Are you dreaming of the life of ease and recreation in your retirement years? If you are, you need to build a sound plan to support that life financially. Besides the usual suspects of an IRA, 401(k), 403(b), annuities, and other investment vehicles, you need to factor inflation into that planning. It will do little good to set up a plan to generate a big income in retirement if inflation makes your expenses even bigger.
Over decades, inflation can be substantial.
If you have not set up your retirement account to adjust for inflationary pressures, the passing of years can erode the income from a great plan. With 20 or 30 years to go before retirement, even a small amount of annual inflation of perhaps 2% can double the amount of money that will be needed at retirement age. Inflation works in reverse of compound interest. Whereas compound interest multiplies your income, continual inflation multiplies your expenses.
You may be retired for a long time.
Not only do you need to worry about inflation between now and retirement, you also need to worry about inflation during retirement. You may not be earning additional income beyond your investments. Inflation will be just as painful during the potential decades of your retirement years. What started as great income when you entered retirement may be dwarfed by accumulated inflation 20 years later.
Low inflation tends to mean lower interest rates.
Another problem that can come from inflation is the reduction of interest rates during times of exceptionally low inflation. It can be hard to build an estate if your interest rates are running under 5%. If these interest rates drop post retirement, you will experience what many in retirement have had to deal with. Dropping interest rates gut out your retirement income. Investments that were generating large sums at the beginning are now creating one fifth or less of what you were receiving.
Retirement income needs to grow faster than inflation for your estate to grow.
Whether it is the dropping of interest rates or spiking of inflation rates, you need enough income being produced to allow your investments to grow. Once you begin to need to draw down your principle to live, your income will drop because of less money in the investment pool. This can start a vicious cycle spiralling downward until your assets are exhausted. As long as your income exceeds your expenses, you can view your retirement income as perpetual.
Research how inflation affects the things most prominent in your spending habits.
Everyone regards different things as important to their existence. In periods of lower inflation, some things still increase in price quicker than other. In times of higher inflation, there are still some items that remain relatively static in price. Because of this, inflation can affect some people markedly differently than others. Take your preferences in spending into account when factoring for inflation.
Check inflation rates in the area where you plan to live in retirement.
Just like some items are more susceptible to inflation, some parts of the country and world are, too. It is common for one country to have rampant inflation while another one has almost no inflation at all. While the inflationary swing is not usually as great, inflation rates can also vary from one region to another of a large nation like the United States. Booming areas will have higher inflation while areas with high unemployment can have an almost deflationary economy. This is especially true with regard to housing and other big ticket items.