We hear that inflation is only “transitory,” which is a vague enough sounding word to make the threat of your money losing value seem benign. And when that threat became real after months of high inflation, Federal Reserve Chairman Jerome Powell eloquently stated “’Transitory’ is a word that people have had different understandings of.”  Americans know that inflation poses a very significant threat to their long-term financial wellbeing, especially wage workers and the elderly. And while many in our government seem unconcerned about inflation, they’re also taking steps that indicate they know it’s around for the long term. 

1. Social Security Benefits Will Increase by 5.9% Next Year

Social Security benefits increase with inflation, and next year’s cost-of-living adjustment is the highest it’s been in almost 40 years! If most workers got a 5.9% paycheck increase, they would be over the moon. However, even with this increase, retirees will have a difficult time protecting their savings from inflation. Social Security benefits have lost an estimated third of their value since 2000 due to price increases, according to a Citizens League study.

2. Indexing Retirement Account Contribution Limits to Inflation 

401(k) and IRA contribution limits may increase every few years, but increases are not indexed to inflation. For 2022, the 401(k) contribution limit is increasing by $1,000, but the IRA contribution will remain the same the fourth consecutive year. Interestingly, the Securing a Strong Retirement Act includes a provision to automatically increase retirement account contribution limits with inflation. It seems our government is anticipating long-term inflation and want to account for it in this one area of the tax code. 

3. Higher Inflation = Higher Taxes?  

Does the government actually get more tax revenue if there’s high inflation? Income tax brackets are indexed for inflation, but plenty of other tax thresholds are not: The $3,000 limit on capital loss deductions hasn’t increased since 1978 and isn’t likely to. Due to inflation, this deduction is effectively worth much less than it once was. Similarly, the $250,000 starting point for the investment surtax isn’t indexed for inflation. Since capital gains are calculated without any adjustment for inflation, consider the impact of inflation on your net profit if you hold an asset for decades. 

Additionally, many people don’t know that Social Security benefits can be taxed. Yes, that’s correct, government benefits funded by payroll taxes are then taxed again when they’re paid out to those who paid said payroll taxes for decades. If your combined income as an individual is over $34,000 or over $44,000 as a married couple filing jointly, up to 85% of your Social Security benefit is taxable. These income thresholds have not increased since they were first instituted in 1984. This means that when this tax was enacted (and probably originally sold to the public as something that would only affect wealthy Americans) it applied to only retirees with income of $89,764 or more in today’s dollars. Now it applies to a retiree with an overall income of just $34,000. As time goes on, this tax will be imposed on a larger percentage of retirees, until even those below the poverty line are affected. 

The Bottom Line 

Savers, retirees, and wage workers are the biggest losers when it comes to inflation, while the government wins by simultaneously printing more money and receiving more tax revenue. Meanwhile, if the ultra-wealthy are negatively impacted by inflation, it’s small potatoes compared to the market returns they’ve seen recently. In a society where your wealth is a major determining factor in the quality of your healthcare, education, and overall standard of living, manipulation of the value of one’s dollars is a major restriction on our pursuit of happiness.  

Even retirees who save saved enough for retirement could find themselves out of funds late in life due to inflation. It’s typically not recommended that retirees take on too much investment risk, which means they’re often pushed towards bonds and CDs. However, these are yielding such low returns that even those with a substantial nest egg could eventually find themselves in hot water. Let’s look at it this way: Even a 2% inflation rate (the Federal Reserve’s target rate) can erode savings significantly over time. After 20 years with a 2% inflation rate, $1,000,000 would only have the buying power of $672,971. If we look at history, we see that the buying power of $100 in 1960 was equal to the buying power of just $40 in 1980, and a mere $11 today.

Unfortunately, the public has a difficult time addressing inflation because economic policy is largely set by an unelected body – the Federal Reserve. It’s up to politicians to put pressure on the Federal Reserve, but will they? If inflation continues to spiral, blue-collar workers and families will continue to migrate from the Democratic Party, and Republicans, if they vigorously protect family budgets by defending the dollar’s value, will have the opportunity to build a growing coalition.  

Laura McLaughlin is a financial planning writer who focuses on tax and monetary policy, Social Security, estate planning, and healthcare. She graduated from Boston College in 2017 with a B.A. in English and philosophy.

Image: Pixabay / Pixabay License

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