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.
Reducing housing costs, for instance, is a step in the right direction. 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.
Another smart move is adding investments to your portfolio that are likely to increase in value as inflation rises. A real estate investment trust or energy sector stocks, for example, are better positioned to see their value grow in tandem with the inflation rate.
Just remember to balance stock investments with more conservative options, such as bonds, which are more predictable and tend to offer stable returns.
Why Inflation Makes Retirement A Moving Target
Lets assume that you will actually spend about the same in retirement as you are currently spending because you will participate in more leisure activities. And lets further assume that you are currently spending $50,000 /yr. if that was all there was to it all you would need to know was what age you planned to retire at and how long you would live after retirement. I know that is a big question. But according to the world bank the average life expectancy in 2010 was 78.2 years. So assuming that you retire at the age of 65 you need to provide for 13.2 years of retirement. At $50,000/ yr. That means that you need to have 13.2 x $50,000 or $660,000. not counting Social Security.
But if you add in the effects of inflation on retirement all that changes.
In personal finance your net worth is your total wealth or what you own minus what you owe. You can use the Net Worth Calculator to estimate your future net worth.
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The Savings Goal Calculator can tell you how much would you have to save every month to reach your savings goal taking into consideration the inflation rate and your rate of return.
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A Tiny Difference In Return Can Mean A Lot
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My wife and I had our photo taken standing in front of a 1,000-year-old Sitka Spruce tree, and this got me thinking about the impact of 1,000 years of growth.
I can barely get my mind around a concept of the time that tree began its life, presumably around the year 1020. What was life like back then? Did anybody notice that tree when it was young?
Most likely well never know.
Still, my curiosity was now aroused, and I found an online site with lots of information about inflation. That topic doesnt directly apply to a tree, but it certainly applies to investors.
When I came into the world as an adult, U.S. inflation was very low. To me, the 1953-1966 inflation rate of 1.5% was normal. Something that I could have purchased in 1953 for $1 would have cost about $1.21 in 1966. By then, my ability to spend money had escalated mightily, so it didnt seem like a big deal.
As a result, I was in no way prepared for the next 14 years. From 1967 through 1980, the inflation rate was 7.1%. By 1980, that mythical item which I could have acquired for $1.21 in 1966 would have cost $3.08.
From 1926 through 2019, inflation in the United States and other developed nations has been roughly 3%, so at the moment it seems to make sense to regard that as a reasonable long-term expectation for the future.
Scanning the table, youll find some interesting data points.
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How To Factor Inflation And Life Expectancy In Retirement Planning
Retirement planning involves looking into the future to figure out how much money you should save today. You also have to account for future inflation and your life expectancy. Of course, no one truly knows what inflation will be or how long they’ll need their money to last. But you’ll want to make the best estimate you can.
You can take certain retirement planning steps to help you plan as accurately as possible.
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 we’re 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, it’s 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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Determine Retirement Spending Needs
Having realistic expectations about post-retirement spending habits will help you define the required size of a retirement portfolio. Most people believe that after retirement, their annual spending will amount to only 70% to 80% of what they spent previously. Such an assumption is often proven unrealistic, especially if the mortgage has not been paid off or if unforeseen medical expenses occur. Retirees also sometimes spend their first years splurging on travel or other bucket-list goals.
In order for retirees to have enough savings for retirement, I believe that the ratio should be closer to 100%, says David G. Niggel, CFP, ChFC, AIF, founder, president, and CEO of Key Wealth Partners LLC in Litilz, Pa. The cost of living is increasing every yearespecially healthcare expenses. People are living longer and want to thrive in retirement. Retirees need more income for a longer time, so they will need to save and invest accordingly.
As, by definition, retirees are no longer at work for eight or more hours a day, they have more time to travel, go sightseeing, shop, and engage in other expensive activities. Accurate retirement spending goals help in the planning process as more spending in the future requires additional savings today.
