How Inflation Can Crumble Your Retirement Lifestyle

Rising prices can turn today's comfortable income into tomorrow's tight budget squeeze, but there are three things you can do to help avoid this problem.

(Image credit: mona plougmann)

Where were you in 1986? What were you doing? It was 31 years ago, but it seems like yesterday, right?

I was fresh out of college. Back then, the average price for a new car was $9,255 (opens in new tab). Today a new set of wheels is going to cost you, on average, about $33,000! The average home in the mid ’80s was about $90,000. According to the latest Census report, today it’s more than $300,000. And a gallon of gas in ’86 was 93 cents. But recently we’ve seen it as high as $4. Those price differences are staggering! That is what you call inflation. And the biggest impact inflation has on your retirement is on your purchasing power.

Here’s some eye-opening statistics for you: At a conservative inflation rate of 2.5%, your dollar today will be worth about 78 cents in 10 years. That same dollar will be worth only 61 cents in 20 years, and only 48 cents in 30 years. Think about how that could impact your lifestyle in retirement.

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One of the greatest increases we’ve seen is in the cost of health care, something retirees must prepare for. Did you know that a couple retiring at age 65 will need $260,000 to meet health care costs (opens in new tab)?

Inflation as Retirement’s Silent Killer

As you look toward retirement, everything will likely cost more, from needs, such as medical expenses and food, to enjoyment of a social lifestyle. How can you help prepare for the inevitable?

It all starts with a sound and thoughtful retirement income plan. If you don’t have a strategy for inflation, it can seriously diminish your purchasing power. So, you must take the necessary steps to help protect yourself now and discover some strategies to help you stay one step ahead of inflation.

Inflation can be dangerous for retirees, especially ones who rely on fixed incomes. Let’s say your fixed income in retirement is $50,000, and that seems to be enough because your yearly expenses are less than that. Let’s say your income need is $40,000, providing a $10,000 surplus.

Here’s the rub: Although your income is fixed, expenses are not and will continue to rise because of inflation. Eventually your $40,000 in annual expenses could grow to $60,000, which would clearly be a problem if your income is fixed at $50,000!

One thing you can do to help reduce the impact of inflation is to include an inflation assumption in your calculations of how much annual income you’ll need.

Another important step is maintaining an investment portfolio that can potentially provide returns well above the inflation rate.

My firm sees many individuals who fail to factor in inflation when calculating their retirement income stream. In other words, their investment plan generates an income that will never rise even if they live 25 years or more after leaving the workforce. Other clients project an inflation rate (3% is the norm), and then calculate how much they can count on today and have a strategy that allows their income to increase every year, and includes having to make larger withdrawals from their retirement funds until they die.

A solid retirement plan should budget for two types of expenses: fixed/essential and social. Fixed expenses include rent/mortgage, food, medical expenses, phone, utilities, insurance and other costs that will always be there. These fixed expenses are likely to increase over time, which is why your Social Security benefits provide an annual cost-of-living adjustment.

Social expenses include travel, entertainment, hobbies and other activities that we all hope to enjoy for as long as we live. However, it’s likely that the ability to participate in these activities may decline with age. You’ll want to take the time to budget these things while you can still enjoy them.

During my years as a financial professional, I’ve seen a wide variety of retirement approaches and outcomes. I have seen clients who plan for all their retirement needs, and just needed someone to keep an eye on things. More frequently, I see people who thought they had planned for inflation and unknowns, yet still run out of purchasing power as the years pass.

On the other end of the spectrum, I have also seen retirees who plan well and are very frugal. In their advanced years, they find that they have more money than they can spend — having overlooked the opportunity to enjoy those funds while they were still young enough and healthy enough.

As you plan for your retirement:

1. Assume you’ll need 20% more income in retirement.

That way if you get hit with unexpected or unplanned expenses, you’ll be better prepared. If a new product is developed that will make your life easier, such as a driverless car or eye surgery that allows you to see better than you have in years, you’ll be glad that you built in that buffer.

2. Assume a reasonable rate of inflation.

From 1982 to 2011, the CPI-E (Consumer Price Index for the Elderly) increased at an average rate of 3.1% (opens in new tab), while Consumer Price Index for Urban Wage Earners and Clerical Workers rose at an average rate of 2.9%.

3. Prepare to be flexible in the future.

While no one can predict the future, it’s essential to be as flexible during retirement as you were during your working years. When inflation is high, plan to be more frugal and reduce those extra expenses as much as possible while still enjoying your retirement. Take advantage of senior discounts. Vacation closer to home. Volunteer to be an usher for your favorite plays and concerts to enjoy the entertainment without the expense.

Following those three steps won’t solve all your retirement questions, but they will go a long way to helping make sure you aren’t overlooking retirement’s silent killer.

Of course, no one can predict exactly what inflation will do. But it’s a safe bet it won’t disappear — and even a mild inflation rate, over time, can erode your purchasing power and even set back your retirement lifestyle.

Rozel Swain contributed to this article.

Advisory services offered through Semmax Financial Advisors Inc., a Registered Investment Advisory firm. Registration does not imply any particular level of skill. Insurance products and services offered through Semmax Inc. Tax services offered through Semmax Tax Inc.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Jay Tyner, RFC
President and Founder, Semmax Financial Group Inc.
Jay Tyner, RFC, is president and founder of Semmax Financial Group Inc., in Winston-Salem, N.C. Jay is an Investment Adviser Representative and insurance professional. He also is the best-selling author of the book "Tsunami Proof Your Retirement." Tyner is regularly broadcast on television and published in local and national media including: ABC, CBS, FOX, NBC, CNBC, the Associated Press, The Wall Street Journal, Forbes, the Washington Post, the Street, USA Today and many others.