When you’re building a retirement plan, it’s easy to focus on market performance or taxes. There is another risk that can quietly derail everything. It’s called inflation, and it often gets overlooked.
In this post, you’ll learn:
- What inflation is
- Why it’s called the silent killer of retirement
- How to protect your income and lifestyle
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What Is Inflation?
Inflation refers to the gradual increase in the cost of goods and services. The Bank of Canada aims to keep inflation at two percent each year. This means something that costs one hundred dollars today should cost about one hundred and two dollars next year.
This target held for many years. In 2021, inflation started to spike. By mid-2022, it climbed above eight percent. Most Canadians felt the effects of that at the grocery store, gas station, and almost everywhere else.
Inflation has since cooled, but it remains a serious concern for retirement planning. Over a 25 to 30 year retirement, even a small increase can have a big effect on how long your money lasts.
Why Inflation Is Called the Silent Killer
Let’s say you plan to spend six thousand five hundred dollars per month in retirement. That works today. Ten years from now, you will need to spend a lot more to maintain the same lifestyle.
Many people don’t think about this. Inflation slowly chips away at your buying power. If you ignore it, you could outlive your savings. You may be forced to cut back on spending or tap into your home equity.
How to Plan for Inflation the Right Way
A Certified Financial Planner will always include inflation in their projections. FP Canada recommends using an inflation rate of at least two point one percent when building retirement plans.
This is important for long-term confidence and clarity. Inflation may seem small on paper, but it adds up quickly over time.
Example: Mr. and Mrs. Inflation
Let’s look at a fictional couple who planned to spend six thousand five hundred dollars per month in retirement. At a two point one percent inflation rate, their plan was solid. It was 105 percent funded and projected to leave behind a one point six million dollar estate. They also had a two-year cushion built into their plan.
Now imagine inflation stays just one percent higher than expected throughout retirement. Their plan drops from 105 percent funded to 78 percent funded. That’s a 27 percent decrease. They now have to rely on their home equity to maintain the same lifestyle.
This is a perfect example of why retirement planning is not a one-time event. Any change in assumptions can shift the entire outcome of the plan.
What Matters More: Inflation or Investment Returns?
Most retirees focus on how their portfolio is performing. That’s important. However, inflation can have an even bigger impact.
Let’s go back to the same couple. Their plan was 105 percent funded using a two point one percent inflation rate. When we increased inflation by just one percent, the plan dropped to 78 percent funded. Now let’s keep inflation the same and instead reduce their portfolio return by one percent. The plan still dropped, but only to 91 percent funded.
A one percent increase in inflation had almost double the impact compared to a one percent drop in performance.
Final Thoughts
Inflation is often called the silent killer for a reason. It builds slowly in the background and can quietly destroy a retirement plan.
If you want your savings to last, make sure inflation is built into your plan from the start. Review your plan regularly and update it as your situation changes.
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