When Olivia, a dedicated high school teacher, retired after three decades in the classroom, she thought she had everything figured out for a modest yet comfortable retirement. She had saved in her 401(k) and contributed to her IRA.
However, as inflation rates crept up, she noticed a troubling trend: trips to visit her twin sons became more expensive, and her utility bills slowly increased.
But Olivia wasn’t about to let rising costs derail her golden years. She discovered new investment strategies to combat inflation and protect her retirement security.
Now she’s all about sharing her journey through the financial markets, and is even considering starting a YouTube channel to help other academic professionals.
Key points for educators responding to Inflation:
- What inflation is
- What’s Behind Inflation? Understanding the Key Triggers
- Plan ahead to offset inflation
- Teachers Retirement Plans to address Inflation Effects
What exactly is inflation?
You may have heard of Inflation as the creeping reality of increasing prices for goods and services across the economy over time, steadily eroding the purchasing power of both consumers and businesses.
That is somehow true, but let’s take a closer look at it so we can better understand this “always present” phenomenon and how it affects our lives.
As the cost of living climbs, what you could buy with $1 a few years ago might cost you several dollars today. This circumstance – not random at all – has its roots in economic policies, particularly when central banks set the interest rate too low or inject money into the system at an accelerated rate.
McKinsey&Company provides an excellent example that we updated here so you can see the whole frame and understand the impact of inflation over the long haul.
54 years ago, a cup of coffee in the U.S. cost about 25 cents. Fast-forward to 2024, the price had shot up to $4.90. The same $5 that would get you 20 cups of coffee in the early “70s only gets you about one now.
That’s inflation in action! It does not just affect coffee but stretches across entire industries and the broader economy.
What’s Behind Inflation? Understanding the Key Triggers
When you think about inflation, it’s crucial to understand that it doesn’t just arise out of thin air. It has drivers—some more direct than others—and monetary policy plays a big role in setting the stage.
Currently, we’re experiencing high inflation rates driven by several factors: a ballooning money supply, soaring costs for raw materials, workforce imbalances, and disrupted supply chains, all made worse by geopolitical tensions.
But that’s not the whole story. When you dig a little deeper, you’ll find that short-term inflation typically falls into two main categories:
Demand-Pull Inflation
This type of inflation occurs when there’s more demand for goods and services than the economy can produce.
Cost-Push Inflation
On the other hand, cost-push inflation is driven by the rising costs of inputs needed to produce goods and services.
Inflation isn’t a simple one-size-fits-all concept. It’s a complex interplay of economic forces and market dynamics. By understanding the key drivers, you can better anticipate its impact and how it might influence everything from the cost of your next grocery trip to the price of a new car.
How Inflation Impacts Your Retirement Income
The bad news is that inflation isn’t just something that increases your grocery bill; it can take a serious toll on your retirement savings over the long run. The value of your nest egg might seem substantial now, but as inflation eats away at purchasing power, you could end up with less income to support yourself during retirement.
This concern isn’t just theoretical. For instance, teachers who benefit from Social Security got a 3.2% cost-of-living adjustment (COLA) for 2024, intended to help them manage rising costs, which might not be enough to keep up with continually climbing expenses.
Consider medical costs, which tend to increase at a rate that’s higher than the Consumer Price Index (CPI), and expect that Medicare premiums and deductibles are likely to follow suit.
Given these trends, it’s no surprise that 62% of workers with 401(k) plans are concerned about inflation’s impact on their retirement, according to a recent survey.
Now for the good news. If you’re planning for retirement, you can account for inflation in your financial strategy. The price of everything, from healthcare to housing, tends to rise over time, so educators will need to ensure their savings hold their value and provide the income they need when the time to retire comes.
To find the best approach for you depends on understanding how inflation impacts pension and then building a plan that considers inflation, adjusting it as necessary.
To stay ahead of this curve, let’s break each of these steps.
Pensions and Inflation
When it comes to pension plans, your benefits are typically calculated based on your final years of earnings while still in the classroom. If a spike in inflation occurs during the last year or two of your career, your pension might not reflect the full scope of that increase.
That’s because your pension is partly derived from pre-inflation salary levels. This means your benefits could be lower than expected if inflation hits just before you retire.
But that’s not the only way inflation can impact teachers’ pensions. If inflation rises after you’ve retired, your pension payments could quickly lose their purchasing power. Since these payments are tied to what you earned in the past, they might not keep up with the current cost of living.
Another factor to consider is whether your pension plan includes inflation adjustments. According to the National Association of State Retirement Administrators, about 75% of pension plans managed by state or local governments offer some form of cost-of-living adjustment (COLA).
However, for those teaching in private institutions, pension plans are less likely to provide these adjustments, leaving retirees more exposed to the impact of inflation.
Therefore, if you’re counting on a pension to see you through retirement, be aware that inflation can play a significant role in influencing how far those benefits will stretch. It’s always a good idea to understand the fine print of your plan and consider other income sources to cushion the impact of inflation.
