Many of the old rules for retirement planning are under siege these days. Determining how much money you'll need to maintain the lifestyle to which you've become accustomed — and how to save it — has never been an easy task. Retirement planning experts offer a variety of conflicting ideas on just how to arrive at that elusive figure. Now, the gut-wrenching changes in our volatile economy are making that job tougher than ever. Millions of business owners and employees who thought they were on the right path to a financially secure retirement are discovering that their goals may now be beyond reach.
Longer life spans and the relentless pressures of inflation have combined to complicate one of life's toughest challenges: how to make your money last longer than you do.
Whether your planned retirement is years away or just around the corner, inflation is destined to exert a major influence on your future economic well-being. Ignore it at your own peril.
Inflation can vary wildly from one year to the next. Whatever the rate, it continues its work relentlessly year after year.
Even low inflation can take a significant toll over time. After 10 years of a modest two percent inflation, that dollar bill in your pocket now will be worth only 82 cents in today's dollars.
Here's an example of how inflation affects your personal life right now: If you paid $60 for a week's groceries in 1985, you're paying about $109.67 for those same items today.
If you paid $18,000 for a new car in 1985, it will cost $34,522 to replace it with a similar 2008 model. Ten years from now, a comparable new car will cost you about $44,191 (assuming a 2.5 percent inflation rate).
Calculating inflation's effects over two or more years can be complex. That's why it's difficult to make simple dollar-to-dollar comparisons from one year to another. If you'd like an easy way to gauge inflation's effects on some of your personal or business expenses, log on to www.westegg.com/inflation. This easy-to-use inflation calculator adjusts any amount of money for inflation, according to the Consumer Price Index, from 1800 to 2006.
You've probably read several variations on how much income you'll need during retirement. Many financial planners estimate that you will need 80 percent of your preretirement income to maintain your current lifestyle in retirement. If your earnings are, say, $90,000 per year just before you retire, you will need $72,000 to maintain your lifestyle. If your annual income is $200,000, you'll need $160,000 per year to retire in the style to which you have become accustomed, according to the most popular school of thought.
But Walt Woerheide, v.p. of academic affairs with the American College in Bryn Mawr, PA, believes most people see a big drop in expenses when they retire. “Chances are your mortgage will be paid off, you'll no longer need to put aside money for savings or college tuition and you'll have the time to do chores that you may have been paying other people to do,” he says.
Dallas Certified Financial Planner (CFP) Carl J. Kunhardt says his experience is different. “We're finding that clients are spending essentially the same in retirement as before. It's what they are spending on that changes in retirement.”
Obviously, experts don't agree on a single model for estimating financial needs in retirement. More problematic, perhaps, is the fact that some of the popular formulas for estimating required retirement income fail to consider inflation. That's why you must.
The Charles Schwab brokerage recently published a retirement planning rule of thumb that takes clear notice of inflation's effects. It suggests that you will need $230,000 in retirement savings in today's dollars to provide $1,000 in monthly income during retirement. For example, if you want to add $4,000 per month to your Social Security income, you would need $920,000 in retirement savings and investments — in today's dollars.
The key phrase in the Schwab formula is “in today's dollars.” If your retirement is a decade off, you will need to increase that $920,000 to allow for the effects of 10 years' inflation.
Obviously, you can't predict the exact inflation rate in advance; all you can do is estimate. Even if you assume that today's inflation rate will remain about the same over the next 10 years, that $920,000 in today's dollars will be about $1,110,528 in 2018 dollars.
Since the current low rate of inflation may not continue for much longer, you should adjust your estimate of required retirement income to compensate for the latest rates.
Financial consultant Ingrid Lamb of Chesapeake Beach, MD, points out that Social Security and some private pensions are adjusted to help counteract the harmful effects of inflation. However, retirees who depend on investments for a significant part of their income may find that's not enough. “One way of compensating for inflation,” she says, “is to invest part of your portfolio in dividend-paying stocks that have a long payment history and a record of steady dividend increases.”
Finance professor Maury Randall of Rider University in Lawrenceville, NJ, agrees that every retirement portfolio should contain some stocks as a hedge against inflation. “Another method of protecting yourself is investment in inflation-indexed treasury securities (TIPS). These Treasury bonds provide a return based on the current rate of inflation,” he says. “So, when inflation rises, you'll get a higher interest rate.” You can get more information on TIPS from any broker or at www.savingsbonds.gov.
Regardless of the method you use for retirement planning, you must take inflation into account. “If you hope to enjoy a comfortable retirement, you'll have to arrange for it yourself,” says Kunhardt. “No one else is going to worry about your financial health in retirement. If you don't take care of it yourself, it won't happen.”
The way to make it happen, says CFP G. Mike Crawford, is to maintain a detailed financial plan for your retirement. “Without a roadmap, it's difficult, if not impossible, to see where you've been and where you're heading,” says Crawford, c.e.o. of Lifeplan Financial Group in Dayton.
Understandably, he believes that a retirement plan prepared by a CFP is the best choice for most people. Still, Crawford recognizes that many people prefer to do their own planning. “That's fine,” he says, “for those who have a good feel for personal finance and how to handle money. Whether you call on a financial professional or prepare it yourself, it's important that your plan stay active and flexible.”
William Lynott is a former management consultant and corporate executive who writes on business and financial topics. You can reach him at lynott@verizon.net.
Prepare a detailed and flexible plan for your retirement and keep it up to date as your circumstances change.
Maximize your contributions. Contribute as much as you can as early as you can to your tax-deferred retirement plan. Allow the magic of compound interest to help counter inflation.
Resist the temptation to use your retirement portfolio as an emergency funding source. Cashing out a portion of your tax-deferred retirement plan will result in taxes and penalties that will put a serious dent in future growth.
Include some equities in your retirement portfolio. Most experts agree that stocks historically offer the best opportunity to achieve a rate of return on investment that will outpace inflation.
Invest in dividend-paying stocks that have a long payment history and a record of steady dividend increases.
Invest a portion of your retirement portfolio in inflation-indexed treasury securities (TIPS).