How inflation affects a retirement plan, and what forecasters expect

Once you retire, there are no more raises at work, and every year that prices go up, your savings have to cover a larger bill. Over a retirement that can last 30 years or more, the inflation rate you assume is one of the most important numbers in the plan.

It is also hard to predict. Two years ago, professional forecasters, the Federal Reserve and the bond market all expected inflation of about 2 percent a year. Since then CPI inflation has averaged 3.4 percent a year, and prices rose 3.7 percent over the twelve months to September. This article looks at how much the inflation rate changes what a household needs to save, what forecasters expect now, and how the last two years compared with their forecasts.

How much inflation changes what you need to save

To put a number on it, we ran three upper-middle-income couples through the planner. Each spends $120,000 a year in today's dollars, plus health care costs, and will receive about $68,000 a year from Social Security, claimed at 67. One couple is 65, retiring now, with 60 percent of its savings in stocks. The other two are 50 and keep 90 percent in stocks: one retires now, and the other keeps working until 65 on a combined salary of $220,000.

The answer depends on something nobody can know in advance, which is whether stock returns rise along with inflation. Bonds pay a fixed number of dollars, so when inflation is higher they return less after inflation. Stocks have historically kept up with inflation over long periods, though not from year to year. The chart shows both possibilities, as the savings each couple needs today for their money to last for the rest of their lives in 85 percent of 2,000 simulated lifetimes:

If stock returns don't keep up with inflation, each extra point of inflation adds a great deal to the savings a couple needs. The couple retiring at 65 needs about $320,000 more for each point on average, and the 50-year-olds who retire now need about $785,000 more, because they have 17 years to pay for before Social Security begins and a longer retirement after that. The working couple's figure grows from about $700,000 to $2.5 million, because the savings they have now and everything they add over the next 15 years earn less after inflation.

If stock returns do keep up, the picture is very different. The extra cost falls to about $125,000 a point for the 65-year-olds, who hold 40 percent in bonds, and to about $90,000 a point for both 50-year-old couples, whose savings are almost all in stocks. With 60 percent in stocks instead of 90, the 50-year-olds would need about three times as much extra under this view (about $270,000 a point for the couple retiring now, against $90,000), which is one of the usual arguments for holding stocks through a long retirement. If bond returns rose with inflation as well, the extra cost would be smaller still, and what remained would come from parts of the tax system that are not adjusted for inflation.

Which view comes closer depends on what markets do, and for planning purposes it is reasonable to assume something between the solid and dashed lines.

What forecasters expect now

Forecasters, the bond market and households each publish estimates of future inflation. Most of the professional and market figures sit near 2.3 percent a year over the next decade, with more disagreement about the next year:

The professional figures come from the Philadelphia Fed's survey of about 30 forecasters, taken in August, before September's jump in gasoline prices. Fed officials measure inflation with a different index (PCE) that usually runs a little below the CPI, so their 2.0 percent is close to the forecasters' 2.3.

The bond market's figure comes from comparing two kinds of Treasury bond. On October 14 the ordinary 10-year bond paid 5.19 percent, and the inflation-protected version (TIPS) paid 2.84 percent plus whatever inflation turns out to be. The difference, 2.35 percent, is the inflation rate at which the two come out even, so it is a fair estimate of what investors expect, though it also carries some compensation for risk. The Cleveland Fed's model combines market prices with surveys and comes out higher.

The household surveys come in noticeably higher. That is common after a sharp rise in gasoline prices, which research finds people weigh more heavily than most other prices (Coibion and Gorodnichenko, 2015), and gasoline is up 34 percent over the past year.

How the last two years compared with the forecasts

In the fall of 2024, the typical forecasts for the next two years ranged from 2.0 to 2.7 percent. Here is what each group expected, next to what happened:

Inflation came in at 2.8 percent in 2025, and 2026 is now expected to finish at about 3.6 percent, higher than any of the 30 forecasters predicted in November 2024. Much of this year's increase is energy: oil prices rose sharply after the war with Iran began in February, and energy prices are up 20 percent over the past year. Core CPI inflation, which leaves out food and energy, was 2.6 percent over the year to September.

What this means for a plan

Whether the recent run of high inflation continues is a judgment call. Forecasters and the bond market expect it to fade within a year or two, core inflation is well below the headline figure, and the Fed raised interest rates in September to slow it down. On the other side, this is the second large rise in five years, and the forecasts have been too low for most of that time. For a plan that has to last decades, the more useful question is how much it costs to be wrong. For the couple retiring at 65, each extra point of inflation adds roughly $125,000 to $320,000 to the savings they need, depending on whether stock returns keep up, and for the 50-year-olds who retire now it adds roughly $90,000 to $785,000.

Most professional and market forecasts put inflation near 2.3 percent a year over the next decade, but they put it at a similar figure two years ago and inflation has run well above it since. For many households, the practical response is a plan that still works at a rate somewhat above the consensus, with enough stocks or inflation-adjusted income to absorb a miss.