Inflation increased by 5 percent from May 2020 to May 2021, as reported by the U.S. Bureau of Labor Statistics. The projected inflation for the coming year sits at 2.26 percent. Still, those saving for retirement and considering their future are frequently feeling nervous.
Perhaps rightly so. “While a moderate and consistent degree of inflation is generally considered a sign of economic health, rapid price increases can have a destabilizing effect on an economy, and they can jeopardize hard-earned retirement savings,” says Thomas J. Brock, a financial adviser at Best Small Business Loans. “Over a sustained period of time, the result can be devastating, financially and emotionally.”
To mitigate risks associated with inflation and retirement savings, it can be helpful to understand how inflation works, along with its impact on long-term savings and spending. Following is a brief look at what inflation is, how it can affect retirement accounts, and what you may need to consider when facing a period of inflation.
What is Inflation?
“Inflation is defined as the period-over-period increase in the price of commonly used goods and services in an economy,” Brock says. Think of what you paid for a meal at a restaurant or a tank of gas a decade ago. Then consider what you spend today for that same meal or tank of gas. Over time, prices tend to rise, and this increase reflects inflation.
Not all sectors react the same to inflation. In a typical household, “some expenses are directly affected, some less so, and some not at all,” says Drew Parker, creator of The Complete Retirement Planner. For instance, if you have a mortgage with a fixed rate, your monthly payments will usually be based on that interest rate. Thus, they will not typically change with inflation. The same is true for other payments based on fixed interest rates, which might include installments on a personal loan or auto loan.
Other expenses, such as groceries, utilities, travel costs, and rent may go up during times of inflation. As interest rates rise, the amount you’ll need to pay back when you take out a new loan could rise also. To cover costs, consumers usually either look for ways to cut back on some expenses to pay for others, earn more income, or find other ways to downsize their lifestyle.
