A Close Look at the Impact Retirement Accounts Can Have During Times of Inflation
June 17, 2021
5 minutes to read
This story originally appeared on The epoch of time
Inflation rose 5% from May 2020 to May 2021, as reported by US Bureau of Labor Statistics. The projected inflation for the coming year can be found at 2.26 percent. Yet those who save for retirement and considering their future often feel nervous.
Maybe rightly so. “While a moderate and constant level of inflation is generally considered a sign of economic health, rapid price increases can have a destabilizing effect on an economy and jeopardize a hard-earned retirement. savings, “said Thomas J. Brock, financial advisor at Best Small Business Loans. “Over an extended period of time, the result can be devastating, financially and emotionally.”
To mitigate the risks associated with inflation and saving for retirement, it can be helpful to understand how inflation works, as well as its impact on long-term savings and spending. Here’s a quick rundown of what inflation is, how it affects retirement accounts, and what you may need to consider in times of inflation.
What is inflation?
“Inflation is defined as the period-over-period increase in the price of goods and services commonly used in an economy,” explains Brock. Think about what you paid for a restaurant meal or a tank of gas ten years ago. Then consider what you spend today on that same meal or that same tank of gas. Over time, prices tend to increase, and this increase reflects inflation.
Not all sectors react to inflation in the same way. In a typical household, “some expenses are directly affected, others less and others not at all”, explains Drew parker, the creator of The Complete Retirement Planner. For example, if you have a fixed rate mortgage, your monthly payments will usually be based on that interest rate. Thus, they will generally not change with inflation. The same is true for other payments based on fixed interest rates, which may include payments on a personal loan or a car loan.
Other expenses, such as groceries, utilities, travel expenses, and rent can increase in times of inflation. As interest rates rise, the amount you will need to repay when you take out a new loan may also increase. To cover the costs, consumers usually look for ways to cut some expenses to pay for others, earn more income, or find other ways to reduce their lifestyle.
Inflation and retirement
Inflation-related price increases are often felt primarily by those living on a fixed income, such as retirees. “Over a typical 25-year retirement period, a 0.25% increase in inflation could easily represent an increase in costs of around $ 200,000,” Parker explains. This means that if you start to retire expecting an inflation rate of 2.75% over a 25-year period, but you are facing an inflation rate of 3% (representing an increase of 0, 25%) over those 25 years, the change could cost you hundreds of thousands of dollars.
For those saving for retirement, paying attention to inflation rates can help you choose investments and make financial plans. “If inflation hits 3% a year, you want your retirement account to surpass that number,” says Chris Castanes, president of Surf Financial Brokers in North Myrtle Beach, South Carolina. “If your savings account or money market account is only earning you 1% to 2%, then you are not keeping up with the rate of inflation. “
Make retirement decisions
If you are living in retirement, it can be helpful to monitor inflation rates and periodically meet with a financial advisor to review your financial situation. If you find that inflation is on the rise, you can adapt to deal with the changing environment. “Maintaining a flexible budget, in which you temporarily adjust living expenses downward during tough times, can be very beneficial,” says Brock. In doing so, you can pay attention to the prices in your area as they may be different from the costs in other places. While the price of fuel may go down in your area, for example, healthcare costs could go up. You can look for ways to reduce transportation costs or travel less, while allocating more funds from your budget to necessary medical expenses.
In anticipation of retirement, you may be able to adjust your savings and accounts to prepare for higher inflation. “Your retirement portfolio can be proactively designed to protect you against inflation,” explains Brock. You could talk to your financial advisor and consider diversification to protect your funds. Some of these options may include the allocation of investments in different assets such as gold or real estate. You may also hear about incorporating Inflation Protected Treasury Securities (TIPS) into the fixed income portion of your retirement plan. “These high quality US government bonds are indexed to inflation, which protects investors from a decline in the purchasing power of their money,” said Brock. Other ways to diversify could include allocating funds to certain stocks like stocks. Before making a decision, you’ll want to consider your retirement timeline, review your current financial situation and future expectations, and then fully research the options available.
By Rachel Hartman