In 1998, you could buy a gallon of gas for about a buck. In August 2017, one gallon costs around $2.30. And it’s not just gas. From eggs to shoes, inflation means that the cost of living keeps rising. To keep up, your income needs to increase, too.
Inflation and a Fixed Income
When you’re working and earning raises, inflation may not be a problem. After all, any increase in prices is made up for with an increase is wages. But when you’re living on a fixed income in retirement, the situation is different. If your retirement income does not increase, there is nothing to offset inflation’s effect on the cost of living.
The effect is not small. According to the Consumer Price Index inflation calculator, $2,000 in June 1997 had the same buying power as $3,056 in June 2017. In other words, you’d need an additional $1,056 to buy the same items.
Let’s say a person retired in 1997. At the time, he calculated that he needed $2,000 a month to maintain a comfortable lifestyle. He made sure his retirement plan provided that amount. Two decades later, he still has $2,000 a month. However, because of inflation, this is no longer enough to maintain his lifestyle. In fact, he’s coming up more than $1,000 short each month.
Keep in mind that the inflation rate has been low in recent years. When the inflation rate is higher, the problem is even bigger.
Anticipating Inflation
Although we can’t predict the future with complete certainty, planning for retirement requires us to do our best to anticipate our future needs. This should include estimations of expected inflation rates.
To predict the future, it’s often helpful to look at the past. Inflationdata.com looked at the data from 1913 to 2013 and found that the average annual inflation rate was 3.22 percent.
Let’s say you determine you need $2,000 a month to maintain your standard of living, and you plan to retire in 10 years. Using the Forward Flat Rate Inflation Calculator at calculator.net, we can see that in 10 years, with an estimated inflation of 3 percent, you’ll actually need $2,687.83 a month. Inflation doesn’t end there – it continues to rise during your retirement. In 20 years, you’ll need $3.612.22 a month. In 30 years, you’ll need $4,854.52 a month.
Adjusting Your Retirement Plan
Social Security benefits include cost-of-living adjustments, but you will need to ensure that the rest of your retirement income is similarly adaptable. When calculating how much you’ll need during retirement, be sure to account for inflation. Additionally, talk to your financial advisor about investment products, such as annuities, that can give you an increasing income stream to make up for inflation during retirement.
Need help planning for the future? PTT can help with Texas financial planning. Download our Financial Planning Overview to learn more.