5 Times Inflation Is Actually Good for Your Finances
When you hear the word “inflation,” you usually think of the negatives — rising prices and a more expensive cost of living. Inflation causes plenty of financial challenges when your income and savings buy less because everything costs more. But there are some situations where inflation can actually help your finances.
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Here are five potential benefits of inflation, and how to make the most of these increases.
1. Larger Social Security Benefits
Social Security benefits increase each year based on changes in the consumer price index, and the payouts rose by just 1.3% for 2021 because of low inflation last year. But the CPI has increased significantly since then, and Social Security benefits are expected to rise at the highest level in years.
Social Security: Understanding the Basics
In May, the Senior Citizens League estimated that Social Security benefits could increase by 4.7% in 2022 — and the payouts could ultimately be even higher as rates continue to rise, especially since the CPI was up by 5.4% in June. It now estimates that Social Security benefits could rise by more than 6% for 2022.
Social Security cost-of-living adjustments are calculated based on the average annual CPI increase in the third quarter of the year (July, August and September) and are announced in October.
2. Higher Pension Payouts
If you have a pension that has an annual cost-of-living adjustment — such as military and most federal pensions — then your payouts are also adjusted each year based on annual changes in the consumer price index. The calculations vary by type of pension, but the higher the CPI increase the larger your payouts will be.
3. Better Rates on Your Emergency Savings
“If inflation does continue, the Fed may decide to start raising interest rates, which means the return on savings goes up,” said Tim Steffen, director of tax planning and private wealth management at Robert W. Baird & Co. The miniscule rates now offered on money-market accounts, savings accounts and certificates of deposit would rise.
However, you don’t want to buy long-term CDs during a period of inflation or you’ll be stuck with lower interest rates while new rates are rising.
“Inflation deflates the value of money, so you get paid back with money that is now worth less,” said Mari Adam, a certified financial planner in Boca Raton, Florida. If you are buying CDs during a period of inflation, she recommends keeping maturities short and resetting interest rates frequently — by replacing them with higher-rate CDs as interest rates rise.
With interest rates still so low, it’s also important to diversify your investments by keeping some of your long-term savings in the stock market, which has historically had better returns (and outpaced inflation) over the long run.
4. More Valuable Fixed-Rate Loans
If you have a fixed-rate mortgage, your payments will remain the same for the term of the loan — usually for 15 or 30 years. Even though other prices are rising from inflation, your payments don’t change.
“You still need to pay off that debt, but every day the true after-inflation cost of that debt decreases,” Adam said. “After all, the value of that $1,000 monthly payment today, for example, is not the same as the value in 30 years. In 30 years, $1,000 will be worth only a fraction of what it is worth today, so locking in a fixed rate today is a good move when there is inflation.”
Mortgages provide an extra benefit because the loan is for an asset that generally rises in value with inflation: your home. “Borrowing money at a fixed rate when there is inflation can be a smart thing to do, especially when you are investing that money into something that can grow and keep up with inflation,” Adam said. If you own rental property, you may get an extra benefit — you’ll be able to charge higher rent while your mortgage payments remain the same.
If you haven’t refinanced your mortgage recently, you may still be able to lock in low rates and lower your monthly payments or reduce the term of your loan.
5. Lower Tax Brackets
“Higher inflation can impact tax calculations,” Steffen said. “The annual increases to the various brackets might end up being bigger, which means more income is taxed at lower rates next year versus this year.” Especially at the lower tax brackets, you might see a positive impact from inflation, he said. “It can also mean a larger standard deduction, which means a bigger reduction in taxable income.”
Additionally, the income levels to qualify for certain tax credits and deductions are adjusted annually for inflation. Since inflation is higher this year, some of those phaseout levels will increase more than usual, making those benefits available to more people, Steffen said.
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