Don’t Forget to Account for Inflation in Your Retirement Planning!

Often overlooked, but imperative for a vital retirement plan, inflation may prematurely deplete your retirement funds years before you expected.

As a rule of thumb, many financial advisors recommend accounting for a 3% inflation rate when planning for retirement. However, this rule presumes that the Fed and banks effectively regulate inflation to that annual increase throughout the course of your entire retirement. History has taught us we can’t necessarily depend on a stable rate of inflation. In the 70s, for example, inflation rates far exceeded this 3% rule, reaching as high as 11.22% in 1979! Now, if you’d planned for a 3% annual inflation in the 70s, you’d be out of luck, down the creek without a paddle.

So, how can you realistically and effectively prepare for inflation if you don’t know how the economy will behave 10, 15, or 20 years from now?

Well, truthfully, there’s not a clear-cut, magical number that will ensure you are totally prepared to take on inflation. You can abate the risk of rising inflation by over-preparing, however. Saving more, investing wisely, and creating strategies to safeguard and grow your wealth after your retire.

Let’s play around with some numbers for a moment. Say, you have $800,000 stashed away for retirement in 2016, and you plan to withdraw 4% annually to cover your expenses, with an expected 3% annual inflation rate. That’s $32,000 a year. But, keep in mind that’s 2016 dollars. Let’s go 5 years down the road to 2021. In order to maintain the same buying power of $32,000 (in 2016 dollars), you’ll need to withdraw around $37,096 in 2012. That’s all well and good, if the inflation rate stays at or below 3%.

Now in the same scenario, you take $32,000 out in 2016, but the years leading up 2021 see much higher inflation rates than you anticipated, let’s say it hovers around 10%. In order to maintain the same buying power of $32,000 (in 2016 dollars), you’ll need to withdraw $51,536 in 2021! And that’s $14,440 over what you expected to be withdrawing for your annual withdrawal! You can see that a few years of higher-than- expected inflation rates could really destabilize and deplete your retirement funds.

So what to do?

While many rely on Social Security’s cost of living adjustments (COLA) to act as an inflation hedge, historically it’s unpredictable. For instance, while recipients received increases to their benefits in 2014 and 2015 of 1.5% and 1.7% respectively, benefits will remain flat for 2016. Moreover, given our 3% example, this only get’s you half way.  While the prolonged low interest rate environment has driven many to elect to invest for growth as the solution to this dilemma, in most cases they do so with far too much risk.  This can potentially be averted by employing certain inflation adjusted securities, as well as inflation adjusted guaranteed income solutions for the more risk averse.     

Given our current economic and geopolitical environment, investors must be cognizant of the risks these uncertainties pose to their investments. That being said, should you be concerned your retirement plan may not be properly positioned to weather high inflation or increases risk in the markets, consider meeting a board Certified Financial Planner, one that will help position your portfolio defensively in bad markets, opportunistically in good.