What to Do About Inflation? How Are People Adjusting Retirement Plans in the Face of Rising Costs?

Inflation. It has not been a problem for the last four decades. However, it is here now and more persistent and perhaps problematic than many experts had predicted only a few months ago. So, what to do about inflation?

What is Inflation?

Inflation represents an increase in the cost of goods and services. Put simply: When there is inflation, things cost more.

Why is Inflation Particularly Concerning to Retirees?

Inflation is not necessarily a primary concern if your income is keeping pace with the increase in prices. However, it can be a big deal to retirees who are living off of a fixed set of resources.

While inflation refers to the fact that things cost more, it also represents a decrease in the value of saved dollars. When inflation rises, it means a decline in the purchasing power of money.

Let’s say you plan to retire next month and had planned to withdraw $5,000 a month from your savings to cover your expenses. However, with inflation at 7.5%, the purchasing power of your $5,000 is no longer $5,000. You now need an extra $375 to buy what you had planned to buy. Over 12 months, that means an extra $4,500. You now require more money for retirement than you had anticipated.

The value of your savings is less because it takes more money to purchase what you had planned to purchase.

What to Do About Inflation?

Recently on the NewRetirement Facebook group, we asked members what they are doing about inflation. How are they adjusting their financial plans for rising costs?

Here are the results:

48% Are Not Doing Anything Different

What to do about inflation? Absolutely nothing say many.

Almost half of the 277 respondents are not doing anything differently in the face of inflation. As Michelle wrote, “Honestly? I’m mostly ignoring it.”

Is this a case of burying your head in the sand? A sane reaction to what might be a transitory or temporary phenomenon? Or, something already planned for?

Here is possible rational for staying the course:

Rates of Return Are Still Outpacing Inflation

Based on comments in the survey, many people are able to stay the course is because investments are doing well. Steve wrote about why he is not doing anything different: “Just cruising along in retirement. High-yield portfolio paying off handsomely.”

And, it’s true. If your money is earning a rate of return that is higher than inflation, then you are keeping pace with or even outpacing the problem.

Inflation May Be Transitory

Many economists still believe that today’s inflation is just a blip as we emerge from the pandemic. And, a temporary bump in prices may not be a big enough road block to cause a shift in behavior.

Reserves

Many people who plan for retirement have back up plans, including reserve funds for spending overages.

42% Are Reducing Spending

A large percentage of survey respondents are reacting to inflation by reducing spending to only essential items. This is a natural economic response and reducing demand can sometimes help to bring prices down.

According to the latest inflation report. The biggest recent price increases are seen in fuel, food, and housing, particularly rentals. In many cases, these are areas where households can reduce.

So, many people are eliminating luxuries, cooking more at home, buying store brands and finding other ways to reduce spending.

Housing is a category where you can reduce spending by a lot.

The good news? For retirees, reducing spending does not necessarily represent a reduction in quality of life. Jolene is enjoying her downsizing. She wrote, “We sold our too-big suburban home and changed our domicile to a no-income state. We are slow-traveling in countries like Bonaire, Panama, Portugal, and Spain where cost of living is lower and we have cut our health insurance cost by 50%.”

Bill is also enjoying life abroad. He wrote, “Retired to Ecuador where the cost of living is about a third of the U.S., and the rate of inflation is still under 2%.” He added that he was jumping off Facebook to go get his $2.50 haircut.

5% Are Adjusting Their Investment Strategy

A few people are re-balancing their asset allocations and purchasing i bonds, TIPS, or inflation linked equities.

And, real estate and commodities are investments that have intrinsic value and typically grow in financial worth during inflationary periods.

With regards to real estate, the value of the asset, the property, is keeping pace with inflation. And, if it is an investment property, then you are probably also able to raise rents.

Explore 8 ways to invest in real estate for retirement.

3% Are Focused on Income

Only a small percentage of respondents are trying to solve the inflation problem with increased income. However, working longer or getting a retirement job (especially with rising income) can be a great response.

Jim intends to simply maintain his job and delay retirement if inflation persists.

Delaying the start of Social Security is also a sane way to keep pace with inflation long term. The longer you wait to start Social Security, the bigger your paycheck will be. And, that money is guaranteed to at least somewhat keep pace with inflation.

Buying a future annuity is another way to have income that is guaranteed to keep up with rising prices.

Bob is both delaying Social Security and investing in an annuity. He wrote, “I am waiting until 70 to collect Social Security and am buying a QLAC through my IRA. I can spend $130k now at age 66 and get $45.7k a year at 85.”

Learn more about Qualified Longevity Annuity Contracts (QLACs), a type of annuity. (One benefit of annuities is that you can buy inflation protection on income.)

1% Are Increasing Debt or Slowing Debt Payments

Some people are “investing” in debt. They are taking on more debt now because if inflation persists, they will pay it back in cheaper future dollars.

Pat wrote, “I’m not taking on more debt but I stopped making extra principle payments on our mortgage.”

Dan says that he is buying his first home, as renting has become too expense.

This is a good idea. When you own real estate, you have an inflation protected asset – its’ value will likely go up with inflation. And, when you purchase real estate with a loan, inflation will mean that you pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers.

The average home loan is currently well below 4%. And, inflation over the past year is above 6%. At those rates, the effective real interest rate is negative. The relative cost to pay back the loan has gone down.

The Best Way to Deal with Inflation? Have a Plan

What to do about inflation? Something? Nothing? You won’t know unless you have a plan.

You should know what will happen to your finances if inflation rises by 2% or 20% over various time periods. (NOTE: What is important for retirement plans is a long term average for inflation, not necessarily a bump in any one month or year.)

NewRetirement’s Retirement Planner gives you both optimistic and pessimistic controls for inflation rates on general spending, housing, and medical costs. It is a good idea to run scenarios at different inflation rates and assess your lifetime financial security in different conditions and develop back up plans (like those above) for inflationary circumstances.

Plus, you can see if you have reserves to cover you through inflationary periods and run scenarios at various rates of return, try out real estate investments and more.

The NewRetirement Planner is the only tool online to give you this kind of flexibility. It is a great way to build confidence in your ability to fund the future you want to have.