Many of us understand that we need to start saving early and contribute consistently, but fail to see the impact inflation can have on our retirement plans.
Lifestyle inflation is the increase in our standard of living over time, while price inflation is associated with a decrease in the buying power of our money. We can maintain our standard of living only if our income increases with price inflation. An increase in salary, which exceeds inflation, can lead to a better standard of living and this, in turn, raises our cost of living. Therefore we must account for future prices and our standard of living increases when planning for retirement.
It’s very easy to become accustomed to the new lifestyle that a salary increase makes possible. It is similarly very difficult to give up this lifestyle, therefore you will need to plan for sustainability. If you haven’t accounted for lifestyle inflation during your retirement planning phase you may see it have a huge impact on your current savings and the contributions you require going forward.
Consider a 25-year-old working person who hopes to retire at 60. All their pay increases have matched inflation over the years and they contribute 10% of their earnings to a private investment company retirement plan. They could maintain their current standard of living to the age of 94 (if you assume an 11% return, 6% inflation and 70% replacement ratio). A 60% increase received at 45 would reduce the period and see them maintaining their standard of living to the age of 79. They now need to increase their contributions or defer retirement for a few years. An increase, whether it’s once-off or gradual, will need to be accounted for.
Factoring in lifestyle inflation
Any improvement to your lifestyle now will need to be funded by your retirement savings in the future. You can increase the probability of achieving your goals if you account for these increases during the planning stages. Consider your financial position at each point and be sure to match the appropriate asset allocation with your risk appetite and goals.
If you are feeling overwhelmed by this then consider consulting an independent financial advisor who can help you formulate a plan.