Inflation Risk
Inflation Risk Is The Silent Retirement Killer
Investors often overlook the need to adjust for inflation when calculating the total withdrawal amount needed to support their retirement income and lifestyle (in addition to Social Security benefits, pension income, part-time work, rental income and so forth).
Current U.S. Inflation Rates: 2001-2023
Inflation Risk Is The Silent Retirement Killer
Investors often overlook the need to adjust for inflation when calculating the total withdrawal amount needed to support their retirement income and lifestyle (in addition to Social Security benefits, pension income, part-time work, rental income and so forth).
From 2001 - 2023, the average annual inflation rate for the United States was #.#%. The lowest annual inflation rate (actual deflation rate) during that period was -0.4% in 2009. The highest annual inflation rate during that period was 8.0% in 2022. *
* Source: usinflationcalculator.com*
At first glance, a #.## average annual inflation rate may appear to be somewhat inconsequential, however, inflation can have a significant impact on your long-term retirement income and lifestyle plan.
Example:
(a) Let's assume you retired on December 31,1999, with a $1,250,000 retirement nest egg at age 65,
(b) you took a 4% withdrawal to receive an initial $50,000 retirement income to maintain your retirement lifestyle (in addition to Social Security benefits, pension income, part-time work, rental income and so forth), and
(c) you adjusted your annual retirement income withdrawal amount each year thereafter with the actual inflation rate [(an inflation COLA (Cost Of Living Adjustment)] to maintain your retirement lifestyle.
Year Withdrawal Amount Needed To Maintain Your Retirement Lifestyle
12/31/1999 Retire with $1,250,000
1 (2000) $1,250,000 x 4.00% = $50,000 initial retirement income withdrawal
2 (2001) $50,000 + 2.8% inflation = $51,400 retirement income withdrawal
3 (2002) $51,400 + 1.6% inflation = $52,222
4 (2003) $52,222 + 2.3% inflation = $53,424
5 (2004) $ + 2.7% inflation = $
6 (2005) $ + 3.4% inflation = $
7 (2006) $ + 3.2% inflation = $
8 (2007) $ + 2.8% inflation = $
9 (2008) $ + 3.8% inflation = $
10 (2009) $ + (-0.4%) deflation = $
11 (2010) $ + 1.6% inflation = $
12 (2011) $ + 3.2% inflation = $
13 (2012) $ + 2.1% inflation = $
14 (2013) $ + 1.5% inflation = $
15 (2014) $ + 1.6% inflation = $
16 (2015) $ + 0.1% inflation = $
17 (2016) $ + 1.3% inflation = $
18 (2017) $ + 2.1% inflation = $
19 (2018) $ + 2.4% inflation = $
20 (2019) $ + 1.8% inflation = $
21 (2020) $ + 1.2% inflation = $
22 (2021) $ + 4.7% inflation = $
23 (2022) $ + 8.0% inflation = $
24 (2023) $ + 4.1% inflation = $
Total Retirement Income Withdrawals = $
Notes:
(a) Due to inflation, $###,### in year 2023 had the same purchasing power as $50,000 in 2000.
(b) The total retirement income withdrawals over the 24 years = $#,###,###, which represents an average annual retirement income withdrawal amount of $##,### to maintain your retirement income and lifestyle.
If you had simply estimated retirement income withdrawals of $50,000 for each year, the total retirement income withdrawals over the 24 years = $#,###,###... which represents an underestimate of $###,### ($#,###,### - $#,###,###) to maintain your retirement income and lifestyle.
Make sure you account for inflation in your retirement income and lifestyle plan.
EFFECTS OF 4% INFLATION
According to CPI: *
- A Sport Utility Vehicle Today: $50,000
- In 10 Years: $74,012
- In 20 Years: $109,556
*CPI, Bureau Of Labor Statistics
Impact Of Inflation On Your Net Worth
What can happen if your net worth is unprotected from inflation? At that same 4 percent rate of inflation, your net worth can dramatically decline.
With inflation at just 4 percent, your assets would be cut in half in 18 years. The purchasing power of a $1,000,000 nest egg today, would be reduced to $460,000 over the course of a 20-year retirement (see the following table).
DECLINE IN PURCHASING POWER
Assuming a 4% rate of inflation, the following table illustrates how a $1,000,000 purchasing power in today’s dollars can erode over time:
- Today: $1,000,000
- 5 Years: $ 820,000
- 10 Years: $ 680,000
- 15 Years: $ 560,000
- 20 Years: $ 460,000
THE RULE OF 72
The Rule of 72 demonstrates the impact inflation can have on your purchasing power. Divide 72 by the expected rate of inflation to determine how long a given rate of inflation would take to cut the purchasing power of your money in half:
- @ 3 percent inflation: 72 / 3 = 24 years
- @ 4 percent inflation: 72 / 4 = 18 years
- @ 6 percent inflation: 72 / 6 = 12 years
A Safe Way To Lose Money?
When you combine the effects of taxes and inflation, many investments offer what some would call “a safe way to lose money.” *
Assumptions:
- 5% interest on investments
- 25% federal marginal income tax bracket
- 4% inflation rate
Initial Investment: $10,000
Interest after one year (5%): $ 500
Less Federal Income Taxes (25%): ($ 125)
Net After-Tax Interest: $ 375
Net After-Tax Investment: $10,375
Divide by 1.04 (4% inflation): / 1.04
Net After 4% Inflation: $ 9,976
Total Return After Taxes And Inflation ( .24%)
*This is a hypothetical example and is used for illustrative purposes only. Only federal taxes are considered (no assumption was made for state taxes). Actual results will vary.
