Inflation has been all over the news lately. And even if you’ve just skimmed the headlines, you’ve probably seen that prices for some everyday items are starting to go up.
It happens, right? (If you’re looking for a quick economic refresher as to why inflation is a thing, this “What is Inflation?” article could be a helpful read.)
Inflation means that prices are going up and your money buys less over time. When money’s worth less, you burn through more of it to cover price increases.
If you think about inflation’s impact on the money you’re saving for retirement, it can almost feel like a double whammy because inflation means that prices are going up and your money buys less over time. When money’s worth less, you burn through more of it to cover price increases.
A few dollars here and there might not seem like a lot, but if you think about all of the everyday expenses you’ll have for all the years you’re retired (as well as other things you’d want to fund during this time like vacations or home upgrades) it can add up!
This can sound scary, but there are a few things that could help the money you’re saving for your second act put up a bit of a fight against inflation.
Ahead, we dive in to some strategies you could use.
Before calculating inflation’s potential impact on your retirement funds, let’s start with how much money you’ll need to save for retirement in the first place. A general rule of thumb is that you’ll need 80 – 100% of your pre-retirement income for every year you’re retired.
A general rule of thumb is that you’ll need 80 – 100% of your pre-retirement income for every year you’re retired.
Let’s say you retire at 65 with an annual income of $150,000. For this example, we’ll use 90% as the percentage of your income you’ll need in retirement.
Take that $150,000, multiply it by 0.90, and you’ll get $135,000 as your annual retirement income. If you live to 90, this would come out to well over $3 million!
Another thing to keep in mind is that your income and spending can change before you retire – lifestyle inflation along with traditional inflation, for example, can affect your budget.
So consider checking your progress every few years to see if you’re still on track to have enough set aside for the future.
A retirement calculator could help here because they consider several variables (like the age you plan on retiring and your projected monthly expenses) to suggest a dollar amount to aim for.
Some calculators may also factor in inflation. To find out, look through their methodology to see how they arrive at their calculations.
How you save money for retirement matters. Savings accounts and CDs have their benefits, but interest in these accounts adds up slowly.
Consider these two figures:
This is a pretty significant gap. It means that inflation could outpace the growth you might see in some savings accounts.
Here’s where the importance of investing comes in; using historical performance as a guide (which doesn’t guarantee it will work out the same way in the future), money that’s been invested over a long period of time has typically earned more than if would have sitting in a savings account.
And when it comes to inflation, history also shows that the S&P 500 has tended to beat inflation over time, by an average return of around 10%.
This long-term view is one reason why your time horizon matters. It’s also why if you have decades to put money into the market and ride things out, you may be encouraged to invest more heavily in a riskier type of asset like stocks, than say, bonds, which have historically offered lower returns.
Retirement accounts, like a 401(k) and/or IRA, are investment accounts and probably one of the first places you’ll put money aside for Life 2.0. (If you don’t have a retirement account you can learn about types of retirement plans here and why you may want a 401(k) in addition to your IRA here).
These accounts, however, may only be part of your investment strategy because there are annual contribution limits. In 2023, for example, you’re allowed to contribute $6,500 ($6,000 for 2022) to an IRA if you’re under 50.
While this pool of money is important for your future retirement income (and annual contributions may provide offer some tax benefits), if you would like to invest more money, you may consider additional investment options. For example, you may consider opening a brokerage account so more of your money may benefit from being in the market.
New to investing? This overview on investing in stocks, bonds and ETFs could help.
Your investment strategy may change as you get older. When you inch closer to retirement, you may see recommendations to put relatively less in stocks and more in investments whose value tends to go up as inflation rises.
These could include Treasury Inflation Protected Securities (TIPS), I Bonds, real estate investment trusts (REITs) or commodities like gold. A financial advisor could help you figure what might make sense for you.
Medical care is one of those things that doesn’t really seem to go on sale – ever see a 2-for-1 offer on X-rays? And when it comes to retirement, health care costs are an important expense to consider because the older we get, the more money we tend to spend on it.
In addition to taking up more of our budgets, medical costs also tend to get more expensive in general. Health Affairs, a peer-reviewed health policy journal, predicted in 2020 that out-of-pocket health costs will increase about 4.1% between 2021 and 2023 – for everyone, not just older Americans. And it doesn’t include inflation.
But a little planning may be able to soften health care’s impact on your retirement funds.
Unlike investing, where your goal is to get a high return, the health care strategies here are more about finding ways to save money outright (such as through an HSA) or getting help with paying for costs (think Medicare). Here are some consider:
Max out HSA contributions if you have one: This may not be an inflation hedge per se, but a Health Savings Account can help you set aside money to use on certain health care costs during retirement. Money in HSAs earns tax-free interest and you won’t pay taxes on withdrawals as long as you use the funds for approved health care expenses.
In 2023, you can contribute $3,850 ($3,650 in 2022) to your HSA if you have a high-deductible health care plan and are single, and $7,750 ($7,300 in 2022) if coverage is for a family.
Stay on top of Medicare: Medicare is federal health insurance you can sign up for once you turn 65. It can be used in conjunction with other health insurance and can help cover medical costs. However, it’s important to enroll when you first become eligible because premiums may be higher if you enroll late.
Explore long-term care insurance (or alternatives) long before you retire: Again, this tip may not directly address inflation, but it could be a way to stretch your funds. Long-term health insurance and related types of coverage can help pay for care that could pop up as you age, like adult daycare or staying at an assisted living facility, among others.
Considering long-term health coverage early – meaning maybe your early sixties – is important because the cost rises as you get older.
Applying too late (think late 70s early 80s) could backfire because you may not be able to get coverage.
Although we’ve been focused on retirement, the reality is that inflation affects the value of all of your money. This includes coins in piggy banks and money you’re setting aside for near-term goals, like buying a second home or college tuition.
It could also impact longer-term goals like setting aside funds for family or a favored charity. To get ahead of inflation, you could use different types of savings strategies like we described here. You could even try to build in 2% to 3% inflation gap into your targets.
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