Inflation Assumption For Retirement Planning


Inflation And Retirement Planning

Retirement Planning Spreadsheets 3: Adding Inflation and Raises to the Model

Back in 1965 if you have $140,000 in the bank you would have been a millionaire by todays standards. From 1965 to 2011, the average annual inflation rate was 4.39%.

Lets face it, the purchasing power of $1 thirty years ago is different that today. I remember as a kid, my sister and I could go into a store with one dollar and get 2 chocolate bars, a bag of chips and a handful of double bubble. Today, if I took two of my kids into the store I could barely get out with just a five dollar bill for those same items.

In 1965:a loaf of bread cost you 27 centsa litre of milk was 31 centsgas for your car was about 10 cents per litreThe average car was 2500and my dad bought our starter home for a little over $10,000

Today that same loaf of bread is about $2.50a litre of milk is $2.60gas for your car is about $1.06 cents per litreThe average new car is over $30,000and to buy an average home in Alberta is about $350,000

Predicting inflation is like predicting the stock market or interest rates or housing prices but one thing I know for sure is the cost of living will increase so when it comes to financial planning and retirement planning it is so important to factor inflation into the picture. If you dont you will not be accounting for the changes in the value of money because of the rising goods. If you think $1 million is enough to retire by todays standards, that $1 million will not be worth the same 10, 20 or 30 years from now.

S To Help Preserve The Purchasing Power Of Your Portfolio

  • High inflation can create challenges for retirees.

  • An effective retirement income strategy should take inflation into account.

  • Keeping a portion of your portfolio invested in stocks can help offset the effects of inflation.

Roger Young, CFP®

Rising inflation can create challenges for retirees, but there are steps you can take to help mitigate its impact. Inflation reduces the purchasing power of your savings by increasing the cost of future expenses. If your living expenses rise higher than the income that your retirement savings can sustainably generate, you risk running out of money.

Higher inflation is often unpredictable and can be an important factor to account for when planning your retirement income strategy, says Roger Young, CFP®, a thought leadership director with T. Rowe Price.

Inflation Investing And Retirement

When you start your personal retirement planningor investing, you may have some important assumptions about your financial plan. You might think its the rate of return on your investment. Or maybe its the withdrawal rate you can get during retirement. Another important assumption might be the savings rate you receive during pre-retirement.

Although all are important in your investing or personal retirement planning, Blair duQuesnay at The Belle Curve reveals, There is something else that eclipses each one the rate of inflation.

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How Inflation Impacts You

If your income stays the same while prices go up, youll feel the effects of inflation. Your money wont stretch as far and youll have to make some changes to your budget. In theory, salaries and wages should rise to keep up with inflation so that workers can maintain their standard of living. Social Security benefits, too, are subject to Cost of Living Adjustments that take rising prices into account.

If your income rises by the same percentage as the inflation rate, your purchasing power is not diminished. It doesnt grow or shrink. If your income rises by a percentage greater than the inflation rate, youll be able to afford more goods and services. This is the scenario most of us want. It makes us feel better to see our purchasing power growing over time.

Of course, if your income shrinks or disappears, you might be in trouble. Other people who feel the negative effects of inflation are those on a fixed income, or those who hold fixed-income investments while inflation takes its toll on their purchasing power.

Although stocks bring risk and volatility, they also have a track record of providing inflation-beating returns over time. Investing in stocks not only helps you grow your retirement savings, but it also helps your retirement savings last throughout your entire retirement. Its important to have enough retirement savings that you wont be up all night worrying about inflation.

Let Social Security Help

Efficient Retirement Income Archives

People love to knock it, but Social Security is still a major part of most Americans retirementabout half of retirees rely on Social Security for more than 50% of their retirement income. It comes with a built-in cost of living increase based on the published inflation rate, and despite much being written about the potential drying up of the Social Security trust fund, its still estimated to provide at least 70% of expected benefits if or when it runs out of cashand thats without any legislative changes. All of that helps.

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What Is Your Attitude To Risk

A key factor in investment decisions is establishing the level of risk that is acceptable to each individual investor, as this differs widely from one person to another. One of our expert wealth planners will spend time with you understanding your concerns and helping you to assess the most appropriate risk level.

Our investment managers can then manage your discretionary portfolios, whether in pensions, ISAs or general accounts, to match your risk appetite. This will generally mean a different asset allocation between equities, bonds, property and other alternatives, with a view to ensuring that the income derived from that portfolio can at least keep pace with inflation.

