How does inflation affect retirement planning?

When it comes to retirement planning it’s 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 doesn’t 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. 

What inflation rate to use for retirement planning?

The government target annual inflation increase is 2% per annum. So when retirement planning, 2% is a reasonable figure to use. However, inflation is very hard to predict and will fluctuate year on year depending on many variables. It’s not uncommon to see inflation rise as high as 5,6 or 7% per annum. It’s also important to consider the possible negative inflation that can occur. As a rule of thumb though 2% is a good figure to use.


How much will I need in retirement with inflation?

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.

Let’s say for example that you want to spend £40,000 per year in retirement based on today’s 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.


How to protect against inflation in retirement?

One of the best ways to protect against inflation in retirement is by investing. This is because if you hold a lot of your money in cash then generally interest rates on cash are well below the rates of inflation.

However, it’s important to be comfortable with investing your retirement funds, this doesn’t mean investing all of your cash in one thing such as property. A better option may be diversifying your asset portfolio, for example, some in cash, some in equities some in bonds.

When working, its normally a good idea to take advantage of any employee pension scheme for the benefits they provide.

You shouldn’t panic about inflation but you should definitely be aware of it. Before making any decisions we would recommend speaking to a financial adviser who will be able to discuss the best options for you.


Why does inflation decrease purchasing power?

Inflation is commonly referred to as “a measure of the rate at which the price of goods and services increases over time.” As inflationary measures increase, this implies a decrease in the purchasing power of your money. In other words, this has an effect on your ‘purchasing power,’ as you can now purchase less with the same amount of money.

Therefore, with time you need more money to purchase less things. The result is that it takes even more time for your earnings to grow in order for them to keep up with the rate at which prices are rising – this decrease in purchasing power affects everyone because all citizens will have lower buying power as their incomes rise indefinitely over time if they do not compensate by saving or investing additional funds from their increasing income levels (due to increased productivity).

UK inflation rate graph year on year in %

How does inflation affect the price of food?

The price of various food types is always rising up and down, this is due to food production companies having to raise their costs to account for the increases in inflation.

Beer drinkers will be disappointed to hear that the price of Beer is almost 62 times more expensive than in 1966 thanks to inflation .But wages have leapt 38 times to help us buy the pricier pints (The Sun 2021 ). The average weekly wage for a male full-time worker in 1966 was £20. Today it is £770.

The price rise in food can also be down to supply and demand however the price tends to rise quickly during times of economic uncertainty. According to The Balance (2021) in 2020, the COVID-19 pandemic sent total food prices up by 3.3%. Most of this was driven by a 4.4% increase in meat, fish, poultry, and eggs. Dairy products, up 3.8%, were also a substantial contributor to the rise. During the pandemic the price of a white load of bread risen by a huge margin of 12.95%.


What rate of return should I use when retirement planning?

We all have different experiences with investments, so it is an individual decision that should be tailored to your needs and comfort level. For some people, the idea of losing anything is terrifying. For these individuals, they might opt into investment options that offer lower rates of returns (even though this means you’re more likely not going to keep up with inflation). But finding a good balance between high-risk/high reward versus low-risk/low reward will help fulfil everyone’s financial goals. Even the savviest investor knows that return on investment is not guaranteed.


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 it’s important to be comfortable with your level of investments.


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.


How much money can I lose in retirement due to inflation?

Inflation is a hidden expense that you pay each year. It is not shown on your statements – it relates to the items you may purchase with your money.

Because inflation reduces the spending power of your money, it also reduces the return on savings and investments.  The real return is the difference between the actual return and inflation. For example, if you invest £100,000 which grows by 6% in a year you would have £106,000 at the end of the year. If inflation is 2% in the same year, the real return is 4% (6%-2%). So, your £106,000 only has the spending power of £104,000 compared to the previous year.  As long as your retirement income and savings grow at least in line with inflation then you won’t lose any of the spending power of your money.

If the actual return on your funds is less than inflation, then your real return will be negative and your spending ability losses will be equal to the negative amount. For example, if you receive an actual return of 0.5% interest on cash savings and inflation is 2% then the real return is -1.5% so the spending power of your cash is reduced by 1.5% compared to the previous year.


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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