All of us have heard (or told) the stories about how much things used to cost in “the good old days.” A candy bar and a soda could both be had for a couple of quarters in the ’70s. A gallon of milk or a gallon of gas were both less than a dollar in the ’60s. The list can go on and on. While the trip down memory lane can be entertaining, it also offers meaningful perspective on the effects of inflation, particularly in regards to retirement planning.
The good news is that most Americans factor in the cost of inflation as they build their overall nest egg. It is common practice to estimate what the cost of living will be once retirement is reached. However, many fail to take into consideration inflation within retirement. The length of the average retirement is approximately 20 years and inflation does not stop once the finish line of the working years is reached. One of the true hidden costs of retirement is how much extra money will be needed due to inflation over the course of the retirement itself.
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So while a $500,000 nest egg might seem to be the right amount on day one of retirement, the reality is that given the cost of inflation, much more is actually needed to keep pace with rising costs and the reduction in purchasing power over the course of the next 20 or even 30 years. Funds could easily be tapped out with many years of retirement ahead.
Keep the following tips in mind as part of the retirement planning process to help prepare for inflation in retirement.
Understand how inflation could impact retirement expenses. Take a comprehensive look at potential retirement income expenses and consider the impact of inflation. One key area of focus should be health care costs and medical expenses. It is very likely that there will be greater expenses in these areas the older one gets, particularly once retirement age is reached. In fact, it is estimated that retirees aged 65-plus can expect to spend 12.2 percent of their income on health care expenses (as compared to 4.6 percent for 25- to 34-year-olds). This figure is very likely to continue to grow as health care costs continue to skyrocket and show no signs of leveling out. (Also, become familiar with Medicare options. Medicare does not cover everything and supplemental insurance may be necessary, which will add to existing monthly expenses.)
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Estimate the number of potential years of retirement. While retirement may be full of unknowns, consider current health status when thinking about potential life expectancy. Also, if married, consider the possibility that one partner may live much longer into retirement. With better health care and longer life expectancies, someone retiring today at age 65 can expect to live another 20 years based on life expectancy tables. Even with a modest inflation rate of 2.5 percent, costs would double over the course of a period of 28 years. With this in mind, those planning an early retirement need to pay even closer attention to how to best address inflation over a greater number of years.
Review retirement income sources and consider if they can help address inflation. Determine whether cost-of-living adjustments or potential increases apply to those sources of income. While Social Security might effectively address inflation, some investments or other financial vehicles might not. Also, consider the impact of potential low interest rates and rising inflation rates during retirement as total rates of return could be much different than anticipated.
Develop a plan to address inflation now. Ideally, work with a financial professional to see what strategies and products should be considered to help address the risk of inflation during retirement. There are multiple variables to take into account, and without proper guidance there are many potentially damaging assumptions that can be made.
For example, in a recent Allianz Life survey on inflation within retirement, 64 percent of respondents do not have a financial plan that addresses the rising cost of living in retirement. Of those who do, 51 percent claimed their financial “plan” to address it was to “be more frugal with money” when they retire. While this is certainly OK, many additional factors need to be taken into consideration to ensure income is not outlived. For example, take Social Security. While Social Security adjusts to an extent for inflation, it very well might not keep pace with health care expenses. The average annual cost-of-living increase for Social Security over the past 30 years has been 2.6 percent. Meanwhile, the average annual premium increase for Medicare Part B over the same 30-year time period has been 6.2 percent.
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History has shown that the cost of living will certainly go up over the course of time. While no one can look in the crystal ball, so to speak, and predict the level of inflation, taking the time to factor inflation into a retirement strategy is a smart move that will help toward planning a more secure retirement for years to come.
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How to Face the Hidden Cost of Retirement originally appeared on usnews.com
