For several years before the pandemic, everyone became complacent about an inflation rate hovering reliably around 2 percent. We were jolted from our torpor by the COVID spike in inflation to nearly 9 percent.
Although inflation has come down sharply, the 3 percent rise over the past year is still above pre-pandemic levels. Higher prices remain Americans’ primary concern about the economy. But a new RAND study has good news, at least for some retirees: inflation’s financial hit to their purchasing power is muted.
The main reason is that Social Security, the largest single source of a typical retiree’s income, is – in contrast to workers’ paychecks – automatically adjusted every year for inflation. In 2023, the benefit checks increased 8.7 percent, countering 2022’s inflation surge during COVID. Most retirees also own their own homes, which rise in value with inflation, and their monthly payments – if they have a mortgage – are fixed and don’t go up.
To the extent rising prices do have an impact, the researchers found that a permanent increase in the inflation rate to 6 percent would be more costly to the people who are best able to weather it: college-educated retirees who earned more while they were working. While the bonds in their 401(k)s lose value when inflation and interest rates rise, their considerable stock portfolios keep pace with increasing prices.
But the impact also depends on another aspect of their finances. What distinguishes college graduates is that they tend to be less reliant on inflation-protected Social Security and are more likely to have defined benefit pensions, which lose value. A $2,000 monthly annuity will be worth much less in 20 years, because corporate pensions aren’t usually adjusted for inflation, and the pensions of retired state and local government workers are only partially protected.
The RAND researchers found that inflation had the biggest impact on single college graduates over 65, who have a smaller cushion of wealth than married couples. The model they used mimics retirees’ spending habits over time in 39 categories of goods and services, as well as their investment returns, taxes and annuities.
Inflation erodes the value of single college graduates’ annuities by $18,000 during all their years in retirement. Even so, the resulting loss of $600 in purchasing power is minuscule for a group whose total consumption during retirement averages $538,000. To maintain their spending, they would have to reduce the amount of money they’ll leave to their heirs.
For married couples with a college education, inflation reduces the real value of their annuity payments by more than $67,000 when inflation rises to 6 percent. These higher-income Americans also live longer than low-income retirees, so inflation does its work on their pensions over a longer period of time. Still, their total retirement spending falls by $3,000.
This study doesn’t really approximate the impact of COVID’s temporary inflation spike, because it analyzed the effect of a permanent jump in inflation from 2 percent to 6 percent. Nevertheless, the findings are broadly in line with a similar study by the Center for Retirement Research, which supports this blog.
Retirees who did not attend college lack the advantage of having substantial savings. But Social Security dominates their finances, and its inflation protection “has the greatest benefits for those with the fewest assets.”
Inflation reduces single high school graduates’ spending by about $500 – a tiny fraction of the $276,000 they spend over their retirement years. For married couples, inflation reduces spending by $1,200 out of a retirement budget of $526,000.
Lower-income retirees’ spending power, the researchers conclude, is preserved by their most important asset: inflation-adjusted Social Security benefits.
To read this study by Michael Hurd and Susann Rohwedder, see “Inflation and Economic Security of the Older Population.”
The research reported herein was derived in whole or in part from research activities performed pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement and Disability Research Consortium. The opinions and conclusions expressed are solely those of the authors and do not represent the opinions or policy of SSA, any agency of the federal government, or Boston College. Neither the United States Government nor any agency thereof, nor any of their employees, make any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of the contents of this report. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply endorsement, recommendation or favoring by the United States Government or any agency thereof.
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