Pensions are a fantastic way to put money aside for the future. Your money is not only invested with the goal of increasing in value over time, but your employer and the government will also contribute to it.
However, both while saving for retirement and when drawing down in retirement, pensions are not immune to the impacts of inflation.
Before retirement
The money you put into your pension is invested, most commonly in the stock market, in order to grow over time. Pension funds expanded by an average of 7.4% every year between 2015 and 2019, substantially faster than the average inflation rate of 1.53% during the same time.
Even yet, inflation erodes the value of your pension every year; if it increased in value by 4% but inflation was 2%, your pension would have grown by just 2% in’real-terms’.
If your pension rose at a rate of 2% per year, it would be worth 122,000 in cash terms, but you’d be no better off in real terms because the cost of everything would have risen by 2% (workplace inflation). Your 122,000 could buy the same things that your 100,000 could ten years ago.
If your pension grew at 4% annually, it would be worth 148,000 financially, and you would be much better off in real terms. Your 148,000 may get you a lot more than your 100,000 could have gotten you ten years ago.
If your pension increased at less than 2% each year, you’d be worse off in real terms because inflation would have exceeded your pension’s growth.
In the instances above, we haven’t included recurring contributions, but the effect on the money you send in would be the same.
After retirement
You’ll want your pension to last as long as possible once you retire. What you do with your retirement funds will determine how inflation affects it.
If you keep your pension invested and take regular withdrawals, inflation will eat away at your savings. However, if the growth of your investments outpaces inflation, this could be countered.
If you buy an annuity with your pension, inflation may or may not affect your annuity income. A ‘fixed annuity’ will be eroded by inflation over time, whereas a ‘escalating annuity’ will increase over time to keep up with inflation.
For retirement calculations, what inflation rate should I use?
When budgeting for retirement, financial gurus recommend considering a 3% yearly inflation rate. That is, in fact, a greater rate than the government has calculated in recent years.
The Bureau of Labor Statistics calculates the current Consumer Price Index (CPI) by tracking monthly average prices of consumer goods. The CPI is defined as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
The rate of inflation is determined by the change in the CPI from one period to the next.
Because their spending is more oriented on products and services with more rapidly increasing costs particularly health care and housing retirees experience cost-of-living increases that are higher than national averages.
As a result, the government devised the CPI-E, an unpublished, experimental inflation gauge for older Americans. From December 1982 to the present, the CPI-E reflects estimated expenditure habits of Americans aged 62 and up.
From May 2018 to May 2019, consumer prices grew 1.8 percent, according to the Consumer Price Index of the United States Department of Labor.
How are pensions affected by inflation?
The impact on pension costs when inflation is included in is significant. With inflation at 2%, the cost of a pension increases by nearly 20%. A constant-purchasing-power pension costs around one-third more than a level-dollar pension at 4% inflation.
Do pensions take inflation into account?
After retirement, benefits are usually not indexed for inflation. As a result, an increase in the rate of inflation would reduce the worker’s real benefits in the years after retirement, making them less than projected.
Are pensions inflation-indexed?
Ad hoc raises aren’t tied to a certain price index. Rather, pensioners’ current pensions are normally increased by a percentage of their current payment, which is usually a fixed amount. For example, pension plan managers may elect to give all annuity recipients a 3% raise.
In retirement planning, how do you account for inflation?
Go2Income planning aims to make planning for inflation and all retirement concerns as simple as possible:
- Make a long-term assumption about what level of inflation you’re comfortable with.
- Avoid capital withdrawals by generating dividend and interest income from your personal savings.
- To achieve your inflation-protected income objective, use rollover IRA distributions from a well-diversified portfolio.
- Manage your plan in real time and make changes as needed.
Everyone is concerned about inflation, whether they are retired or about to retire. Create a plan at Go2Income and then tweak it based on your goals and expectations. We’ll work with you to develop a retirement income strategy that accounts for inflation and adjusts for potential retirement risks.
Is a high rate of inflation beneficial to pension funds?
Inflation devalues your money over time, potentially reducing your purchasing power later in life. Investing your money in a pension is one approach to potentially mitigate its consequences.
Is an increase in interest rates beneficial to pensions?
Interest rates influence how much you earn on your savings and how much you have to pay back on your debts. When they rise, they can be beneficial to savers, but they might be detrimental to people who are in debt. When interest rates rise, it’s a good idea to pay off debts and put money into savings accounts like pensions.
Is inflation detrimental to retirees?
Inflation might be a death sentence for retirees, but it doesn’t have to be for those who take the time to devise a strategy to combat it. Reduced spending, the development of a realistic retirement budget, and the use of leveraged assets can all assist to mitigate the impact of inflation on long-term savings.
What exactly is the 4% rule?
The 4% rule is a typical retirement planning rule of thumb that can assist you avoid running out of money in retirement. It claims that you can withdraw 4% of your savings in your first year of retirement and adjust that amount for inflation every year after that for at least 30 years without running out of money.
It sounds fantastic in principle, and it might work in practice for certain people. However, there is no one-size-fits-all solution for everyone. And if you blindly follow this method without thinking if it’s appropriate for your circumstances, you may find yourself either running out of money or with a financial excess that you could have spent on activities you enjoy.