benefits adversely:
Every year the Social Security benefits are assessed and adjusted as per the Cost Of Living Adjustments (COLA). This exercise is carried out to protect people and their benefits from the rising costs of goods and services. As per a study, since the turn of the century Social Security benefits have lost one-third of their purchasing power over the past two decades. Having a period of high inflation can put a significant dent in your benefits check and force you to modify your budget in retirement.
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What retirement planning tips can you use to safeguard your retirement against high inflation?
To protect your retirement savings against high inflation, you can employ the following retirement planning tips:
1. Invest your money in investments that offer inflation-beating returns
Inflation if left unchecked can quickly eat away your retirement savings, thereby, it is critical that you invest your money in high-yield instruments that can generate inflation-beating returns. You can invest in real estate, currencies, commodities, high-yield bonds, cryptocurrencies, initial public offerings (IPOs), and more that offer high returns but carry significant risk as well. However, if you do not have a high risk appetite, you can invest in gold that offers a hedge against inflation. You can also consider investing in Treasury Inflation-Protected Securities (TIPS) that mimic the inflation rate in the country. The U.S. government issues TIPS which are a kind of U.S. Treasury bond. This investment option is inflation protected meaning with a rise in the inflation rate, the interest rates also increase and with a fall in the inflation, the interest rates also decrease.
2. Consider delaying your retirement or working on a part-time basis during retirement
If you are planning for retirement or are already retired, you may want to consider delaying your retirement by a few years if the country is experiencing a high inflationary period. Since inflation can deplete your savings, it is critical that you keep earning money otherwise you risk running out of money during retirement. For example, if you were planning to retire in 2022, you may be better off delaying your retirement by a few years due to the unusually high inflation rate of 8% over the past year. Doing so would allow you to earn more money and grow your retirement corpus. If it is not possible for you to work on a full-time basis, you can opt to work for limited hours. You may not earn as much but you would still be able to contribute to your corpus and meet your monthly expenses.
3. Build a diversified investment portfolio
Financial experts advise both new and old investors to diversify their investments. This helps protect against market volatility and ensures the investor can enjoy optimal growth at minimal risk. You can diversify your portfolio by investing in international stocks and bonds. You receive exposure to another country’s growth prospects that can help counteract losses from domestic stocks. Pick international stocks based on the company’s fundamentals, core principles, government policies, the country’s demand and supply situation, and more. Take care to diversify your international holdings as well by investing in different market capitalizations, sectors, etc. When it comes to international bonds, you can earn dividends at a steady clip allowing you to build your retirement fund at low risk. International bonds are similar to domestic bonds except for the fact that they are issued in a different currency. Further, before investing in international stocks and bonds, ensure that you understand the ensuing taxation rules and the risk involved in the said investment.
4. Lower your expenses
Cutting back on your expenses can enable you to save more money for retirement and prevent your monthly budget from spiraling out of control in times of high inflation. In a high inflationary period, meeting essential expenses can be tough let alone non-essential ones. To keep your expenses in check, create a budget and stick to it. Keep an eye on every dollar that you spend and try to inculcate financial discipline. Postpone any discretionary expenditure such as a vacation, a new car, etc. to another time. Further, prioritize spending on retirement contributions, debt repayments, and health insurance premiums. These are essential expenses that should not be deferred or cut back on. Skipping or reducing your retirement contributions can affect your future financial security while not paying health or life insurance premiums can leave you in a precarious position should you suffer a health emergency or an untimely death. Not to mention you would have to pay a higher premium if you invest in health or life insurance in your 50s or 60s. Lastly, if you miss out on repaying your debt, doing so will lower your credit score and it will be harder to secure a future loan.
5. Consider downsizing your home
Downsizing can be hard for families and children and may also have a bearing on your social standing. That said, if you move to a smaller home you can cut back on your expenses significantly. You can lower your maintenance expenditure and perhaps even do a garage sale to earn some extra money. You can also use the opportunity afforded by downsizing to move to a more modest neighborhood having lower rent, quality schools, affordable supermarkets, etc., or to a location preferably near your place of work to save money otherwise spent on commuting. Retirees may consult with a professional if they are thinking of downsizing. The advisor can assess the value of real estate in their present area of residence to figure out if the prices are rising or falling. If the value of real estate is going up, selling your property and moving to a more affordable city or state can prove to be helpful to cover the gap caused by inflation. At the time of making this decision, do not neglect to compare the taxes of different states and pick one that best matches your needs.
6. Consult with a professional financial advisor
A financial advisor can help navigate any twists or turns caused by inflation in your retirement planning. They can assist you with budgeting, tax planning, estate planning, buying insurance, investment planning, and more. In addition, the advisor can help you downsize or relocate to another state or city where you would be able to live comfortably in retirement. Hiring a financial advisor may seem like an additional expense, but it is critical that you understand their value and the fact that it is an investment for your future. A financial expert can help manage your finances and offer their years of experience to make informed decisions. You can hire a professional on an hourly, monthly, or annual basis, on a retainer, or for a one-time project.
To conclude
Every retiree wishes for a financially secure retirement where inflation does not play spoilsport. But it is likely that may not happen. This is why it is advised that you follow the retirement planning tips mentioned earlier to minimize your risk. A period of high inflation may be followed by one with low inflation, where you can afford to feel a bit more at ease. However, until that happens, it is advised that you remain vigilant with your money and not make hasty decisions. Moreover, you can also consider hiring a financial advisor who can help guide you on how to safeguard your retirement funds against inflation and generate steady returns during this period.
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