How to Factor Inflation and Life Expectancy in Retirement Planning (2024)

FAQs

How do you factor inflation into retirement planning? ›

Retirees worried about future inflation may want to steer clear of renting. Add inflation-correlated investments to your portfolio. Some investments do better when inflation is high. Consider rebalancing your portfolio to include inflation-proof stocks or higher-interest bonds.

You could even try to build in 2% to 3% inflation gap into your targets. Working with a financial advisor is also a good idea – they can work with you to review your overall financial picture and help put together a retirement plan that's tailored to you and your goals.

As prices rise with inflation, the value of your retirement plan savings may stay the same. This leaves you with even less retirement income for what you need and want, especially on a fixed income.

For many people, it's not just about the money. There are other key factors to consider in addition to finances, including lifestyle, family, health, and community involvement. It's important to assess how prepared you are today and know the steps you may need to take before you're ready to make a decision.

Calculating the inflation-adjusted return requires three basic steps. First, the return on the investment must be calculated. Second, the inflation for the period must be calculated. And third, the inflation amount must be geometrically backed out of the investment's return.

Consider using 3% inflation as a basic planning assumption. Three percent has been the average inflation rate over the past 50 years. If you want to be conservative, use a higher inflation rate in your plan.

The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve's mandate for maximum employment and price stability.

Over time, inflation can reduce the value of your savings, as prices go up in the future. This is most noticeable with cash. If you keep $10,000 under your bed, that money may not be able to buy as much 20 years into the future.

Why are retired people hurt by inflation? ›

“Retirees don't necessarily have income, meaning they need to make that lump sum last as long as possible, and high inflation erodes those savings,” Benson says. “If you have a lump sum of money that could provide a year's worth of groceries, with high inflation, it may only be able to buy a few months' worth.”

COLA is an annual cost-of-living increase that begins the second calendar year after retirement and helps your retirement benefit keep up with the rate of inflation.

Retirement planning should include determining time horizons, estimating expenses, calculating required after-tax returns, assessing risk tolerance, and doing estate planning.

A good plan isn't just about the size of your nest egg. It's also about how you manage these three things: taxes, investment strategy and income planning.

Retirees may struggle to maintain their financial stability when their purchasing power is reduced. Therefore, it's vital to understand and intuitively plan for inflation when creating a retirement budget and setting up an income plan.

The 4% rule entails withdrawing up to 4% of your retirement in the first year, and subsequently withdrawing based on inflation. Some risks of the 4% rule include whims of the market, life expectancy, and changing tax rates. The rule may not hold up today, and other withdrawal strategies may work better for your needs.

The 4% Rule in Action

Using the 4% rule, someone with $1 million saved would withdraw $40,000 the first year under the 4% rule, then give themselves raises aligned with inflation. So, if overall prices rose 3% the next year, they would take out $41,200 and so forth.