Finally we have the federal government’s acknowledgement of what the rest of us seemed to have known for a while: This bout of inflation is not a minor transitory event. It wasn’t plausible when they said it, and you can’t deal with what you don’t acknowledge.
Now that the government acknowledges that inflation is a problem, we get the problems that come from the cure on top of the original problem of inflation. We get high interest rates to go with increasing prices.
No one is more negatively impacted by this double whammy of high interest rates and high inflation than retirees, especially those just coming into their retirements.
The Inflation Trap
Historically many people retired on fixed incomes, and inflation would sound the death knell for their standard of living. Far fewer retirees live on fixed incomes today. Those with investment assets have a fighting chance, in the long run.
Far too many retirees, however, have Social Security as their primary income source. Social Security gets adjusted for inflation. Social Security increases tend to run about half the rate of actual price increases. In times of benign inflation, those living on Social Security see a gradual decline in their standard of living as their Social Security increases fail to maintain their purchasing power.
If Social Security increases in the same manner it has in the past, the gap will be wider due to higher inflation. Retirees will see the purchasing power of their Social Security payments decline at a greater rate. Getting half of a larger increase in costs puts you further behind. Math shows no favorites.
For those who have assets to generate their income, the situation likewise gets bleak.
A pool of assets can generate only so much income. If a retiree had just enough to retire comfortably based on historical inflation, they just got a big setback with this out-of-the-ordinary explosion in cost of living.
For all retirees, inflation places a heavy burden on their ability to maintain their standard of living. Unless your retirement was significantly overfunded, you probably need to adjust. And adjust means live on less, just so we are clear. That’s whammy number one.
The Lump-Sum Factor
Many retirees who lost their defined benefit pensions in the great pension shift got another plan as a replacement. Some got 401(k)s; or got cash balance pension plans. Some kept their pension plans. This is very common in the teaching profession, and for many unions. There are fewer people with pensions, but there are still many pensions.
Not all pensions have a lump-sum option. When they do, and when interest rates are low, this option allows the pensioner to take the lump-sum value of their pension, invest it themselves, and have the potential to be significantly better off, financially, as a result.
But pension lump sums have an inverse relationship with interest rates. When interest rates increase, the actuarial value of the lump sum required to generate a specific stream of income decreases.
The actuarial value of this stream is how the lump sum is determined.
Higher interest rates mean smaller lump-sum options. A smaller lump sum makes the generally beneficial lump-sum option less attractive.
People approaching retirement expecting a certain lump sum may be astounded how much their payout will shrink as a result of increased interest rates. They can now expect to have less money to work with, but have higher costs due to inflation. Double whammy.
The Mythical Silver Lining
There are a plethora of articles on the web touting the benefits to consumers of inflation. Examples are that fixed annuity rates will increase, and you’ll pay down existing debt with dollars that are worth less.
The positives are positive, but not overall a net benefit. It’s like getting a T-shirt in a blizzard — better than nothing, but you’ll still freeze to death.
The consolation doesn’t really help.
When 10 percent of your life got easier when 100 percent got harder doesn’t make things better. The silver lining is a silver lining that doesn’t justify the storm.
The Bottom Line
Humans are remarkably resilient. Inflation sucks, but we will all get through it. There are some things that can make it a little easier.
We should be careful of spending. Reducing unnecessary spending is a way to lower costs, and for retirees a dollar you save today is worth a few down the road. Don’t spend what can compound.
Some retirees may want to consider working — at least part time. There are many jobs out there at the moment, and wages are higher than ever. This can help keep money invested where it can be used later.
Retirees may want to consider being a little more aggressive with long-term investments. Especially those early in retirement, where time is still on their side.
Most people in and approaching retirement have been through tough economic times before. They know that this too shall pass. The key is to continue to make informed decisions, keeping the long-term in mind. Tightening the belt for a while now can make a big difference down the road.