How Do Older Households React to Inflation? – Heart for Retirement Analysis

Introduction 

U.S. inflation peaked at 8.9 % in June 2022, and, whereas the speed has declined considerably since then, inflation nonetheless stays an necessary concern.  That concern is justified in that the primary transient on this two-part collection – in addition to quite a few different research – have proven that inflation harms older households by each lowering their consumption and diminishing their wealth.  Most researchers, nevertheless, don’t contemplate how households react to inflation and the way these reactions may have an effect on their outcomes.  

This transient builds on the state of affairs evaluation within the first transient by together with behavioral responses when trying on the impact of inflation on consumption and wealth of close to retirees and retirees.  The behavioral responses come from a brand new survey that explores how older households reacted to latest inflation – by way of labor provide, saving, and asset allocation.  These responses are integrated into the state of affairs evaluation to offer a extra full image of the impression of inflation on the consumption and wealth of older households.    

The dialogue proceeds as follows.  The primary part briefly recaps the principle findings from the state of affairs evaluation within the first transient.  The second part describes the survey, which reveals that a good portion of each close to retirees and retirees scale back new saving and enhance withdrawals from current accounts, however just a few close to retirees delay their deliberate retirement.  Curiously, older households don’t alter their asset allocation in response to inflation to any significant extent.  The third part incorporates decreased saving and elevated withdrawals into the state of affairs evaluation, displaying that these behaviors offset the drop in consumption brought on by inflation.  This enchancment in consumption shouldn’t be costless, nevertheless, since households find yourself with considerably much less wealth on the finish of the interval.  The ultimate part concludes that households should be capable of atone for saving – however will they achieve this?

Recap of Situation Evaluation (w/out Behavioral Responses) 

The primary transient estimated the impression of inflation on the funds of close to retirees (head ages 55-62) and retirees (head ages 62 and older) from 2021 to 2025.  We targeted on two metrics: 1) the actual change in consumption from the start of the evaluation interval to the tip; and a couple of) the inventory of family wealth (monetary and housing) on the finish of the interval.   

Since inflation can have completely different results relying on the Fed’s coverage response, we thought-about 4 hypothetical situations: 1) No inflation, which serves because the baseline, 2) Everlasting shock, the place inflation spikes at 4 % and stays there; 3) Gentle touchdown, the place inflation progressively returns to 2 % in 2025 with no recession; and 4) Recession, the place inflation begins to rise once more in 2024 and the Fed responds aggressively by elevating charges.  All outcomes have been reported relative to the “no-inflation” state of affairs. 

Because the outcomes confirmed that inflation had little or no impression on housing wealth, this transient solely presents the findings for the change in consumption and monetary wealth.  By way of the distinction within the progress fee of consumption relative to the “no-inflation state of affairs,” the important thing discovering is that close to retirees expertise a smaller decline than retirees, even having fun with actual consumption features within the “smooth touchdown” state of affairs (see Desk 1).  This end result is because of the actual decline in mortgage funds relative to earnings.  In distinction, retirees have much less erosion of actual debt, and infrequently additionally lose actual revenue as employer pension advantages are solely partially listed to inflation.

By way of monetary (non-housing) wealth in 2025, we see that inflation has an unambiguous detrimental impression (see Desk 2).  Prime-wealth households, nevertheless, all the time lose lower than their lower-wealth counterparts, as a result of they put money into equities, companies, and different property that develop with inflation.

In brief, most older households lose actual consumption and wealth after an inflation shock.  The magnitude of the loss will depend on the character of the shock, the actual progress of revenue and property, and the family’s publicity to fixed-rate debt.  The questions addressed on this evaluation are how households react to inflation and the implications of their reactions for his or her consumption and wealth.

How Have Households Reacted to Latest Inflation? 

Since financial idea is ambiguous about how older households ought to react to inflation, we undertook a brand new survey to discover how inflation impacted their conduct between 2021 and 2023.  The survey was fielded by Greenwald Analysis in November 2023 and consists of 1,501 respondents ages 55-85.  To align with the state of affairs evaluation, famous above, we deal with two teams: close to retirees, who have been below age 62 and dealing full time in 2021; and retirees, who have been 62 or older and retired from their main profession in 2021, with a partner additionally retired. Finally, 322 respondents within the survey meet our definition of close to retirees and 630 meet our definition of retirees.  

