WE’VE ALL SEEN THE HEADLINES — in 2022 inflation rose to its highest level since the early 1980s. After topping 9% in June of that year, the Consumer Price Index (CPI) measured the increase in the average cost of goods and services at 3.7% for the 12-month period ending August 2023.¹ While it seems things might be cooling down, that number can still seem high for folks who enjoyed a decade of inflation mostly below 2.5%.²

Whether or not the 2022 spike in inflation — driven largely by pandemic-related factors and supply chain disruptions — was temporary, as some economists expect, “it’s a useful reminder of the importance of factoring inflation’s effects into your retirement planning,” says Lauren Galvin, national sales manager, Personal Retirement, Bank of America.

The risk to retirees

Most people notice inflation when they shop: Things cost more, from clothes, gas and groceries to appliances, cars and even homes. If you’re working, you can budget for that — and your salary might also rise with inflation. But for retirees and those nearing retirement, inflation has more serious financial consequences: Over time, rising prices can significantly reduce your spending power when you’re living on a fixed income. For instance, if the current 3.7% inflation rate persisted for five years, it would whittle the buying power of a $1 million cash account down to $828,193. But even a hike as small as 2% or 2.5% in inflation can have a sizable impact. See above chart.

Retirees received an 8.7% cost-of-living adjustment (COLA) to their Social Security benefits for 2023³ —the largest increase in 41 years — to help them cope. A more modest increase of 3.2% is expected for 2024, and advocates say that’s unlikely to offset costs that continue to rise.⁴ The price of healthcare, for example, typically increases even faster than the CPI, and you’re likely to see rises over time in Medicare premiums and deductibles as well. So it’s not surprising that 62% of workers with 401(k) plans now say they’re worried about the impact of inflation, according to one recent survey.⁵

Plan ahead to offset inflation

“We need to be financially prepared for 100-year lives,” says Galvin. “When you consider how long your retirement is likely to last, having a plan to help you deal with inflation’s effects is a must.” If you’re retired or nearing retirement, here are four approaches you can discuss with your advisor.

Delay claiming Social Security benefits. While you can begin collecting Social Security at age 62, waiting until age 70 could, by comparison, give you lifetime monthly benefits that are about 77% higher.⁶ This is one way to hedge against the potential for inflation, but it’s not a one-size-fits-all strategy. Considerations like your health and expected longevity, the age difference between you and your spouse, how much longer you may want to work, other sources of income and tax issues might all play a role in helping you determine the best approach, Galvin says. Your advisor can help you run the numbers and create a Social Security claiming strategy that works for you.

Invest for growth and rebalance regularly. “In response to higher inflation and interest rate increases by the Federal Reserve, bond yields have become attractive again,” suggests Joe Curtin, head of CIO Portfolio Management, Chief Investment Office, Merrill and Bank of America Private Bank. “While equities may offer an opportunity for the growth of your assets to exceed the inflation rate over the long term, bond yields have become more attractive and warrant a higher allocation in diversified portfolios.”

“We think interest rates will run higher for longer, and that is not always a bad thing,” says Curtin. But it makes rebalancing your portfolio periodically more important than ever. Doing so allows you to maintain the proper mix of asset classes that match your objectives, time horizon, liquidity needs and risk tolerance. “We believe the traditional role of bonds as yield enhancer, portfolio diversifier, and volatility dampener has returned,” he adds.

Consider the role of annuities. These contracts — long-term investments designed for retirement purposes, typically issued by insurance companies — can be indispensable in your retirement toolbox, says Galvin. When you invest a portion of your retirement assets in an annuity, you are provided with a consistent stream of fixed income for life or for a period of time specified in the contract. “In combination with Social Security, that guaranteed income might give you the confidence to pursue a slightly more growth-oriented investing approach with your remaining assets,” Galvin notes. Your advisor can help you understand the various types of annuities and what they can offer as well as their risks. “Annuities are only one part of a larger set of asset allocations that might also include cash, equities, fixed income and, for qualified investors, alternative investments such as precious metals, real estate or commodities,” she adds.

Prepare for future long-term care costs. “If you look at the arc of human history, in spite of diseases, we have steadily increased longevity over the long term,” says Galvin. “We need to be prepared for the costs associated with it.” In retirement, a 65-year-old couple with median drug expenses is likely to need $318,000 to cover their out-of-pocket healthcare costs.⁷ And considering that increases in the cost of healthcare tend to outpace inflation, planning ahead is key.

One strategy to help offset rising healthcare costs is to contribute the most you can to a health savings account (HSA) — but be aware that to open an HSA, you must be enrolled in a high-deductible health insurance plan. You can keep the account after you start being covered by Medicare Part A, but you can no longer make contributions. HSAs let you carry over funds year to year and offer the triple benefit of pre-tax contributions, tax-free growth and tax-free withdrawals for qualified expenses. Eligible expenses generally include Medicare premiums as well as long-term care premiums and services. (Please consult with your attorney or tax advisor to understand the tax and legal consequences of establishing and maintaining an HSA account.)

Another option to consider is a life insurance policy with a long-term care benefit rider, which could potentially cover some healthcare costs while also providing a death benefit to your beneficiaries.

Inflation isn’t something we can control, says Galvin. “But there are concrete steps we can take to lessen its impact on our retirement security.” Discussing each of these strategies with your financial advisor and legal and tax professionals can help ensure that you’ll be able to afford the life you want in retirement, even when inflation boosts your cost of living.