Inflation Risk

Posted September 9, 2025, By Cole Ferrier

Key Takeaways:

• Inflation Risk is the danger that rising costs will erode the purchasing power of your savings, making your retirement lifestyle more expensive over time.

• Retirees often face a higher personal inflation rate than the general population due to the disproportionate and rapidly rising cost of healthcare.

• A fixed income stream, like a pension without a COLA, can lose more than half its real value over a long retirement, creating a "sinking" income floor.

• The most effective solutions are to own assets that outgrow inflation (equities), prioritize inflation-adjusted income (Social Security, TIPS), and build flexibility into your spending plan.

In our last article, we established that Longevity Risk determines the length of your retirement ultramarathon. Now, we turn to the most persistent and corrosive headwind you’ll face during that race: Inflation Risk.

If a catastrophic market crash is a sudden, obvious threat to your portfolio, inflation is the silent thief. It’s the slow, quiet, and relentless erosion of your purchasing power over time. It doesn’t send you panicky alerts or show up as a big red number on your statement. Instead, it works in the background, ensuring that the dollar you saved today will buy less tomorrow. For a retiree on a fixed income, this is one of the most significant long-term dangers to their standard of living.

From my engineering perspective, failing to account for inflation is like designing a bridge without considering the gradual effects of metal fatigue and rust. The structure might seem strong for the first few years, but over decades, these persistent, low-level stressors can lead to a catastrophic failure. A retirement plan that ignores inflation is just as vulnerable.

By the Numbers

• 50%: The approximate reduction in a dollar's purchasing power over 24 years, assuming a 3% average annual inflation rate. (Source: Rule of 72 calculation)

• ~0.2%: The historical average annual difference between the Consumer Price Index for the Elderly (CPI-E) and the standard CPI for Urban Wage Earners (CPI-W), highlighting that retiree inflation is often higher, primarily due to healthcare costs. (Source: Bureau of Labor Statistics data analysis, https://www.bls.gov/cpi/research-series/r-cpi-e-home.htm)

• $345,000: The estimated amount a 65-year-old couple retiring in 2025 would need just to cover their health care and medical expenses throughout retirement, an amount that has risen dramatically over the past two decades. (Source: Fidelity Investments, 2025 Retiree Health Care Cost Estimate, https://newsroom.fidelity.com/pressreleases/fidelity-investments--releases-2025-retiree-health-care-cost-estimate--a-timely-reminder-for-all-gen/s/3c62e988-12e2-4dc8-afb4-f44b06c6d52e)

From the Case Files

Let's consider a retiree, Susan, who starts with a $60,000 annual pension that is not indexed for inflation. The general inflation rate is 3% per year. However, her personal inflation rate, driven by rising Medicare premiums and out-of-pocket medical costs, is closer to 4.5% per year. After 20 years, her pension's purchasing power has fallen to just $33,266. Her actual expenses, however, have soared to $144,651. She is forced to withdraw increasingly large amounts from her portfolio just to maintain her standard of living, dangerously accelerating the depletion of her assets.

Understanding the Risk: Your Personal Inflation Rate

Inflation risk is the danger that the rising cost of goods and services will reduce the purchasing power of your income and assets. We all have a general sense of this from the headline CPI numbers. But for retirees, the situation is often more acute. The basket of goods and services that seniors spend money on is different from that of the general population, with a much heavier weighting toward healthcare.

Because healthcare costs have historically risen much faster than overall inflation, retirees often experience a personal inflation rate that is significantly higher than the reported CPI. Even a modest, seemingly harmless inflation rate has a powerful effect due to compounding.

Basic Formula for Doubling Time (Rule of 72):

Years to Double = 72 / Inflation Rate

Example: 72 / 3% = 24 years

The Impact on Your Plan: A Sinking Floor

Inflation attacks every part of your financial plan, but it is particularly devastating to the "safe" components.

• Interaction with Longevity Risk: This is a classic example of how longevity risk acts as a force multiplier. A 20-year retirement gives inflation 20 years to erode your fixed income. A 40-year retirement—a real possibility for a healthy FIRE retiree—gives it twice as long to do its damage, making the final real value of that income substantially lower.

