As a 20-year veteran in the financial industry, I’ve been trained, repeatedly, on how to design a retirement financial plan. I’ve come to the conclusion that many of the assumptions present in generic planning software are inaccurate. One common variable which nearly every planning tool emphasizes is the effect of inflation.
Most tools assume a 3 percent inflation rate throughout your retired years. If you do the math, that means that a gallon of milk which costs $5 now, will cost $10 twenty-four years from now.
While a 3 percent inflation rate is a reasonable assumption, it can really throw a wrench in most retirement scenarios.
It stands to reason that if your monthly budget is presently $4000, you can expect for it to be $8000 a quarter century from now.
A little scary, isn’t it? Maybe you should just sit on all of your savings as long as possible so that inflation doesn’t ruin you. You don’t want to spend your nineties living in a cardboard box behind a gas station.
Luckily, I have great news. The fear of inflation is a bunch of B.S. Or more accurately, the underlying assumptions in these calculations are missing one enormously important factor: You will spend significantly less money in your eighties and nineties than you will in your sixties and seventies.
The U.S. Bureau of Labor Statistics found that retirees between the age of 65 and 74 spend 35 percent more money than retirees older than 75.The Government Accountability Office found that Americans spend 41 percent less in their early seventies compared with their late forties.
How can this be?
- You pay off your mortgage. This is an important variable to consider when designing a retirement budget. If your $1200 mortgage payment is going to end in six years, you need to account for that reduction in required monthly funds.
- You will spend less on clothing, travel, gas, food, and entertainment. That doesn’t mean you don’t travel or go out to eat. Think about it—you won’t have to buy a new work wardrobe every year or so. You won’t have to pay for your kids to travel with you (if you have them). You’ll still go out, but you may go out less.
- You will not be buying a new car every few years. Hopefully, in the next ten years there are more public transportation options anyway, so all of us can stop buying a new car every few years!
- Medical expenses generally do not increase until the end-of-life stage, at which point there can be a small spike in spending. Remember that 90 percent of retirees in America spend less than $2,000 a year on medical expenses while on Medicare.
- Social security accounts for inflation. Another key factor to remember is that your social security payments will grow with inflation. Social security increases are based on the Consumer Price Index (or CPI).
Let’s say Bobby Biggins retired 25 years ago with a monthly social security benefit of $1,000. Today that same monthly benefit would total $1,755.
For 2021, Social Security increased by 1.3 percent for those of you receiving benefits. If you have yet to take social security, the 1.3 percent is still added to your future benefit.
So, to review, as you get older, inflation will increase the costs of goods and services, but this increase is offset by the natural reduction in spending as you age. Social security will take inflation into account when determining your monthly benefit.
So what does all of this mean? For many of you, you may be able to spend more money earlier in your retirement.
Don’t let the online retirement calculators fool you. You may be in much better long-term shape than you realize.
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