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Why Inflation Is Still a Problem for Today’s Retirees

The cumulative effects of inflation make retirement a lot more expensive than it used to be.

A photo collage of stacked coins with an upward arrow indicating inflation

There’s been good news on the retirement front. Fidelity recently reported that a record number of 401(k) accounts (485,000) on its platform held balances of $1 million or more as of the end of the first quarter. This total doesn’t reflect the entire retirement savings universe, either. Retirement accounts held by other major retirement plan recordkeepers such as Schwab, Vanguard, and Empower probably reflect similar trends.

What’s behind the soaring account values? A robust equity market in 2023 and the first half of 2024 has helped portfolio values climb back after both stocks and bonds suffered sharp losses in 2022. In addition, plan sponsors have helped employees become better savers by adopting features such as automatic enrollment, automatic savings escalations, and default investment options like target-date funds, which provide a simple, all-in-one way for workers to get a diversified portfolio with an appropriate asset mix for a given retirement date.

But not everything is sunshine and roses for retirement savers. In this article, I’ll explain why inflation is still a major problem for retirement spending and suggest some ways for retirees to mitigate that risk.

The Inflation Challenge

Inflation has shown some signs of moderating in recent months and is well below its recent peak of 9.1% as of June 2022. The Consumer Price Index measuring the cost of goods and services in the United States increased 3.3% over the 12-month period ended in May 2024. The market is currently pricing in projected inflation rates of about 2.2% over the next five years and 2.3% over the next 10 years, which would be about in line with historical levels.

But even if inflation continues to moderate, the negative impact of previous inflation surges will still be an issue. That’s because price levels almost never decrease; they just increase at a lower rate. That means that all of the previous growth in prices is still built into today’s pricing levels. On a cumulative basis, the Consumer Price Index has risen by about 22.5% over the past three years.

As a result, today’s retirees need to spend significantly more than they did three years ago for the same types of goods and services. Before the recent spike in inflation, a retiree might have been able to cover annual spending needs with an initial withdrawal amount of $40,000. But the same spending needs would now cost more like $49,000. Put another way, a $1 million retirement portfolio doesn’t go as far as it used to.

How to Handle Inflation Risk

There are a few ways to cope with this challenge. One option would be to postpone retirement for a year or two. By doing so, retirees not only can make additional contributions to retirement savings but also delay taking withdrawals from the retirement portfolio, allowing it to potentially benefit from market appreciation. Part-time work is another possibility.

People who would rather not continue working still have other options, though. One essential step is getting a more precise picture of your actual spending needs. Not every component of the Consumer Price Index has been growing at the same rate. Recently, for example, higher costs for rental housing have been a major contributor to overall inflation, while food and energy costs have been growing at a slower rate. Retirees who own their own homes instead of renting therefore wouldn’t have seen their monthly costs increase as much as the headline inflation numbers might suggest.

Following a more flexible approach to retirement withdrawals is another way to cope with higher inflation. Our recent research on safe withdrawal rates concluded that using a baseline of 4% of the portfolio’s value for an initial withdrawal amount and then adjusting for inflation each year is a reasonable starting point. However, other approaches to retirement withdrawals allow for significantly higher spending rates, as shown in the table below.

Spending Methods Summary

A table showing four metrics for several different approaches to retirement spending methods.
Source: Morningstar. Data as of Sept. 30, 2023. Data shown is based on results for a 40% stock/60% bond portfolio with at least a 90% chance of not depleting assets over a 30-year retirement period.

We estimate that the “guardrails” approach originally developed by financial planner Jonathan Guyton and computer scientist William Klinger would allow for a starting safe withdrawal rate of 5.2%. The actual spending method, which incorporates the average decline in spending that occurs over the retirement lifecycle based on empirical data, would allow for a starting safe withdrawal rate of 5.0%. Building a ladder of TIPS with staggered maturity dates would allow for a starting safe withdrawal rate of about 4.6%, while forgoing the annual inflation adjustment after a portfolio loss or keeping portfolio withdrawals in line with required minimum distributions both allowed for withdrawal rates of 4.4%.

Of course, all of these strategies involve trade-offs. For example, the guardrails and RMD methods both allowed for higher starting safe withdrawal rates, but at the expense of much greater variability in cash flows from year to year. Making gradual reductions in actual spending over time allowed for a higher initial withdrawal rate but led to a lower lifetime withdrawal rate. Another trade-off involves how much money is left at the end of the spending period. The base case and actual spending methods led to more assets that could be left behind for heirs or charity, while other methods are best for retirees who want to maximize consumption rather than leave behind residual assets.

Despite these trade-offs, a flexible approach to retirement withdrawals can help offset the negative effects of inflation in two (directly related) ways: It allows retirees to withdraw a larger dollar amount that can help cover higher prices on goods and services, and it reduces the portfolio savings needed to support retirement spending over a given period.

The strategies discussed above can help retirees mitigate the negative effects of inflation that has already happened, but future inflation is another potential risk. Social Security payments are indexed to inflation, which can help cover growing costs for goods and services. But retirees who expect to tap into their retirement portfolios for a larger portion of spending should make sure their portfolios include some type of inflation protection, such as TIPS and stocks.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

Amy C. Arnott, CFA

Portfolio Strategist
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Amy C. Arnott, CFA, is a portfolio strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. She is responsible for developing and articulating best practices to help investors and advisors build smarter portfolios.

Before rejoining Morningstar in 2019, Arnott was an Associate Wealth Advisor at Buckingham Strategic Wealth, where she was responsible for portfolio analysis, asset allocation, rebalancing, and trade recommendations. Arnott originally joined Morningstar as a mutual fund analyst in 1991 and held a variety of leadership roles in investment research, corporate finance, and strategy from 1991 to 2017.

Arnott holds a bachelor’s degree with honors in English and French from the University of Wisconsin – Madison. She also holds the Chartered Financial Analyst® designation.

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