• Fixed Income Sources: Any income stream that is not indexed to inflation—such as a corporate pension, a fixed annuity payment, or bond interest—is on a guaranteed path to decline in real value. What feels like a solid income floor at age 65 can feel like a sinking foundation by age 85.

• Increased Withdrawal Pressure: As the real value of your fixed income declines, you are forced to pull more and more from your investment portfolio to cover the same lifestyle costs. This directly compounds Excess Withdrawal Risk and Sequence of Returns Risk, especially if this pressure coincides with a down market.

Solutions & Your Risk Mitigation Toolkit

A durable retirement plan must be designed with inflation as a core variable, not an afterthought. The goal is to build a system where your income and assets can grow at a rate that at least keeps pace with, and preferably outpaces, your personal inflation rate.

• Tool #1: An Equity-Heavy Portfolio. Over the long term, the asset class that has historically provided the best returns above inflation is equities (stocks). While stocks introduce short-term volatility (Market Risk), they are the primary engine for preserving and growing your purchasing power over a multi-decade retirement. A diversified, low-cost portfolio of global stocks is your best offensive weapon against this silent thief.

• Tool #2: Inflation-Adjusted Income Streams. The most valuable sources of retirement income are those that come with a built-in Cost-of-Living Adjustment (COLA).

  • Social Security: A key reason delaying Social Security is so powerful is that benefits are indexed to inflation. By maximizing this benefit, you are creating the largest possible government-backed, inflation-protected income floor.

  • TIPS and I-Bonds: For the bond portion of your portfolio, consider Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds. The principal value of these bonds adjusts with the CPI, ensuring that your investment keeps pace with inflation.

  • Inflation-Adjusted Annuities: While less common and often more expensive, some immediate annuities offer riders that will increase your payments based on a fixed percentage (e.g., 3% per year).

• Tool #3: A Realistic Inflation Assumption. When projecting your retirement needs, use a higher inflation rate for healthcare expenses than for other categories of spending. This "blended" inflation rate will provide a much more realistic picture of your future needs and ensure you are saving enough to meet them.

• Tool #4: Flexible Discretionary Spending. Recognize that not all of your spending needs to keep pace with inflation. While essential expenses will rise, you have control over discretionary spending. Being willing to cut back on travel or entertainment during periods of high inflation can relieve pressure on your portfolio.

A Resilient Strategy for Rising Costs

Strategically, the threat of inflation isn't a sudden shock but a constant, corrosive force that erodes the purchasing power of your assets. It is particularly damaging to the parts of a retirement plan that often feel the safest: income streams like corporate pensions or bond payments that are not indexed to rise with the cost of living .

A resilient plan must therefore address this from two angles. The primary offensive measure is to own assets with the long-term potential to outgrow inflation, which historically has meant a meaningful allocation to equities. Defensively, the goal is to secure income streams that automatically adapt to rising costs, such as maximizing inflation-adjusted Social Security benefits and utilizing Treasury Inflation-Protected Securities (TIPS).

Conclusion: The Great Balancing Act

Inflation is a constant, corrosive force. A financial plan that fails to account for it is designed to fail over the long term. The great balancing act is between the short-term comfort of "safe" fixed-income assets and the long-term necessity of growth-oriented equities to preserve your purchasing power. By building a portfolio with a strong allocation to growth assets and prioritizing income streams that adjust for the rising cost of living, you can build a resilient plan.

Create Your Financial Compass with Us

Is your financial plan built to withstand the silent erosion of inflation? We specialize in creating durable retirement income strategies that account for rising costs and protect your long-term purchasing power. Contact us today for a consultation.

Resources:

• Social Security Administration: Provides detailed information on how Cost-of-Living Adjustments (COLAs) are calculated for Social Security benefits. (www.ssa.gov/cola)

• Bureau of Labor Statistics (BLS): The primary source for data on the Consumer Price Index (CPI) and inflation trends, including a CPI Inflation Calculator. (www.bls.gov/data/inflation_calculator.htm)

• TreasuryDirect: The official U.S. government website for purchasing Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds. (www.treasurydirect.gov)