From gas to health care, prices are rising, and while some costs may come back down, retirees need to prepare for fluctuating expenses in retirement. After all, it wasn't too long ago that inflation was around 8%.
Sure, your Social Security benefits will keep up with the pace of inflation, but your retirement savings, pension and other income won't, which can significantly affect your retirement lifestyle.
"Inflation is something that is constantly changing," said Chandler Riggs, CFP, VP and financial consultant at Fidelity Investments. As a result, "it should be a concern to retirees."
At last check, inflation stood at 3.3% in March, up from 2.4% in February. Where it's heading is unclear, which is why making sure your retirement savings are inflation-proof should be a top priority.
To ensure you're on the right track, ask yourself these three questions.
1. Is there enough growth in my portfolio?
During our working years, we focus on amassing a retirement nest egg and growing our portfolio, which often means taking on risk. But when we shift into retirement, preservation kicks in, and many of us become conservative.
However, being too conservative can backfire if our risk-averse nature results in an investment portfolio that doesn't keep up with inflation. That's why Riggs says the first question you need to ask yourself is: Is there enough growth in my portfolio?
"Inflation doesn't destroy a portfolio overnight; it erodes it slowly," says Riggs. Without enough growth, your purchasing power could diminish over a twenty or thirty-year retirement, making the risk of outlasting your savings real, she said.
How conservative is too conservative depends on how much you saved, how much you plan to withdraw each year, the lifestyle you envision, and your sources of income. If you have enough income to leave your investments alone for several years, you can be more aggressive than if you need your money in the short term.
Riggs says some people set aside money in an easily accessible "inflation bucket" that is outside their growth, and an emergency bucket to be used for any extra costs in retirement.
That will prevent sequence of returns risk, which occurs when you are forced to sell stocks in a down market early in your retirement to cover expenses. These often badly-timed withdrawals can be a permanent drain on your nest egg, making it difficult for your portfolio to fully recover when the market turns around.
"Having an inflation strategy is really important," Riggs said.
2. Can my spending withdrawal strategy sustain an increase in inflation?
Saving is part of retirement planning, but so is determining how you'll withdraw the money once you retire.
If you draw down too much too quickly and inflation rises, you could end up running out of money. That's why Annette Anderson, Sr. Wealth Consultant at Charles Schwab, says the second question you need to ask yourself is: Can my withdrawal strategy sustain an increase in inflation?
Anderson says retirees have to test their withdrawal strategy under different circumstances to see if their money will last twenty or thirty years. Start with 4%, the traditional rule of thumb, and then see what happens if you are forced to withdraw 5%, 6%, 7% or 8% a year due to rising costs.
Will your money last for three decades in those environments? If you can answer yes, you should be fine. If not, you may have to adjust your portfolio's risk or find areas in your budget where you can trim your expenses.
"If inflation does impact it, it's not a successful plan," says Anderson. "One has to make an adjustment somewhere in the savings or spending."
3. Is my retirement plan adaptable?
Inflation is a big question mark in retirement planning. It's one of the things that can throw your plan off course, especially if it jumps 8% like it did in 2022. That's why Riggs says the third question you need to ask yourself is: Is my retirement plan adaptable?
"Most inflation-resistant plans aren't rigid," said Riggs. "They are built to adjust as spending changes, as the market changes, as prices change and as life changes."
Just as the active "go-go" years of retirement require different spending than the later "slow-go" years, inflation could force you to spend more at unexpected times. You need a plan that can easily adjust.
If not, you may get anxious and react with emotion, leading to costly mistakes such as panic-selling stocks at the market bottom, moving your entire portfolio into low-yield cash, or canceling long-term insurance that you may need later on.
So, how do you ensure your plan is adaptable? Structure your strategy into a three-bucket framework — short-term, medium-term, and long-term — and make sure you hold one to three years of expenses in highly liquid vehicles, such as CDs, money market funds or high-yield savings accounts.
Additionally, review your portfolio once a year to ensure your asset allocation remains aligned with your risk tolerance and changing living costs. "Think through what you have and revisit your plan each year," said Riggs.
Building an inflation-proof retirement
Retirement isn't set in stone, nor should your saving and spending habits be. Inflation can crop up at any time, throwing a curveball to even the best laid out plans.
If there is enough growth in your portfolio, you have a withdrawal strategy that can handle rising costs, and you and your plan are adaptable, you should be able to handle whatever life throws your way.
Editor's note: This article is part of an ongoing series looking at three questions to ask yourself before making a major financial or lifestyle decision. The other stories in the series are: 3 Questions to Ask Before Deciding if a Roth Conversion Is Right for You, 3 Questions That Reveal If You're Actually Ready to Age in Place, and 3 Questions That Determine If You're Actually Ready to Retire Early.