Educators Relying on Social Security
It’s noteworthy that around 60% of all American educators will depend on Social Security benefits during their retirement. Given that teachers and other school staff have traditionally had modest salaries, many rely heavily on these benefits to support themselves after their working years.
As aforementioned, Social Security benefits undergo an annual review to adjust for inflation through what’s known as the Cost of Living Adjustment (COLA).
What’s concerning is that these adjustments do not always keep pace with inflation. For instance, in 2015, the COLA was 0%, offering no increase in Social Security benefits despite a steady rise in living costs.
When Social Security adjustments fail to match inflation, educators may find themselves struggling to cover their expenses, highlighting the need for a more reliable system to ensure their financial well-being in retirement.
Plan Ahead to Offset Inflation
In the meantime, educators who are either far from retirement or approaching it and have diligently saved over the years may express worries about how inflation could erode their savings or hinder their capacity to continue saving adequately for retirement.
Regardless of whether you’re still in the workforce, already enjoying retirement, or on the cusp of it, comprehending the measures to safeguard your finances against inflation within a teacher retirement plan is crucial for both your current financial stability and your future security.
Teachers Retirement Plans and Inflation Effects
The most effective solution to combat inflation during retirement lies in the strategy of early and consistent saving whenever feasible. Here are some important points to consider in your personal plan to the never ending fight against inflation:
Examine Your Budget in Detail
When inflation is high, you end up spending more on everyday goods and services. As your purchasing power dwindles, it’s crucial to understand your spending habits.
Here’s an exercise to help you navigate these uncertain times:
Start by reviewing your credit card and bank statements for the past year. This exercise will give you a detailed snapshot of your average monthly expenses and whether they’ve been climbing as inflation has increased.
Next, create a simple T-chart. On one side, list your variable expenses—things like dining out, entertainment, and other non-essential spending.
On the other side, list your fixed monthly costs—items like rent or mortgage payments, utility bills, groceries, subscriptions, and insurance premiums.
Now, add up both your fixed and variable expenses for an average month, and subtract that total from your monthly income. If you’re left with a negative number or something close to it, you need to scrutinize your variable expenses to identify where you can cut back.
However, if there’s a healthy surplus after subtracting your expenses, you’re in a stronger position. This extra cash can be used to pay down debt or boost your savings, giving you a bit of a cushion to help weather the effects of inflation.
Stay Committed to Saving
When inflation is high, it’s tempting to cut back on all expenses.. If your income hasn’t taken a hit, you should continue contributing to your employer-sponsored retirement plan, aiming for the maximum amount that gets matched.
This approach ensures you’re making the most of your employer’s matching contributions, which is essentially free money to boost your retirement savings.
If you have some financial flexibility, look beyond the usual options below to consider individual retirement accounts. It’s crucial to stay as consistent as possible with your contributions to avoid jeopardizing your long-term retirement goals.
Important Considerations for 401(k) and IRA Contributions
Initiating savings early entails channeling funds into your 401(k) or IRA right from the onset of your professional journey, maximizing the potential of compound interest to bolster your retirement nest egg.
Consistent saving involves capitalizing on the yearly maximum contribution limits allowed for tax-advantaged retirement plans, ensuring you’re making the most of available opportunities to secure your financial future.
An article recently featured on Investopedia suggests diverting retirement savings into a Roth account rather than a traditional one. This approach involves paying income taxes on contributions in the year they’re made.
While it may require a bit more sacrifice in the present, the long-term benefits are substantial. As a retired educator, opting for a Roth account means potentially avoiding additional taxes on your savings down the road.
Build a Diversified Portfolio
There’s another well grounded article at Teachers Retirement Plans that brings out essential knowledge proving that having a well-balanced portfolio is key to managing retirees’ risk and achieving steady returns.
Diversification means spreading your investments across a range of asset classes, like stocks and bonds, and adjusting your allocation based on your risk tolerance.
Additionally, there are assets considered “inflation-resistant,” such as gold and real estate investment trusts (REITs), which can add another layer of security to your portfolio in retirement.
Flexibility is crucial when the future is uncertain, and being open to expand your strategy can lead to greater financial stability in retirement.
At the end of the day, it’s all about cash flow—ensuring you have a reliable stream of income, not only savings. That covers your expenses and maintains your lifestyle as you navigate through uncertain times.
Combating Inflation in Retirement with Professional Support
Inflation is an economic force beyond our control, but there are practical strategies that educators can use to mitigate its impact on retirement security. These methods have been carefully outlined by professionals, offering a roadmap for educators to follow.
Talking to your advisor about the right steps, can be crucial. They can help you build a resilient plan to protect your retirement savings from the pressures of rising costs. This means ensuring that you can afford the lifestyle you envision in your golden years, even when inflation drives up prices.
Need consultation with financial advisors to ensure your retirement strategy is on track against inflation risks and to navigate uncertainty with confidence? CONTACT US AND GET YOUR FREE SECOND OPINION TODAY!