Should You Budget Or Track Spending

Many people dont have a formal budget. Thats ok budgeting can be helpful for some and emotionally draining for others. But its important to understand what makes up current spending in order to understand what spending looks like in retirement.

One way to build the financial plan is to assume spending is the same during working years and retirement. This assumption, though not exact, provides for some flexibility if anything changes an important part of building a 30-year plan.

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How Does Inflation Affect Retirees

Rising prices could produce a gap between your planned income and what you actually require to pay your bills. If you need to withdraw a higher amount from your retirement savings over time, that activity could affect the long-term sustainability of your retirement income plan.

Prices generally do not rise evenly across the board, however. The cost of medical care services, which are particularly important in retirement, has risen significantly in recent decades. However, these costs rose at a slower rate than overall inflation over the 12 months through May 2022, at only 4.0%.1 Meanwhile, food, fuel, and electricity costs rose substantially over the same period, accounting for nearly a quarter of the overall rise in inflation.1

Unadjusted 12-Month Rise Ended May 2022: Prices Do Not Rise Evenly

Some costs rise at different rates than during other times of inflation.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index May 2022.

How Inflation Affects Retirement Savings

Investing for Income in Retirement: Planning and Withdrawal Strategies

The Federal Reserve generally considers an inflation rate of 2% as acceptable to maintain a healthy economy. At this rate, a dollar you save today will be worth about 98 cents next yearand then less again the year after that. To overcome this effect, your retirement savings would need to grow at a 2% annual rate to maintain your spending power into the future, provided inflation remains at 2%.

When inflation is higher, as it has been recently, the buying power of your savings declines more rapidly. Given that it is impossible to know what inflation will be like in the future, it is important to build a margin of safety into your savings plan. This means carefully considering your investment allocation and your retirement timeline. Growth beyond inflation is necessary to ensure that you accumulate the savings you will need to support yourself in a retirement that could last several decades.

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Interest Dividends Or Rental Income

Passive forms of income such as interest, dividends, or rental income sometimes move in line with inflation. However, each have interesting ties to rising costs. It’s estimated that 46% of all retirees collect at least one of these three sources.

Interest rates usually rise when the Federal Reserve implements increases to the federal funds rate as a way of combating inflation. Inflation itself does yield higher interest revenue, but government action to fight it often does.

Dividends are the results of companies paying out a portion of their net income to investors. When high inflation occurs, the Federal Reserve may decide to raise the federal reserve rate. By raising interest rates, it makes obtaining credit more expensive and it attempts to make the economy cool off. In general, the government is intentionally trying to slow down the economy when high inflation occurs. Therefore, if the economy slows, companies may generate less earnings and have less income available to distribute dividends.

Rental income is often a strong income source during higher periods of inflation. If leases are locked into semi-short terms , landlords can decide to raise rent at the end of the lease term. Long-term leases may be locked into unfavorable terms that can’t easily be changed.

Inflation And Your Sources Of Income

To protect yourself in retirement means creating an income plan that anticipates inflation over many years and allowing yourself to adjust for inflation spikes that may affect your short-term budget.

First, when creating your income plan, its important to look at your sources of income to see how they respond directly or indirectly to inflation.

  • Some income sources weather inflation quite well. Social Security benefits, once elected, increase with the CPI. And some retirees are fortunate enough to have a pension that provides some inflation protection.
  • Dividends from stocks in high-dividend portfolios have grown over time at rates that compare favorably with long-term inflation.
  • Interest payments from fixed-income securities, when invested long-term, have a fixed rate of return. But there are also TIPS bonds issued by the government that come with inflation protection.
  • Annuity payments from lifetime income annuities are generally fixed, which makes them vulnerable to inflation. Although there are annuities available that allow for increasing payments to combat inflation.
  • Drawdowns from the equity in your house, which can be generated through various types of equity extraction vehicles, can be set by you either as level or increasing amounts. Use of these resources should be limited as a percentage of equity in the residence.
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    What Does History Tell Us

    An environment of high inflation and low returns may be uncommon, but its impact on investors can be severe, as our experience in the 1970s illustrates. In 1973, the inflation rate increased to 6%, and the S& P 500 dropped 15%. The inflation rate was 11% in 1974, and stocks lost 26% of their value. Interest rates were high from a historical perspective, resulting in fixed-rate investments generating more interest income for retirees. However, inflation consumed the increase in income. This experience from 50 years ago may be contributing to concerns that investments might not keep pace with inflation1 in the future.2


    How Much Will I Need In Retirement With Inflation

    Growth Assumptions (Retirement Planner)  Personal Capital Support

    A better way to phrase this question in your mind would be, what sort of lifestyle do I want to have in retirement. This is because your lifestyle will tell you how much you want to spend. Once you know this figure, you can then start to work out how much you will need in retirement when accounting for inflation.

