How Inflation Impacts Your Retirement Income

Most Americans probably consider inflation in the short term when they go to the grocery store to buy food or fill up their vehicle with fuel. Not only does inflation affect the prices of consumer goods in the short-term, but inflation must also be considered when planning for costs in the future.

On an individual level, the inflation rate affects how much your retirement dollars will really be worth. Over time, inflation can seriously devalue your savings and income. Understanding how inflation may hurt your retirement strategy is a must for ensuring that you have enough assets to last through your later years.

Key Takeaways

  • Inflation has a direct impact on the revenue, savings, and spending of all consumers, including retirees.
  • The federal government uses inflation as a benchmark when deciding to increase contribution limits to qualified retirement plans or raise monthly Social Security benefits.
  • However, pensions may or may scale with inflation, and private companies often have internal policies about how and when to implement cost of living adjustments.
  • The primary concern for retirees is how inflation affects how they can spend their money on important necessities such as healthcare, travel, and leisure - all of which likely cost more during inflationary periods.
  • Retirees can diversify their revenue streams, allocate their savings wisely, and make mindful spending choices to protect against rising costs.

Retiree Sources of Income

First, let's talk about how retirees pay for expenses when they're no longer working. Not all sources of income are the same, and some provide better protection against inflation compared to others.

Social Security

Approximately 79% of all retirees in the United States claim Social Security benefits as part of their source of income during retirement. A wide majority of older retirees depend on it, as 93% of retired individuals aged 65 and older claim Social Security.

An absolutely critical part of Social Security is the annual evaluation of the inflation index to protect beneficiaries from the loss of purchasing power. Every year, Social Security benefits are evaluated against price indexes. Year-over-year changes to price indexes are used to calculate the cost of living adjustments and further affect the benefits awarded by the Social Security program. Historically, the cost of living adjustments have been seen as widely inadequate; The Senior Citizens League estimates that Social Security Benefits have lost 1/3 of their purchasing power since 2000.

Between January 2000 and January 2020, Social Security benefits increased 53%. A study by The Senior Citizens League estimates the cost of goods and services typically purchased by retirees increased 99.3% during the same period.


Over half of all retirees collect pensions, and 68% of retired individuals age 65 and older collect pension benefits. There are several ways pensions are negatively impacted by inflation.

First, pension plan benefits are usually tied to the last several years' salary rates earned by the employee. If high inflation occurs during the last years of a retiree's career, their benefits may be negatively impacted as the benefits are partially based on pre-inflation salary figures. If inflation occurs after the retiree is done working, all of their benefits are based off an outdated salary that may not reflect the current market rate for their old job.

Second, pension benefits may or may not adjust for inflation. The National Association of State Retirement Administrators estimates that 75% of pension plans sponsored by state or local governments provide some coverage of cost of living adjustments. Meanwhile, private pension plans often do not offer cost of living adjustments. Without spending any money, a retiree's income source may be negatively impacted if they only rely on their pension income.

Interest, Dividends, or Rental Income

Passive forms of income such as interest, dividends, or rental income sometimes move in line (at least directionally) with inflation. However, each have interesting ties to rising costs. It's estimated that 46% of all retirees collect at least one of these three sources.

Interest rates usually rise when the Federal Reserve implements increases to the federal funds rate as a way of combating inflation. Inflation itself does yield higher interest revenue, but government action to fight it often does.

Dividends are the results of companies paying out a portion of their net income to investors. When high inflation occurs, the Federal Reserve may decide to raise the federal reserve rate. By raising interest rates, it makes obtaining credit more expensive and it attempts to make the economy cool off. In general, the government is intentionally trying to slow down the economy when high inflation occurs. Therefore, if the economy slows, companies may generate less earnings and have less income available to distribute dividends.

Rental income is often a strong income source during higher periods of inflation. If leases are locked into semi-short terms (i.e. no greater than one year), landlords can decide to raise rent at the end of the lease term. Long-term leases may be locked into unfavorable terms that can't easily be changed.

Wages, Salaries, or Self-Employment Income

After an individual retires, they may choose to pick up a part-time job, side hustle, or work for themselves. One-quarter of all retirees generate this type of income. Broadly speaking, there is no mandated cost of living adjustment for salaries or wages; companies often set policies on their own and decide what adjustments to make. On the other hand, government entities often have regulated requirements on evaluating payroll costs.

In 2022, all active federal works received a 2.7% pay raise, while retired federal government employees received an additional cost of living adjustment depending on which retirement system they were covered by.

Cash/Prior Savings

After a long, successful career, some retirees may find themselves with a large investment balance or high cash savings. While it's great to have a large amount of money on hand, retirees are at risk of the worth of non-yield-producing assets deteriorating. Consider that a dollar in 1983 would buy $0.37 cents worth of goods and services in 2021. With retirees possibly living four decades or more after they leave the workforce, they must be prepared to not only continue to earn income if they need it but preserve what they've already worked so hard to achieve.

Inflation Impacts on Retiree Expenditures

The primary concern for retirees is how inflation affects their purchasing power. This is true even if inflation remains low as retirees still spend money even if their income stream has decreased or stopped. The Center for Retirement Research at Boston College found retirees tend to consume less than when they were not retired, though this is heavily dependent on their income levels and health.

