How to Plan for Inflation in Your Long Term Financial Projections | NewRetirement (2024)

Inflation is a major factor for your long term wealth and security, especially after retirement. It is important that you understand inflation and plan for the potential impacts. However, how exactly to do that can be confusing.

Here are 6 tips for planning for inflation, especially now with rates so high:

1. Understand Why Inflation is Pivotal to Your Retirement Security

When you are working, your salary is supposed to increase roughly in line with inflation. However, when you are retired, you have a fixed set of resources to draw from for as long as you live.

Ideally these resources outpace inflation, but that is often not the case. It can be difficult to insure that your investments stay ahead of the inflation rate, especially as investments become more conservative as you age. And, few retirement income sources are indexed to inflation, with the exception of Social Security and some lifetime annuities.

So, you want to make sure that you have adequate resources to sustain you as prices increase over the 15, 20, 30 or more years you live in retirement.

2. Use a Planning System that Enables You to Set Your Own Inflation Rate

First things first, if you want to understand inflation you need to see it in your long term financial plans.

Many simple calculators and even retirement planning systems used by big investment firms use simple assumptions for inflation. You’ll need to dig into the system’s assumptions to see what inflation rate is being used. And, even if you agree with the long term rate, it can be difficult to see the impact on your plans.

The NewRetirement Planner enables you to set your own inflation rate. You can vary the rate and immediately see the impact on your potential out of money age and net worth at longevity. You can even set optimistic and pessimistic rates of inflation and you can evaluate a Monte Carlo analysis – toggling the effects of inflation on and off to analyze your chance of success.

The system gives you a tremendous amount of control and also enables you to set your general inflation rate, Social Security COLA, medical inflation rate, and housing & other asset appreciation individually.

3. Determine a Sane Long Term Inflation Rate

Inflation is currently over 9%. That is tremendously high. You could use that rate in your long term plans, but it is unlikely to stay that high for significant periods of time. You probably want to use a long term “average” rate.

Here are some options to consider:

• The average yearly inflation rate in the US over the last 61 years, 1960-2021, was 3.8%
• Some say that we are better at monetary policy now than we were before. The average inflation rate over the past 31 years, 1991- 2021, was 2.4%
• Consider splitting the difference and using a long term inflation rate of 2% for optimistic and 4 or 5% for pessimistic projections.

On the NewRetirement Facebook group, Bob suggested, “If you want a more technical, market based opinion of the future inflation, go to the St. Louis Fed’s webpage and look up “breakeven inflation”. They have a web page with 5y, 7y,10y, 20y, 30y, breakeven interest rate estimates based upon current market expectations. If you go to each of these breakeven yearly pages and change the graph to annual, you get the current market estimate of inflation for that many years out in the future. You can graph it if you like. Back in June, the 5y rate was 2.55% and the 20y-30y was 2.35-2.41%. These rate estimates change frequently. These are the best future estimates of inflation.”

4. Run “What If” Scenarios for Different Inflation Rates

While you probably want to use a long term average inflation rate in your plans, it is a good idea to know what will happen to your finances at various inflation rates. To do this, look at your plan with optimistic and pessimistic scenarios. (In the NewRetirement Planner, you can toggle between the two scenarios with a drop down menu found in the upper right side of the screen.

Or, run “what if” scenarios and consider your solvency at low rates of inflation and high.

5. Run a “What If” Scenario with High Inflation for a Shorter Period of Time

If you are worried about the impact of inflation over the next few years, but believe that it will eventually return to a sane long term average, you can stress test your plan for short term inflation by adding an expense to represent the short-term increased costs.

Let’s say you believe that high inflation will last three years, you can increase your expenses for the next three years by 8-9%. This will mimic short term inflation and have a ripple effect in your plan. It will deplete accounts faster which will slow growth in your plan, etc…

The NewRetirement Planner enables you to vary your expenses over time, which enables this type of planning.

6. Understand Your Personal Inflation Rate

You may be more or less impacted by inflation than the average person. And, you may want to consider your personal inflation rate.

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