Many unknown variables could affect your retirement plan. The top of the list include taxes, future unplanned medical expenses, and of course, inflation. My dad loves to talk about when the price of gas was 32 cents per gallon and how he could get a bag of cookies for 5 cents as a kid. As we all know, prices have certainly changed over the years. While we are currently in a low inflation environment, when we plan for a client’s retirement, we have to use a reasonable cost of living adjustment for the next thirty-year time span.
As many of you know, we are conservative planners. While we cannot predict what future inflation will be, we have done a great deal of research to ensure that we are using a practical average inflationary adjustment in our retirement plans. Inflation has been under the 2% Fed target for the last couple years and is expected to gradually increase to that Fed target over the next several years. Since inflation has been lower recently than in the past, what does this mean for those retiring soon?
Earlier this year we analyzed the CPI-E, which is the Experimental Price Index for the Elderly. This index measured the price increases for Americans who are 62 and older from 1990-1995 (this is the most recent release, which you can see here). When compared with the CPI for all urban consumers (CPI-U), the CPI-E rose at a slightly higher rate each year, mostly due to medical expenses.
We also looked at our in-house inflation projections as well as those from economists and other financial institutions. The consensus is an inflationary rate of approximately 2% going forward. However, after completing our analysis and discussing this in-depth with some of our portfolio management team, we now use 2.5% inflation for our retirement plans. This goes back to taking a conservative approach and factoring in that retirees have historically experienced slightly higher cost of living adjustments relative to the general population.
That being said, after all this planning, it is funny to notice that our retirees rarely ask for a pay raise! Perhaps this is indicative of the low inflation environment we are currently experiencing. It will be interesting to see what happens over the next few years as interest rates increase and with it, inflation. Note that we use 2.5% as an average. We know that some years it will be higher and some years it will be lower. While we cannot predict exactly what will happen, know that we are ever attentive to what is going on in the world economy and we weigh these factors accordingly in your financial planning.
Kim Butler, CFP®
Associate Financial Planner