The Fed raised interest rates for the first time in nine years on Wednesday. Unfortunately for many retirement savers, along with rising rates comes another factor that has been absent from the economic landscape for years: inflation.
The 0.25 percent increase in the Fed funds rate was widely anticipated, and a statement from the Federal Open Market Committee made clear we should also look for "gradual" rate hikes in the future as economic conditions warrant.
According to the Fed, those conditions include an improving labor market and a return to 2 percent inflation. Inflation had been stuck below 1 percent for years, well below the Fed's 2 percent target. But that has changed.
In November, on the year, the largest 12-month increase since May 2014, driven by rising housing prices.
You haven't seen it in a while, but be prepared. Inflation over time could have a significant impact on the money that you've put away for your golden years. Don't underestimate the power of inflation to eat away your retirement savings, some financial advisors caution.
Say you plan to live on $50,000 a year when you retire in 2035 — and plan to live at least 20 more years beyond that. With zero percent inflation, you'd need to have saved $654,266 by the time you retire — that translates to $245,586 invested today, assuming a 5 percent annual return.
With inflation rising to 2 percent, you'll need to have saved nearly double that amount — $1,144,081 (or $431,192 invested today) — by the time you retire in 20 years to be able to count on $50,000 a year in income for two decades in retirement. So, as inflation rises, you'll need to save even more. Check out the impact of inflation on your retirement with Bankrate's online retirement calculator.
Some financial advisors suggest you can mitigate the effect of inflation on your retirement savings by doing this:
- Save more than you think you'll need, and don't be too conservative in your investments.
- Don't be afraid to stick with mostly stocks. Despite their volatility and potential losses, stocks historically offer the best returns. These long-term gains will help you outpace inflation so your retirement will stay on track.
- Contribute to your 401(k) or workplace retirement plan at least up to the company match. Increase contributions as much as you can every year until you reach the maximum limit. And if you're over 50, take advantage of catch-up contributions to add a little extra.
- Put money away for retirement outside of your workplace plan. If you qualify, contribute to a Roth IRA. If you're self-employed, use tax-advantaged accounts, like a Sep IRA or Solo 401(k). Save money in a taxable account, too.
