Inflation and Retirement Savings
What You Need to Know
Many clients try hard to save enough for retirement.
Fewer have defenses against inflation in place.
Some annuities offer features that can help the holders increase their income over time.
Inflation is top of mind for many people lately. With the Consumer Price Index hitting 40-year highs, your clients could be wondering how high it will go.
According to the Bureau of Labor Statistics the CPI rose 7% last year. That’s the largest 12-month increase since the period ending June 1982.
Energy prices jumped a staggering 29.3% over the past 12 months, and food prices increased 6.3%.
Those numbers are eye-popping for many Americans, with 74% saying life hare concerned about their purchasing power over the next six months, according to a the 2021 Q4 Allianz Life Quarterly Market Perceptions Study, which was based on an online survey, of 1,004 respondents ages 18 and older, that was conducted in December 2021.
The Savings Erosion Threat
The return of inflation is particularly concerning to retirees who, could lose purchasing power throughout retirement, or risk erosion of their retirement savings.
Over the past 20 years the CPI rose on average by 2% per year.
At a modest 2.5% rate of inflation, costs would double in about 28 years — and living 28 years after retiring is entirely possible, with people living longer and retirements stretching 25 to 30 years.
How much savings erosion a client can experience due to rising costs varies widely by individual.
Exposure is based on a number of things such as longevity, overall expenditures, and related inflation during retirement years.
Income Increase Tools
Many clients worry about whether they have “enough” saved for retirement.
A more compelling question is whether they have a strategy in place for increasing retirement income.
The following are some of the different asset types, as well as their ability to produce increasing income and relative risk associated with relying on those assets for increasing income:
Equities (high risk): Equities tend to have market volatility and sequence-of-returns risk. They are unpredictable. But, in the past, they have generally kept up with inflation over long periods of time.
Real Estate (high risk): The housing bubble may still make people nervous, and some people can’t afford to invest in real estate or don’t want to be landlords.
Bonds (moderate risk): Increasing interest rates tend to devalue bonds. The potential for rates to increase in the future is causing many to shy away from bonds.
Earnings from work (moderate risk): Retirees who work can get raises, but the ability to work may last for only a portion of retirement.
Pensions (low risk): These may or may not have cost-of-living adjustments (COLA).
Social Security (low risk): The benefits have COLAs.
It’s notable that, while some sources of low-risk increasing income, like Social Security, have COLAs, those increases apply only to that income source, not to the client’s other sources of income.
What’s more, a COLA doesn’t always keep pace with inflation. The 2021 Social Security COLA was 5.9%, for example, but the 2020 COLA was only 1.3%.
The difference between the COLAs and the inflation rate means that there is often a gap between a client’s income and inflation-impacted expenses over time.