To supply context for the principle evaluation, the survey requested a collection of questions on respondents’ value of dwelling, the expansion of their revenue and property (relative to the change in costs), and their financial outlook.  Determine 1 reveals the share of respondents reporting a change of their value of dwelling between 2021 and 2023.  Fifty-four % of close to retirees and 40 % of retirees fee the rise as “very substantial,” and one other 30-31 % fee it “substantial.”

In the meantime, Determine 2 reveals the share of close to retirees who report that their family’s work revenue stored tempo with inflation over this era.  Over half report that their earnings have gone up lower than inflation, 35 % report that earnings stored tempo with inflation, and solely 11 % skilled actual wage progress.  This sample aligns with the Federal Reserve Financial institution of Atlanta’s Wage Progress Tracker, which experiences that staff ages 55+ noticed a decline in actual wages from the start of 2021 by means of Could of 2023.

Equally, Determine 3 reveals the reported efficiency of family investments between 2021 and 2023, relative to cost ranges.  Seventy-two % of close to retirees and 64 % of retirees state that their investments grew lower than inflation, 11 % report that investments tracked inflation, and solely 6 % noticed actual progress.

To quantify the impression on family budgets, the survey additionally requested respondents to estimate the greenback enhance of their month-to-month value of dwelling between 2021 and 2023 as a share of 2023 family revenue.  This query measures the extent to which costs rose quicker than revenue for every family.  Though these greenback values are topic to recall error (and are top-coded at 8 % of revenue) we are able to decide whether or not bills rose 5 % quicker than revenue or extra, and the way that extra worth progress correlates with respondents’ notion of inflation.  As anticipated, 34 % of respondents experiencing “very substantial” inflation report that their month-to-month bills rose at the least 5 % quicker than revenue, in comparison with 11 % of respondents within the “substantial” group, and solely 2 % of respondents within the “not a lot” group.

Unsurprisingly given these experiences, many older households are pessimistic concerning the trajectory of the financial system.  Fifty-three % of close to retirees and 43 % of retirees have a detrimental outlook for 2024 (see Desk 3).  Moreover, 60 % of close to retirees and 52 % of retirees consider that final yr’s inflation will contribute to a weaker financial system over the yr.

The following step is to take a look at how respondents’ expertise with, and perceptions of, inflation affected their conduct.  The survey requested respondents whether or not they had made modifications since 2021 alongside 4 dimensions: 1) labor provide (retirement age and hours labored); 2) saving fee; 3) withdrawals from financial savings; and 4) asset allocation.  For respondents reporting a change in conduct, the survey had them rank their motivations so as of significance.  We attribute a change in conduct to inflation if the respondent cited rising costs as their main motivator.  

Labor Provide 

Desk 4 experiences the impression of inflation on labor provide.  The primary row reveals that whereas 34 % of all close to retirees modified their retirement age, solely 4 % did so due to inflation.  Amongst these reacting to inflation, the subsequent row reveals a median anticipated delay of 4 years.  For context, this size of delay is just like outcomes from earlier survey analysis, however we discover many fewer people select to delay in any respect.  One rationalization is that earlier analysis interviewed respondents on the top of inflation in 2022, whereas we fielded our survey in November 2023.

Saving and Withdrawals

Turning to monetary wealth, 39 % of close to retirees declare to have modified their saving due to inflation (see Desk 5).  Amongst these primarily motivated by inflation, annual saving declined by $4,065, on common, or 4 % of annual family revenue in 2023.

Moreover, rising costs induced each close to retirees and retirees to dip into their financial savings.  Desk 6, which mixes the outcomes for each teams as a result of they’re fairly comparable, experiences that 23 % of respondents modified their withdrawals from 2021 to 2023 due to rising costs.  Amongst these making modifications, the typical enhance was $3,620 (5 % of 2023 family revenue).

Asset Allocation  

In distinction to the substantial shares of households altering saving and withdrawals, a a lot smaller share modified their asset allocation.  Desk 7, which once more combines outcomes for close to retirees and retirees, signifies that, whereas 35 % of all households modified their allocation between 2021 and 2023, the magnitude of the shift could be very small.  To the extent that shifts occurred, households moved away from equities and towards fastened revenue.

