Inflation has long been a threat to many people's financial security in retirement. It's because of inflation that savers are encouraged to invest their nest eggs, rather than let their money sit in cash. The goal there is to grow their balances over time in a manner that outpaces inflation.
At the same time, seniors are commonly encouraged to leave a good chunk of their savings invested during retirement so that their money can continue to keep up with or outpace inflation. And in recent years, we've seen how important that is.
Image source: Getty Images.
Granted, the inflation that's been plaguing consumers from mid-2021 through to today isn't exactly the norm. But over time, 2% annual inflation is not only considered the norm, but also acceptable -- at least in the eyes of the Federal Reserve.
It's not all that hard to invest assets in a manner that can deliver an average yearly 2% return. Even a safe portfolio of bonds might well outpace that.
But savings aren't the only income source available to seniors in retirement. For many, savings actually take a back seat to Social Security benefits because the latter is their primary income source.
The problem, though, is that while Social Security may be designed to keep up with inflation, it often fails to provide seniors with the buying power they need. And that's something lawmakers need to address.
Social Security COLAs often fall short
Each year, Social Security benefits are eligible for a COLA, or cost-of-living adjustment, that's tied directly to inflation. COLAs are measured based on third-quarter data from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). But as one might imagine, the costs that tend to apply to urban wage earners and clerical workers aren't necessarily expenses that commonly eat up most of seniors' income.
Gas prices, for example, are a big driver of the CPI-W. But gas doesn't tend to be such a large expense for seniors on Social Security since many are retired and don't have a daily commute.
On the other hand, healthcare does tend to be a big expense for seniors. So it would be more helpful to calculate Social Security COLAs based on an index that actually reflects the costs seniors commonly face.
Some advocates have proposed using such an index -- a CPI-E, or Consumer Price Index for the Elderly. Switching to this system would likely result in higher COLAs for Social Security beneficiaries.
But lawmakers seem hesitant to make a switch. And given that Social Security is deep in the throes of a financial crisis, it's easy to see why policymakers would not want to make a change that might result in added spending.
All told, Social Security is set up to keep pace with inflation. Whether it really succeeds in helping seniors retain buying power from one year to the next is arguable. It's for this reason that workers today are encouraged to build up savings so they can rely on their nest eggs in retirement more so than Social Security.
