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How Does Inflation Affect Pensions?

Angela Mae Updated: June 26, 2023 • 4 min read

Inflation is a particular period in the financial cycle. As inflation rises, there’s a chance that your pension income will be impacted. Generally, in order to grow over the long term, pensions are invested - usually in the stock market. Your finances may suffer if inflation exceeds the rate of growth in your pension. This could mean you’ll end up with a lower retirement income than expected, depending on the plan.

Your money is devalued over time as a result of inflation, which could eventually lead to a reduction in your money's purchasing power. It can also hurt your retirement funds, even if you’re lucky enough to have a pension.

What is a pension?

A pension is an employer-funded retirement plan designed to give you a regular monthly income in your retirement years. It’s a great way to prepare for retirement — and ensure financial stability later in life.

Once you retire, you can then start drawing from the account to cover your living expenses each month. This is usually a set amount that lasts for the rest of your life. The exact amount depends on how long you’ve worked for the company, your retirement age, and your salary leading up to retirement.

Typically, pensions are available in corporate positions and through local and state government jobs. In some cases, you can also contribute to your pension account.

The U.S. Department of Labor has established certain rules regarding pensions, such as how much money an employer must put into the account each year. Most pensions can also be taxed. Additionally, a company has the right to end a pension plan. This would freeze the plan at the amount you’ve already earned.

The Pension Benefit Guaranty Corporation (PBGC) also typically protects pension plans. If your employer fails to pay into the plan, the PBGC can come in and pick up the slack.

Generally, the longer you work, and the more you earn, the higher your monthly pension income will be. The average private pension payout is around $10,788 a year. The average federal plan, meanwhile, is $27,687 a year. There are also personal pension plans.

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What is inflation?

Inflation is essentially the decreased value of your money over time. This makes it where you have less purchasing power, which can be especially problematic for your retirement savings and income. Inflation is usually represented as a percentage, such as 2% or 3%. The rate of inflation fluctuates constantly. In 2021, it was around 6.7%.

Here’s a simple example:

Let’s say a loaf of bread currently costs $3.00. If the rate of inflation increases 2% next year, that same loaf of bread would cost around $3.06. The following year, it would cost around $3.12 and so forth. Now, say a desktop computer costs $1,500 at a consistent inflation rate of 2%. That same computer would cost $1,530 next year and $1,560 the following year.

If your retirement income doesn’t increase with inflation, you’ll start to have less bang for your buck.


Does pension increase with inflation?

Unfortunately, not all pensions adjust for inflation. Even if the cost of living increases, your pension income could remain the same each month.

Some local and state government employers do offer a slight adjustment in their pension plans to help combat inflation. This is called a cost-of-living adjustment or COLA. The yearly increase is usually around 2% or 3%. Most private and corporate pensions don’t increase with inflation, though.

Before 2021, pensions that received a COLA were able to stay on top of inflation. However, the rate of inflation has risen significantly over the past two years. This has had a negative effect on many people’s retirement income.

Also, some states — such as Ohio — have stopped making adjustments to certain pension plans altogether. One major reason for this is that these adjustments are expensive and, for some companies, unsustainable.

How to protect yourself from inflation

If the rate of inflation is higher than the rate of growth in your pension, then you could end up struggling financially. Fortunately, it’s possible to protect some of your retirement savings and income from inflation.

One option is to place your money in an account that earns interest, such as a high-yield savings account, Roth IRA, or 401(k). To protect yourself from inflation, the interest rate would have to match the inflation rate at least.

Another option is to diversify your portfolio by investing in other things like stocks, real estate, or mutual funds. Ideally, the earned amount will be higher than inflation. If it is, you’ll be able to protect your retirement savings from inflation better.

Written by Angela Mae

Angela Mae is a personal finance writer specializing in loans, debt management, investing, retirement planning, and financial literacy. She comes from a journalistic background and pulls from hands-on experience and deep-dive research to breathe life into her stories. Her goal is to help others achieve financial stability and independence. When not writing, she can be found traveling, honing her yoga skills, hiking, or exploring new means of healthy, sustainable living.