Your longevity also needs to be considered when planning for retirement, so you dont outlast your savings. The average life span of individuals is increasing.
Assumed Rate Of Return
Ive seen people use everything between 5% and 12% for average annual returns over a lifetime of investing. But which rate of return is more accurate: 5% or 12%?
Maybe both. There are two big factors to consider:
- Whether or not the assumed rate of return accounts for inflation.
- The investment time period.
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Know Your Target Asset Allocation And How It Might Change In The Future
Your asset allocation should be determined by your goals, time horizon, and risk tolerance.
When any of those factors change, you may want to shift your target asset allocation .
Age is the most predictable factor that may change your target asset allocation.
You can use the NewRetirement Planner to change your rates of return at a future time. Project one rate of return now and then predict another rate of return starting on a future date.
Major Causes Of Inflation
While it may seem like theres a conspiracy to sabotage successful retirement planning, inflation actually happens for logical reasons. I have summarized the major causes of inflation below as explained further in an excellent post at EconomicsHelp.org.
Basically, the causes of inflation relate to either economic growth that is too fast or cost related factors.
Here are some examples that demonstrate the effects of inflation. Its easier to plan for anything you understand, while lack of understanding increases risk.
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How Does Inflation Affect Retirement Planning
When it comes to retirement planning its important to consider inflation in the planning process. But first, we have to understand what inflation means. Inflation refers to the rise in the prices of most goods and services of daily or common use. So, a fixed amount of income will buy less in the future than it buys today. So how does inflation affect retirement planning?
If you have got a retirement income, that doesnt increase, at least in line with inflation, then you might not be able to continue buying the same things and afford the same lifestyle, the longer that retirement goes on. This is because of the effect of inflation and things getting more and more expensive as time progresses.
Assessing Average Inflation For Retirement
Retirement planners across the country will likely provide you with a variety of answers when it comes to defining the “perfect” inflation rate you should use for retirement planning. Although a rate of 3 percent has traditionally been used for years, data shows that average inflation rates vary significantly depending upon your frame of reference. For example, although the average inflation rate for the past 100 years has been 3 percent, an average rate of 3.9 percent occurred between the closure of World War II and 2013. Likewise, the average rate of inflation exceeded 6 percent between the years of 1981 and 1994.
With that in mind, your retirement planner will likely factor in the estimated time you will be living off of your retirement funds when deriving an average inflation rate. While it is impossible to predict how inflation rates will change in coming years, evaluating these historic trends can help you make the most educated decision possible.
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The Impact Of Inflation On Retirement Planning
Published on February 2, 2013Updated on February 7, 2014 by Tim McMahon
Planning for retirement is difficult enough without having to worry about inflation. There is a lot to consider when you stop working a regular job. Do you plan on living where you are now. Do you want a change of scenery? Would you prefer a place with less maintenance or a place where you can have a big garden or a workshop where you can build things?
There of course the financial aspects to consider as well. Will your retirement savings be adequate to provide the type of lifestyle you desire? There are a variety of Retirement Planning Calculators that can help you try to figure out how much you will need to save to have a happy retirement. You need to estimate your expenses once you are no longer commuting to work. So some experts use a rule of thumb that you will spend 20% less in retirement than you spend during your working years.
But suppose you want to travel more, or play more golf? Wont that actually add to your expenses? And what about additional medical expenses. Isnt it reasonable to assume that you will need more medical care as you get older? In addition to all these variables there is inflation. At the moment, inflation is moderate, but what if inflation heats up? What effect will that have on your retirement? Unfortunately, adding inflation into the retirement equation is like adding a moving target to a shooting range, it makes things much more difficult.
Get The Most From Your Social Security
Social Security has automatic, built-in cost-of-living adjustments. It’s a unique, life-long inflation-adjusted source of income, and smart planning can help you get more out of it. The cost-of-living adjustment for 2022 is 5.9%.
Almost one-third of retirees will rely on Social Security to provide 90% of their retirement income. More than half will rely on Social Security for more than 50% of their retirement income.
