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Why should you keep inflation in mind as you plan for retirement?

Updated: Jun 20, 2022

“The price of everything keeps going up!” How many times have you heard that? The continuous increase in prices year after year has a name: inflation. And inflation could affect your retirement plans. See why your financial planner factors in inflation to make sure you’ll have enough to retire on.

Why do I have to think about inflation in my retirement plans?

For one simple reason: To make sure you have enough money to live on for the rest of your life.

Retirement is a straightforward concept: You stop working so you can enjoy life. But once that happens, you no longer have a salary. You need to rely on savings and other sources of income, such as government benefits or a pension plan. Proper planning will help you be ready for this important stage in your life.

Money you save grows in value over time because it generates returns. Given that the cost of living will keep going up, the big challenge is knowing how much money you need to set aside to meet your needs in retirement.

Financial planning experts use formulas based on a host of variables, including inflation. If inflation is properly accounted for, you’ll have a steady income stream over time. Take the time to look over the scenarios your financial planner suggests, for greater peace of mind and a retirement that suits you to a T.

How is inflation calculated?

In Canada, inflation is measured with a tool called the Consumer Price Index. Statistics Canada does the math by comparing the year-to-year prices on a range of products and services, such as food, housing, and transportation.

The Bank of Canada has a strong hand in influencing what happens with the economy, primarily through its special “key interest rate.” The bank regulates the rate in an effort to hold inflation steady at around 2% per year. Although certain events can cause inflation to rise every now and again, historical trends are a reliable estimate.

If you’ve planned properly for retirement, your financial strategy should be able to withstand short spikes in inflation. Talk to your advisor if you think your retirement plan needs a health checkup.

How can I safeguard my income against inflation?

Your salary should normally go up annually to keep your purchasing power the same. Your financial advisor should take these salary increases into account in their calculations. Tell them if your situation changes.

Your long-term investments in such things as mutual funds should outpace inflation, based on historical performance. Depending on your strategy, you could invest in more volatile, higher-risk growth securities or take a more conservative approach. Either way, returns should exceed inflation to generate enough retirement income.

Make sure you get sound advice to help you decide on the right strategy for you. And remember, you could be charged management fees for certain types of investment. You’ll need to deduct those fees to get a clearer picture of your actual returns.

What if my needs change as time goes by?

With proper planning, your retirement savings should hold up despite inflation, especially as your needs will change as you age.

Once you’ve paid off your mortgage, for example, you’ll spend less of your budget on housing. That doesn’t necessarily mean you’ll have more money in your pocket. New expenses such as health care and home repairs are likely to crop up.

Your retirement budget should take your changing lifestyle into account. Again, talk it over with your planning specialist. They’ll factor inflation into the mix to make sure your financial plan is realistic.

Are my government benefits inflation indexed?

Your income sources for retirement should include payments from various levels of government. Your Old Age Security pension is a federal program, and the Québec Pension Plan is managed by the provincial government. Benefits under these programs are indexed to the cost of living, which means they go up a little bit each year to keep pace with inflation.

You can push back the age at which you’ll receive your government benefits. Doing so means that a bigger portion of your retirement income is indexed, for more protection against inflation and the needs that come with living longer.

What type of plan do I have?

If you pay into a pension plan through your employer, ask the program managers if your pension is indexed. Not all of them are.

Non-indexed retirement plans

Most defined-benefit pension plans in Canada are not indexed, which means that payments under the plan are fixed. If you have this type of plan, your purchasing power will drop over time due to inflation. You’ll need to take out bigger and bigger chunks from your savings to compensate.

In certain circumstances, such as if a fund has performed well, defined-benefit pension plan administrators may decide to increase pension payments anyway. But this is rare, and you should not bank on it when planning your retirement income. If you do get an increase, think of it as a bonus.

Partially indexed retirement plans

Pension plans for provincial government workers include a formula to compensate for inflation. It might be indexed at 50% of the rate of inflation or some other rate that counters any unusual swings in inflation.

Fully indexed retirement plans

A small number of plans, such as those for federal government employees, are fully indexed to the rate of inflation.

Once you’re familiar with the ins and outs of your pension plan, you’ll have a clearer picture of how your future income will stand up to inflation. If you need to save more to maintain your purchasing power, start now to avoid unpleasant surprises later on.

As you can see, there are plenty of options and just as many variables when it comes to inflation. Your retirement planning specialist factors inflation into both the income column (when applicable) and the expenses column, to create an accurate snapshot of your financial situation. In most cases, your role is to stay up to date on how your pension plan is performing. Leave the math to your advisor. Just be sure to give them all your tax documents and tell them about any change in circumstances. With the right strategies, your retirement income will cover your needs. Need help? We’re here to answer your questions.

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