Many of the time-honored rules for retirement planning are under siege. Determining how much money you’ll need to maintain the lifestyle you’ve become accustomed to—and knowing how to save it—has never been an easy task for professionals.
Retirement-planning experts offer a variety of conflicting ideas on just how to arrive at that elusive figure, and the changes in today’s volatile and unpredictable economy are making that job tougher than ever. Millions of professionals in practice who thought they were on the right path to a financially secure retirement are discovering that their goals may now be beyond reach.
Whether your planned retirement is years away or just around the corner, inflation is destined to exert a major influence on your future economic well-being. Ignore it at your own peril.
Inflation Never Lets Up
Inflation can vary wildly from one year to the next. Whatever the rate, it continues its damaging work relentlessly year after year.
Even the seemingly harmless inflation rate of the last few years takes a significant toll over time. After 10 years of a modest 3 percent inflation, that dollar bill in your pocket now would be worth only 74 cents in today’s dollars.
How Inflation Will Affect Your Retirement
Here’s an example of how inflation affects your life right now: if you paid $60 for a week’s groceries in 1995, you’re paying about $91.08 for those same items today.
If you paid $25,000 for a new car in 1995, it will cost you approximately $38,706 to replace it with a similar 2014 model. Ten years from now, a comparable new car will cost you about $47,182 (assuming a very modest 2 percent inflation rate—most economists expect inflation to run considerably higher than that over the next few years.)
Calculating inflation’s effects over a period of two or more years can be dauntingly complex. That’s why it’s difficult to make simple dollar-to-dollar comparisons from one year to another. If you’d like an easy way to gauge inflation’s effects on some of your personal or business expenses, log on to www.westegg.com/inflation/. This easy-to-use inflation calculator adjusts any given amount of money for inflation, according to the Consumer Price Index, from 1800 to 2012.
How Much Income Will You Need in Retirement?
You’ve probably read several variations on how much income you’ll need during your retirement years. One popular formula estimates you will need 80 percent of your pre-retirement income to maintain your current lifestyle in retirement. If your earnings are, say, $60,000 per year just before you retire, you will need $48,000 to maintain your lifestyle. If your annual income is $100,000, you’ll need $80,000 per year to retire in the style to which you have become accustomed, according to the most popular school of thought.
However, Walt Woerheide, PhD, VP of Academic Affairs at The American College in Bryn Mawr, Pennsylvania, believes most people experience a significant drop in expenses when they retire. “Chances are your mortgage will be paid off, you’ll no longer need to put aside money for savings or college tuition, and you’ll have the time to do chores that you may have been paying other people to do,” he says.
Certified financial planner (CFP) Carl J. Kunhardt, of Dallas, Texas, says his experience is different. “We’re finding that clients are spending essentially the same in retirement as before. It’s what they are spending on that changes in retirement.”
Obviously, experts are unable to agree on a single model for estimating financial needs in retirement. More problematic, perhaps, is the fact that some of the popular formulas for estimating required retirement income fail to take inflation into consideration—that’s why you must.
The Charles Schwab brokerage firm has published a retirement planning rule-of-thumb that takes clear notice of inflation’s effects. It suggests you will need $230,000 in retirement savings in today’s dollars to provide $1,000 in monthly income during retirement. For example, if you want to add $4,000 per month to your Social Security income, you would need $920,000 in retirement savings and investments in today’s dollars.
The key phrase in the Schwab formula is “in today’s dollars.” If, say, your retirement is 10 years off, you will need to increase the $920,000 mentioned above to allow for the effects of 10 year’s inflation.
Obviously, you can’t predict the exact inflation rate in advance; all you can do is estimate. Even if you assume today’s inflation rate will remain about the same over the next 10 years (very unlikely according to most experts), that $920,000 in today’s dollars will be about $1,110,528 in 2018 dollars.
Since the current low rate of inflation may not continue for much longer, you should adjust your estimate of required retirement income to compensate for the latest rates.
Whatever form your final plan takes, whatever the size of your investment portfolio, make certain that you take the inevitable effects of inflation into account. Today’s skyrocketing costs for food and energy seem to signal a pattern of higher inflation ahead.
BEATING INFLATION’S EFFECTS
Use these tips to help meet your retirement goals:
• Prepare a detailed and flexible plan for your retirement and keep it up to date as your circumstances change.
• Maximize your contributions. Contribute as much as you can as early as you can to your tax-deferred retirement plan. Allow the magic of compound interest to help counter inflation’s effects.
• Resist the temptation to use your retirement portfolio as an emergency funding source. Cashing out a portion of your tax–deferred retirement plan will result in taxes and penalties that will put a serious dent in future growth.
• Include some equities in your retirement portfolio. Most experts agree that stocks historically offer the best opportunity to achieve a rate of return on investment that will outpace inflation.
• Invest in dividend paying stocks that have a long payment history and a record of steady dividend increases.
• Invest a portion of your retirement portfolio in inflation-indexed treasury securities (TIPS).
—William J. Lynott has an extensive background in management consulting, marketing, and finance. He's written more than 900 articles appearing in a wide range of consumer magazines, trade publications, and newspapers in 17 countries. Contact him at lynott@verizon.net.