Thankfully for retirees, health care costs have historically been impacted less by inflation compared to other expenditure categories. From May 2021 to May 2022, the cost of medical care services increased 4.0%. However, total health spending in the United States has been increasing. From 2019 to 2020, total healthcare spending was up 9.7%, more than double the year prior.

Retirees in good health with more time on their hands may wish to travel more. Unfortunately, airline prices increased 37.8% from May 2021 to May 2022, and gasoline was up nearly 49% over the same period. Even if the retiree is not directly paying for the good, they may be assessed passthrough charges (i.e. higher cruise prices due to higher operating costs).

Retirees often face the important decision of whether to sell their home and enjoy the flexibility of becoming renters again or keeping their home. Should retirees decide to part ways with their house, they must be mindful of escalating rent costs. In May 2022, rent expenses across the nation have increased 5.1% year-over-year. Not only may rent be a new expense for retirees, but it may also be a growing expense.

Last, a survey from the Employee Benefits Research Institute found that 45.9% of retirees spent more in the first two years after they retired than they did in the years immediately prior. Twenty-eight percent of households were spending 120% of their pre-retirement income over that same period, which suggests that some seniors may be experiencing lifestyle inflation. With more time on their hands, retirees may be tempted to spend more.     

Downsizing in retirement to a more affordable apartment or house may help seniors save money over time. If the retiree purchases a house for less than what they can sell their current house for, they may avoid having to pay rent while still relocating to an ideal housing situation.

​What Retirees Can Do to Curb Inflation’s Side Effects

While seniors can't directly affect the inflation rate, there are ways to minimize the shadow it casts over their retirement.

  • Reduce housing costs. Trading in a larger home for a smaller one, even if the mortgage is paid off, reduces the monthly outflow for property taxes, utilities, homeowners insurance, and maintenance. Retirees that are worried about future inflation may attempt to steer clear of converting from an owner to a renter.
  • Add inflation-correlated investments to your portfolio. As rent charges tend to rise along with inflation, real estate investment trust (REIT) or energy sector stocks, for example, may be better positioned to see their value grow in tandem with the inflation rate.
  • Diversify income streams. Some income streams will naturally increase due to inflation; others will remain stagnant. Retirees would do well to make sure they can obtain sources of income that are associated with cost of living adjustments. This includes moving away from fixed-income sources of income.
  • Calculate retirement needs as early as possible. By factoring inflation into what you will need, it's easier to plan, prepare for when to leave the workforce, and what type of lifestyle you'll be able to afford when consider price increases.

Just remember to balance stock investments with more conservative options, such as bonds, which are more predictable and tend to offer stable returns. Retirees may feel tempted to shift into riskier asset classes if they are afraid of inflation not causing them to have enough resources on hand. If this is your predicament, consider consulting a financial advisor for their portfolio allocation opinion.

Does Social Security Increase With Inflation?

Sort of. The federal government does use price indexes to determine cost of living adjustments for social security benefits. The price indexes have historically led to cost of living adjustments less than prevailing inflation rates, but the government does recognize that inflation deteriorates the purchasing power of Social Security benefits and adjusts accordingly.

What Will Inflation Do to My 401(k)?

Inflation has a complicated relation with your 401(k), and it largely depends on the assets you're holding. Inflation causes company revenue to increase, but it also often escalates the input costs to manufacture, distribute, and market products.

Your 401(k) is more likely to be impacted if and when the government acts against inflation. By raising interest rates, bond prices fall, companies find it more expensive to raise debt, and real estate leases turn unfavorable when locked into very long-term leases. Alternatively, commodity prices may raise along with inflation, and specific government bonds may be pegged to inflation rates. There are ways to shield your 401(k) against inflation, though there are ways it can also deteriorate.

What Should I Do With My Money During Inflation?

This question is best poised for a financial advisor. Many will suggest considering Treasury Inflation-Protected Securities or short-term bonds. Some may recommend considering real estate investment trusts tied to short-term leases. Others may also suggest alternative assets that have a positive correlation to inflation such as gold or commodities. Be mindful that any decision you make to protect against inflation may have residual impacts regarding other considerations for your portfolio.

​The Bottom Line

Inflation can be a retirement killer, but it doesn't have to be for seniors who take the time to develop a plan for beating it. Reducing spending, creating a realistic retirement budget, adjusting asset allocations, and being mindful of revenue streams can all help to soften the blow inflation may give to long-term savings.

Article Sources
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  1. Board of Governors of the Federal Reserve System. "Economic Well-Being of U.S. Households 2020 - May 2021."

  2. The Senior Citizens League. "Social Security Benefits Lose 30% of Buying Power Since 2000; No COLA Likely For 2021."

  3. National Association of State Retirement Administrators. "Cost-Of-Living Adjustments."

  4. Federal News Network. "What If Your Next Pay Raise Is a Retiree COLA?"

  5. Federal Reserve Bank of St. Louis. "A Dollar's Worth: Inflation Is Real."

  6. Center for Retirement Research at Boston College. "Do Retirees Want to Consume More, Less, or the Same As They Age?"

  7. U.S. Bureau of Labor Statistics. "Table 1. Consumer Price Index for All Urban Consumers."

  8. American Medical Association. "Trends in Health Care Spending."

  9. Employee Benefit Research Institute. "Change in Household Spending After Retirement: Results from a Longitudinal Sample."

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