Implications for Retirement Safety

The following step is to include households’ behavioral responses into the state of affairs modeling.  For this train, we deal with the modifications in saving and withdrawals, since only a few close to retirees modified their retirement age or asset allocation.  For every near-retiree family, we calculate the overall discount in saving (the decline in saving plus the rise in withdrawals between 2021 and 2023).  On common, this discount equaled 4 % of 2023 revenue, which we annualize to 2 % per yr.  Equally, retirees enhance their annual withdrawals by 2.5 % of revenue (annualizing the 5-percent change reported within the survey for 2021-2023).  For simplicity, we assume that households throughout the wealth distribution reply equally and that the annualized charges of change begin in Could 2021 and persist by means of December 2025.   

Desk 8 reveals the distinction within the progress fee of actual consumption, from 2021 to 2025, relative to the “no inflation” state of affairs as soon as we incorporate behavioral responses reported within the survey.  Unsurprisingly, households are in a position to shut a lot of the inflation-consumption hole by tapping into their financial savings.  The important thing distinction in outcomes right here is between close to retirees – who all present features in consumption – and retirees – who primarily see small declines.

This short-term achieve, nevertheless, comes on the expense of future consumption.  Desk 9 compares actual monetary wealth in 2025, with behavioral responses, to the “no inflation” state of affairs.  As anticipated, decreased saving and elevated withdrawals compound the direct impression of inflation on wealth.

To obviously illustrate this trade-off between present and future consumption, Determine 4 compares the outcomes incorporating the behavioral responses to the unique baseline evaluation for one sort of family: close to retirees within the middle-wealth tercile below the “smooth touchdown” state of affairs.  Recall that, within the authentic mannequin, the expansion fee of actual consumption was 0.5 share factors greater than within the “no inflation” state of affairs (because of the actual decline in mortgage debt).  After households scale back their saving, actual consumption grows 6.4 share factors greater than in “no inflation.”  Nevertheless, whereas the preliminary mannequin discovered a 6.6-percent discount in monetary wealth in comparison with “no inflation,” the outcomes incorporating behavioral responses create an 11.9-percent drop.  This similar trade-off holds throughout all age teams, wealth terciles, and macroeconomic situations.

Conclusion

Excessive inflation in later life is usually dangerous to retirement safety.  Compounding the direct impacts on actual revenue and wealth, many households reduce their saving and enhance withdrawals when inflation spikes.  So, what can older households do to mitigate the chance of a future inflation shock?

Households which can be nonetheless working when inflation hits have essentially the most flexibility to enhance their state of affairs.  Since wages are inclined to lag costs, households that keep within the workforce are more likely to expertise actual wage features ultimately, permitting them to atone for their saving.  Working longer additionally reduces the interval over which financial savings should unfold.  

Retired households have much less alternative to earn inflation-adjusted revenue.  Nevertheless, they’ll nonetheless take protecting steps when inflation hits, akin to – to the extent potential – re-investing their fixed-income holdings to benefit from rising rates of interest, fairly than making withdrawals that lock in giant preliminary losses.  

The inflation shock that prompted our research is beginning to recede, and the Federal Reserve now appears more likely to obtain a smooth touchdown.  Will households reverse course as inflation moderates, saving extra and withdrawing much less?  We go away these and different questions for future work.

References

Aubry, Jean-Pierre and Laura D. Quinby. 2024a. “How Does Inflation Influence Close to Retirees and Retirees?” Concern in Temporary 24-12. Chestnut Hill, MA: Heart for Retirement Analysis at Boston Faculty. 

Aubry, Jean-Pierre and Laura D. Quinby. 2024b. “How Do Households React to Inflation? New Survey Proof.” Working Paper 2024-3. Chestnut Hill, MA: Heart for Retirement Analysis at Boston Faculty.

Aubry, Jean-Pierre and Laura D. Quinby. 2024c. “What Dangers Do Close to Retirees and Retirees Face from Inflation?” Working Paper 2024-4. Chestnut Hill, MA: Heart for Retirement Analysis at Boston Faculty.

Federal Reserve Financial institution of Atlanta. 2000-2023. “Wage Progress Tracker.” Atlanta, GA.

Franklin, Glen. 2023. “The Influence of Inflation’s Return on Retirement Planning.” Highlands Ranch, CO: 401k Specialist. 

MFS Funding Administration. 2023. “Inflation is Already Reshaping Retirement Methods and Expectations, 2023 MFS World Retirement Survey Finds.” Boston, MA.

Nationwide. 2022. “Nationwide in Plan Sponsor: Survey Report.” Columbus, OH.

U.S. Board of Governors of the Federal Reserve System. Survey of Shopper Funds, 2019. Washington, DC.