A gift of $ 1,404 for some, a retirement barrier for others

Inflation rarely creates a positive connotation. And rightly so. The concept that a dollar will be worth less tomorrow than it is today is a scary thought. Hyperinflation can bankrupt an economy – or, in the case of 1920s Germany, sow the seeds for war.



a hand holding a piece of paper: Inflation: A gift of $ 1,404 for some, an obstacle for others in retirement


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Inflation: A gift of $ 1,404 for some, an obstacle to retired others

However, moderate inflation isn’t necessarily a bad thing. In fact, inflation routinely rose above 4% during the economic boom of the 1950s. By the end of 2021, unemployment in the Federal Reserve will drop to just 4.5% and inflation to 2.4%. This could save US households in debt an average of $ 1,404. Here’s why rising inflation can be a good thing when you are in debt, but a bad thing when you are retired.



a hand holding a cell phone: several tiny 100 dollar bills in a person's hand.


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Several tiny 100 dollar bills in a person’s hand.

Why inflation is rising

In just one year, the US rose from practically 0% inflation and 15% unemployment to 2.6% inflation and 6% unemployment. There are several reasons for this.



Graph, line chart: US inflation rate


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US inflation rate

Low interest rates and stimulus checks make it easier to buy goods and services such as homes, cars, consumer goods, and much-needed vacations. The result: a spike in the real estate market (which is now hitting a 10-year high), not to mention a global chip shortage.

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With vaccine distribution well advanced and the U.S. economy coming back to life, demand for experiences that haven’t been felt in over a year outstrips supply. Baseball stadiums that are 50% busy have no sell-off issues so they can raise prices. Bars and restaurants that have had problems for months tend to raise prices and consumers are happily willing to do so. After skipping their annual 2020 summer vacation, many Americans are expected to let go this year, meaning companies like airlines, cruise lines, and resorts have the green light to raise prices.

A boon to those in debt

Price increases in various sectors of the economy are the essence of inflation. You and I are experiencing it right now. However, inflation coupled with low unemployment means that wages should rise too. As business improves, companies big and small try to hire more workers, which makes it easier to find a job or to stand up for a raise. In its March 2021 report, the National Federation of Independent Business (NFIB) found that 42% of business owners had a record high they couldn’t fill, 28% increased compensation (most in the past year), and 17% went to plan Increase in compensation over the next three months.

Rising wages illustrate the benefits of inflation in paying off debt. Let’s say someone making $ 20 an hour gets a 5% increase to $ 21 an hour. If inflation is also 5%, the cost of a baseball game could also go from $ 20 to $ 21. So it breaks off. However, the face value of the existing debt remains the same. If the same person has a fixed rate mortgage, student loan, or credit card debt, the actual cost of paying off that debt has decreased by 5%. Debt is simply an obligation to repay someone, usually in US dollars. If one dollar is worth less than it used to be, or if you make more money than it used to be, then you effectively owe less. As great as that sounds, remember that inflation is a double-edged sword that can hurt retirees as much as it helps debtors.

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A curse for fixed income retirees

While inflation can benefit those who borrow, rising inflation is usually very bad news for retirees. There are several important reasons for this.

Inflation is no friend of social security recipients

Most retirees rely primarily on social security as their main source of income. Benefits are supposed to be protected from inflation, but that was not the reality. Cost-of-Living Adjustments (COLAs) – also known as periodic benefit increases – are tied to the Consumer Price Index for Urban Wage earners and Office Workers (CPI-W). This price index underestimates how much seniors spend in key areas such as housing and healthcare. In both areas, prices tend to rise faster than the average.

Social Security COLAs have so poorly kept pace with the seniors’ actual inflation experience that the Seniors League estimates that benefits have lost 30% of their purchasing power over the past two decades.

And COVID-19 only made things worse because it changed the way people spend money, but the shopping cart of goods and services used to calculate CPI-W hasn’t changed accordingly. In fact, seniors received one of the lowest cost of living adjustments in years in 2021, despite their spending increasing in two key areas – food and housing costs. And the loss of purchasing power is only likely to continue or accelerate with rising inflation.



Chart, Line Chart: Chart showing Social Security COLAs over time.


© Diagram by author
Social security COLAs graph over time.

Savers are also hard hit by inflation

Retirees also rely on their savings as their main source of income. And if prices go up, they will either see a downgrade in their standard of living or have to withdraw more money from their retirement accounts – putting them in danger of draining their nest egg too quickly.

For example, senior citizens who follow the 4% rule will be informed by experts that they will not run out of money if they withdraw 4% of their account balance in the first year of retirement and increase the amount in each subsequent year by the rate of inflation. When the inflation rate is 2.6% instead of 0%, they’ll have to subtract much more from their accounts each year to maintain the same purchasing power – especially if their social security benefits also lose ground.

While it is easy to argue that when the economy is booming, their investment account balances will increase, it’s important to remember that seniors are usually conservative in investing, and for good reason – they don’t have time to look at downturns in the market waiting. While a conservative portfolio is a safe bet, it imposes inherent limits on the returns retirees can achieve.

How much could high inflation affect seniors? An older study found that with an inflation rate of 1%, seniors relying on average Social Security benefits alone would see a shortfall of $ 34,306 when retiring for 20 years. If the inflation rate climbs to 3% (which could very well be where we’re going) that shortfall jumps to $ 117,553. That’s a lot of extra money to be withdrawn from a retirement account (assuming seniors have one).

Unfortunately, there is little that retirees can do to reverse the rising inflation trend – but they can prepare for it. Seniors worried about the loss of purchasing power should consider exploring investments that can serve as a hedge against inflation while maintaining a balanced portfolio and budget that will allow them to maintain a safe payout rate.

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