How much does inflation affect retirement?

Inflation. It’s the talk of the town these days and for good reason. Inflation plays an important role in the daily life of all Canadians. It affects the cost of everyday goods and services that people need to purchase to live. Essentials like gas, groceries, and housing are all affected by inflation, but its reach extends far beyond these goods to, well, almost everything.

This includes things you may not even think about. One area of our lives that’s often “out-of-sight, out-of-mind,” is retirement. Yes, retirement is affected by inflation. But by how much? And how can you combat the effect?

This is what we’re here to talk about today.

If you’re tempted to click away at the word “retirement,” don’t. Even if you don’t plan to retire for thirty or forty years, you still need to hear this. In fact, the sooner you understand how inflation affects retirement, the better. This certainly won’t be the only time in your life you experience inflation. And if you’re nearing retirement, this certainly isn’t the first time.

Without further adieu, let’s dive in and discuss all the ways inflation is impacting the here and now, and the future.

What is Inflation?

Inflation is the decrease in purchasing power of a particular currency over time. For consumers, inflation is reflected in the increase in the prices of goods and services, which effectively make their dollars worth less.

If you’ve paid more at the pump recently than usual, you’ve experienced inflation. Of course, the price of certain commodities, like gasoline, is influenced by other factors as well, such as world events and supply and demand. However, the gradual rise of prices over time can be attributed to inflation.

Inflation is normal.

In fact, low levels of inflation show that the economy is growing. However, high levels of inflation cause prices to rise at a rapid rate. As suppliers raise prices, sellers raise prices, and the effective price increase gets laid on the consumer. This hurts Canadians’ wallets as they are somewhat suddenly able to afford less on the same income.

How Does Inflation Affect You?

In January 2022, Canadian inflation surpassed 5% for the first time since September 1991, rising 5.1% on a year-over-year basis according to the Consumer Price Index (CPI).

The CPI is calculated by tracking the price increase of a specific “basket of goods'' over a certain time period, in this case, from January 2021 to January 2022. The basket includes things like rent, common foods like milk and potatoes, public transportation, etc. Prices of these goods are weighted based on the proportion of income allocated to each. For example, a rise in rent prices will affect the CPI more than a rise in milk prices because the majority of Canadians spend more on rent than they do on milk.

This means that goods you purchased in January of 2021, say a roll of paper towels or carton of eggs from the store, or a new car, cost, on average, 5% more today.

You can see how this could dramatically affect your budget.

Even if you received a raise at work over the course of the last year (which isn’t the case across the board), that raise likely went fully toward the rising cost of living, rather than, say, your savings account or the new washing machine you needed.

The big problem is wages haven’t kept up with inflation. Wage data from the Labour Force Survey found wages rose 2.4% from January 2021 to January 2022. That’s less than half the rate of inflation. This means many Canadians are experiencing a squeeze on their personal finances.

Considering so many already live paycheque to paycheque, this is troubling news. Simply affording everyday necessities has become more difficult. This could easily lead struggling Canadians into debt or further into debt.

And this is just how inflation affects your life today.

What about how it will affect your life in the future?

How Does Inflation Affect Your Retirement?

We’re going to cover two scenarios here to exemplify how inflation affects your retirement. But you should know, no matter how old you are, inflation will affect your retirement, so you should plan accordingly.

For everyone, inflation means you will need more money to retire in the future than you do today. Given current inflation, this applies to people who plan to retire tomorrow or twenty years from tomorrow.

There are a lot of financial calculators out there that can help you determine how much you need to retire. This number takes into account your average yearly expenses and the lifestyle you hope to have during retirement, which is different for everyone. These calculators do factor inflation into their calculations, however, this is based on a modest “average” rate of inflation.

What we are experiencing today, have experienced over the past year, and will likely continue to experience in the near future is a rate of inflation that is well above average.

If you are retired or nearing retirement…

First, if you’re nearing retirement (i.e., plan to retire in the next few years) or are already retired, you will spend more on regular living expenses in the coming years than you thought you would.

For retired or soon-to-be-retired folks, this means, you will have to pay much more to maintain the same lifestyle this year, next year, and the years after that. If you are able to bolster your savings in any way, it’s important to do so, but if you’re no longer working, adjusting your lifestyle to live on a smaller budget may be necessary.

If you are a ways away from retirement…

For anyone who plans to retire in more than a few year's time, inflation can eat away at any earnings in your retirement fund. The main way most people save for retirement is by way of an investment account, such as an Employer Pension Program, an RRSP, a TFSA, or a combination of these.

If you haven’t started saving for retirement (and by saving, we mean investing), don’t waste any more time.

With current inflation, money simply set aside in a low-yield savings account or in cash is losing value by the day. If you think that cash will be worth the same amount in ten, or even five, years, think again.

With an investment account, though, such as the retirement vehicles we listed above, you can earn a return on your money. The goal is that the annual rate of return you make on your investments would far exceed the annual rate of inflation. And this is certainly possible. For instance, if you invested your retirement funds into an exchange-traded fund (ETF) that tracks the S&P/TRX, your average annual returns over the past 40 years would be 9.1%. This is a modest tactic and yet the rate of return well outpaces inflation.

Given the amount of time you have until you retire, you can afford to take more risk in the stock market. This could include investing in emerging markets, high-growth companies, and international markets. As always, though, remember the importance of a diversified portfolio.

How To Protect Your Retirement from Inflation

There are a few steps you can take to protect your retirement from inflation whether it’s near or far off.

First, take a good look at your budget and cut back where you can to reduce your monthly expenses. If you can reduce your cost of living now, you can stretch what you have saved to last longer.

Second, make sure you’re investing. Stock prices tend to rise in tandem with inflation. This is why investing in stocks is typically regarded as one of the best ways to minimize risk due to inflation. While the stock market can seem scary during uncertain times, investing is the best way to grow your nest egg over time and prevent your dollars from losing value. If retirement is less than five years away, stick to safer assets such as dividend stocks and bonds.

If you take these steps, you’ll be well prepared to enjoy your retired years and inflation doesn’t have to have a catastrophic impact on your retirement.

If you’re worried you won’t have enough to live off of during retirement, it may be a good idea to talk to a financial advisor. An advisor can analyze your unique financial situation and provide tailored-advice to help you reach your goals.