One of the most important things you can do to protect yourself against rising prices is to make sure you get the most out of your Social Security benefits, for both you and your spouse, by choosing to defer SSI income until you are 70.
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Use A Conservative Inflation Rate For Planning Purposes
Since your retirement is likely to span decades, consider inflation over long time periods. Inflation is running at historically low levels, this wont last forever. However since World War II inflation has averaged well over 3 percent. Inflation will have a huge impact on your retirement finances, assuming todays low inflation rate into retirement could be setting you up for disappointment down the road.
Is It A Good Idea To Keep My Retirement Savings In A Savings Account
In general, leaving all of your money inside a UK bank of England savings account will leave you at risk of losing money due to rising costs due to inflation. In order to lower your risk, it can be a good idea to invest your retirement fund in different things such as the stock market, or bonds, that tend to out outperform the rate of inflation.
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Retirement Planning: What Rate Of Inflation Should I Use
Michael James on Money started it. Then BigCajunMan took over trying to estimate how much income he could draw out of a retirement nest egg based on various factors including inflation and the rate that the investments grow before withdrawal. As he says, it is very hard to pick what percentage to use for inflation. CPP is also indexed to inflation at a rate picked by the government so your monthly check can go up. Ive generally found our bills go up more in a year than that government rate, though. So for my personal retirement planning I wondered what rate of inflation I should use.
Why Does Inflation Matter
Inflation matters because you can buy less than you could before with the same amount of money.
Think of how important this is! You think youll have a certain amount of money based on retirement planning, and you will. Only it wont buy anywhere near as much as it did when you were planning for retirement years earlier.
And like aging, you dont see the depletion of your money from one day to the next, but you sure see it over a few years.
Lets use an analogy we can all relate to. Imagine you have a grocery budget of $ 200 a week that allows you to easily buy everything you want. You take an envelope to the grocery store with 2 crisp $100 bills in it every week.
Then time travel five years. You take that same $200 to the grocery store, only now, you can only buy 90% of what you could buy just 5 years prior due to inflation based on the recent historical rate of inflation of 2%. And using older past inflation data, its even higher than 2% a year!
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Go Green And Grow A Garden
The best thing you can do is buy everything you might possibly need now if you really expect inflation to kick in. Make yourself as self-sufficient as possible.
Stock up on durable goods now if you’re worried that prices will rise quickly. Make your home as energy-efficient as possible, reducing your exposure to rising energy prices. Grow your own garden, and if you can, get livestock, or at least a few chickens. You’ll be insulated from inflated food prices, and, if necessary, you’ll have something to barter.
Try to live in a community where you can walk, bike, or take public transportation for your daily needs. This reduces your dependence on potentially rising insurance, gas, and maintenance costs.
Retirement Calculator With Inflation
Its not all doom and gloom. Besides social security increases for inflation, more good news is that most retirement planning calculators have inflation built right into them, which makes it easy to factor inflation into retirement planning.
Some retirement planning calculators have inflation of a certain percent built into the numbers you can usually find this in the calculator footnotes.
Other retirement calculators allow you to enter your own inflation rate, which can be very tricky since inflation is completely out of our control and therefore impossible to predict with complete accuracy. This is obvious from the inflation rate extremes in the chart above.
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Will Inflation Affect My Retirement Savings
Inflation can affect your retirement savings depending on what you do with that money. Leaving your money in a bank account with low interest is a risk as your money will not outgrow the rate of inflation. However, investing your retirement savings in equities may help protect against the rising cost of inflation. Of course, any investments come with risk and its important to be comfortable with your level of investments.
How Inflation Impacts You
If your income stays the same while prices go up, you’ll feel the effects of inflation. Your money won’t stretch as far and you’ll 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 doesn’t grow or shrink. If your income rises by a percentage greater than the inflation rate, you’ll 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. It’s important to have enough retirement savings that you won’t be up all night worrying about inflation.
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