    Lets say for example that you want to spend £40,000 per year in retirement based on todays prices. Next year that would cost £40,800 and in 5 years that would cost £44,163 because of 2% per year inflation. So, by planning on the expenditure of a certain amount as your desired lifestyle, it will help you how much investments or savings you need when accounting for inflation.

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    Inflation For Older Adults

    That illustrates the role of geography and lifestyle choices play in each of our consumption baskets, which in turn influences how much inflation were experiencing. Age tends to play a role, too, as reflected in a statistic called CPI-E, the Consumer Price Index for the Elderly, which captures the spending of adults who are age 62 and above. The Bureau of Labor Statistics has been calculating CPI-E since 1982, so there are now almost 40 years worth of data. By comparing CPI-E to CPI-U, the latter of which includes people of all ages, its possible to see how people post-age 62 spend their money relative to the broader population and also what rates of inflation they experienced.

    For the one-year period ended December 2020, CPI-E was 1.4%. That was right in line with the increase in CPI-U during that same period. Since the Bureau of Labor Statistics began calculating CPI-E in 1982 through 2020, it averaged 2.79%a touch higher than CPI-U, which inflated about 2.60% per year, on average, over that same stretch.

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    What Retirees Can Do To Curb Inflations Side Effects

    While seniors can’t directly affect the inflation rate, there are ways to minimize the shadow it casts over their retirement.

    • Reduce housing costs. Trading in a larger home for a smaller one, even if the mortgage is paid off, reduces the monthly outflow for property taxes, utilities, homeowners insurance, and maintenance. Retirees that are worried about future inflation may attempt to steer clear of converting from an owner to a renter.
    • Add inflation-correlated investments to your portfolio. As rent charges tend to rise along with inflation, real estate investment trust or energy sector stocks, for example, may be better positioned to see their value grow in tandem with the inflation rate.
    • Diversify income streams. Some income streams will naturally increase due to inflation others will remain stagnant. Retirees would do well to make sure they can obtain sources of income that are associated with cost of living adjustments. This includes moving away from fixed-income sources of income.
    • Calculate retirement needs as early as possible. By factoring inflation into what you will need, it’s easier to plan, prepare for when to leave the workforce, and what type of lifestyle you’ll be able to afford when consider price increases.

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    Will I Need To Delay My Retirement

    Nearly a quarter of Canadians reported delaying retirement when markets took a downturn at the beginning of the pandemic, but today the challenge for those hoping to retire is that we dont know when inflation will normalize.1If saving more isnt an option, you may choose to push back your retirement date, giving you more time to save. That may also give the economy the time it needs to recover. On the other hand, working later may carry implications for your health and family. Naturally, few people are keen to delay retirement and you should speak to your financial advisor before making such a big decision. Depending on your situation, delaying retirement may be unnecessary.

    Weve all met that person who knows exactly how many days, hours and minutes are left until their retirement, Seberras says. If thats you, you may not be willing to delay. Instead, you may have to make another adjustment. It really depends on the person.

    Inflation Assumptions In Your Financial Planning Program

    Do Pensions Make a Difference in Retirement?

    by Alex Long

    Projecting clients expenses in your financial planning program requires the planner to set an assumed inflation rate. A small change to the assumed inflation rate can make a big impact in the overall success of a clients plan. provides a rich resource for information on inflation data, including the chart below displaying average annual inflation by decade. Financial plans typically project over a long time span of 20+ years. If you look at inflation over the last 30 years as a base to help estimate a reasonable inflation rate for the next 30 years, you would find an average inflation rate of about 2.6%. However, if you step back 50 years, to include higher inflation periods of the 70s and 80s, the average rate would be about 3.7%. Projecting expenses using a 2.6% compared to a 3.7% inflation rate will lead to very different results, especially over a 20+ year plan.

    To illustrate the impact, lets use the What If? in Silver Financial Planner. Below are the results of a retirement projection created with Silver Financial Planner for a married couple in their 50s, projecting out 40 years until age 90.

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    How Do I Avoid Losing My Retirement Savings To Inflation

    You can help counteract any potential losses to your retirement savings by investing your assets in a portfolio that will outperform the rate of inflation. In other words, as previously discussed you invest your money into something such as equities, bonds, or stocks which would average out at a better rate of return than leaving all your money in a bank account with a low-interest rate. As with any form of investing there is risk to account for and there are no opportunities with a guaranteed return on investment.

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