When people talk about inflation, groceries and gas get a lot of attention. But how can it affect your retirement plans? Julie Seberras, Senior Manager, Wealth Planning Support, TD Wealth, joins Kim Parlee to look at the effect inflation can have on your investments and pension, and what those nearing retirement can do to prepare themselves.
Originally published February 16, 2022
Here's the question. I am hoping to retire in the next 10 years. How could inflation affect my plans and savings?
- So Kim, when analyzing whether or not you're on track to your goals, which includes retirement, there are a number of assumptions that go into that analysis, including inflation. So if we increase the assumption that we've used for inflation, the result is that it's also going to increase the amount of savings required to achieve that goal. So let's put some numbers around this.
So let's say that person who wants to retire in 10 years is looking for $60,000 of retirement income in today's dollars. If we were to inflate that at 2%, which is a very typical inflation rate to use, it would equate to $73,000 approximately in 10 years time. Now, let's say we increase that assumption to 3%. Your 60,000 of today's dollars now equals about 80,000 of dollars in 10 years time. So you're going to want to work with your planner or your advisor to determine whether or not any adjustments are going to need to be made to your plan. This can include saving a little bit more on an ongoing basis, pushing out that retirement age, or decreasing your retirement income expectations.
- So what about the portfolio itself, and how it's constructed, and what's inside of it, how do you need to adjust that for inflation?
- So when it comes to inflation, the rate of return that you're achieving on your investment needs to exceed the rate of inflation, so that you maintain the same purchasing power. If the rate of return that you get on your investments is less than inflation, that's what we call a negative real rate of return. So some investments are impacted by inflation differently than others. So what you'll want to do is work with your financial advisor to review your portfolio to get an understanding of how it's going to impact the investments that you are holding.
Now, we also know that inflation creates a little bit of a cash flow crunch, because the cost of everyday goods and services has increased. And the result of this is that you might be left with a little less for savings. So work with your advisor to review that portfolio, your saving strategy, as well as your cash flow. And hopefully, you can still find some savings capacity in that cash flow.
- Now, you have that power to adjust things when it's your portfolio. Some things like pensions, if they're a defined benefit, you do not have that power to change things. So how does it affect things like that?
- Yeah, Kim, with a defined benefit plan, some of them may include a benefit which is called indexing. And that benefit essentially provides you with an ongoing increase to keep pace with inflation. However, not every defined benefit plan includes that benefit.
So in the case where you don't have that benefit available to you, you may need to start to tap into some of your personal savings to top up your income amount, so that you can maintain the same purchasing power. For the recipients of Old Age Security, as well as Canada Pension Plan, these are reviewed on an ongoing basis, and do receive regular updates to keep pace with inflation, and they will receive increases. In addition, for 2022, Old Age Security recipients at least age 75 or older will receive a permanent 10% increase to their Old Age Security benefits.
- One last question for you, one that I always get good answers from when I ask, what else should I be asking you, Julie?
- So we have no idea how long this period of prolonged inflationary increase is going to last. And so what you want to do is meet regularly with your advisor, keep an eye on your portfolio, as well as your financial plan, to make sure you're on track. And if you can give your RSP savings a little boost this year to keep pace with inflation, if you do so before March 1, you can use that deduction for your 2021 tax return.
- Julie, always a pleasure. Thanks so much. That's Julie Seberras. And if you would like to ask questions to us, send them into firstname.lastname@example.org, with Ask MoneyTalk in the subject line. Ask us the question. We'll find the answer. And you can watch them on moneytalkgo.com.