Understanding the Impact of Inflation

In the 1960's, you could buy a gallon of gasoline for 35 cents or less. In 2014, getting a gallon of gas for $3 is considered a real bargain. The gas isn't intrinsically worth any more today than it was a half century ago, but the cost of acquiring it has gone up anyway. The reason is inflation. Inflation means that the price of goods and services is rising over time, and, therefore, the purchasing power of the dollar is declining.

Fortunately for us, our economy does not currently suffer from inflation that is out of control. However, it does exist, and this fact bolsters the importance of retirement planning.

Do you remember your grandparents telling you that they could once buy everything and anything, including a house, for a penny (and still have change left over)? Have you ever reminisced that once upon a time you could buy almost everything for a quarter or a mere dollar? These moments of nostalgia are mostly your own personal experiences with inflation and its effect on your purchasing power.

Despite its constant presence, it is not uncommon for an individual to ignore the effects of inflation when planning for retirement. People also often fail to realize that inflation doesn't stop working just because you do. To be effective then, any retirement plan must be an ongoing plan that continues to be revised and updated on a regular basis during the retirement years.

Example An expense costing $100 at age 65 will cost $208 at age 80 assuming an annual inflation rate of 5 percent between the ages of 65 and 80.

The only thing that you can really do with the issue of inflation during the planning process is to choose carefully the projected inflation rate you will use in your calculations. For example, choosing an inflation rate of 5 percent or more would be a conservative approach ensuring that any projections you make will not fall short of your retirement goals on account of inflation. An inflation rate of 3 or 4 percent is probably a closer estimate of the average yearly inflation rate. With a lower estimated inflation rate, 2 percent or less, you are running a high risk of falling considerably short of what you will need for retirement income.

Tip The impact of inflation on your retirement plan investments cannot be ignored, predicted or lessened. Inflation is just another factor that must be considered when trying to predict the amount you will need to retire comfortably. Also remember that, whether you are putting together a retirement plan by yourself or with professional help, you should choose the inflation factor that fits the level of risk you are ready to assume in a worst-case scenario.

To help you do your own inflation rate calculations, we provide the table below. To use the table, take the amount of money at issue and multiply it by an inflation factor from the table. This will let you know how much money you will need in the future due to inflation. For example, to have the same buying power as $1,000 today, you will need $1,280 five years from now assuming a 5 percent inflation rate ($1,000 x 1.28).

Financial Calculators The value of your savings can be affected by both inflation and taxes. Use this Savings, Taxes and Inflation Calculator to help you determine how much your savings will be worth with these two important variables in mind. Click the "View Report" button to get more information and a year-by-year savings schedule.