Inflation and retirement

If you’re looking to maintain your standard of living in retirement, you could need about 70% of your average gross annual income of the past three years. Some people will need more than this, while others will need less.

This 70% is hypothetical and depends on several factors, including your personal financial circumstances.

However, you also need to take inflation Inflation is the widespread increase in the price of consumer goods and services. It is the opposite of deflation.

For an approximation of inflation’s impact on an investment’s return, subtract the annual inflation rate from the annual rate of return. For example, if you hold a guaranteed investment certificate (GIC) earning 1.5% when inflation is 2%, your real rate of return (after inflation) is approximately -0.5%. In other words, in this example, if you take inflation into account, you’re losing money. 
 into account. If your retirement income isn’t indexed Income is indexed if it is regularly adjusted to fully or partially offset cost of living increases.  (meaning if it doesn’t increase with inflation), the 70% will quickly become insufficient.

How will inflation affect your retirement?

Let’s take the case of Charles. He retires at age 60, with income equivalent to 70% of his average gross annual income of the past three years. The table below shows the impact of inflation. When he reaches 90, the cumulative effect of inflation Inflation is the widespread increase in the price of consumer goods and services. It is the opposite of deflation.

For an approximation of inflation’s impact on an investment’s return, subtract the annual inflation rate from the annual rate of return. For example, if you hold a guaranteed investment certificate (GIC) earning 1.5% when inflation is 2%, your real rate of return (after inflation) is approximately -0.5%. In other words, in this example, if you take inflation into account, you’re losing money. 
 over the years will decrease his purchasing powerA person’s purchasing power is their capacity to buy goods and services.

When a person’s income increases less than inflation, their purchasing power diminishes.  
from 70% to 33% of his salary if his retirement income is not indexed.

Cumulative effect of inflation over the years

Number of years of retirement

Charles' age

Annual inflation

Purchasing power

 0 (start of the retirement)

60 years

2.5 %

70 % of his salary

 1 year

61 years

2.5 %

68 % of his salary

 5 years

65 years

2.5 %

62 % of his salary

10 years

70 years

2.5 %

55 % of his salary

20 years

80 years

2.5 %

43 % of his salary

30 years

90 years

2.5 %

33 % of his salary

A 60-year-old Québec male has a 50% chance of living until the age of 89. A Québec woman has the same likelihood of living until the age of 91. These are averages issued by the Institut québécois de planification financièreThis link will open in a new window. Generally speaking, people have a better chance of living longer today and seeing their retirement span an extended period.

In order not to run short of money in retirement, you could factor in the possibility that you might exceed your life expectancy.

How will inflation affect your savings?

Not only will inflation decrease the value of your income over the course of your retirement, but it will also lower the value of your savings before retirement.

The following table shows the amount accumulated on an annual investment of $1,000. For example, the amount accumulated after 10 years will be $12,486. However, once inflation is taken into account, the actual value of these savings is only $10,841.

Amount accumulated on an annual investment of $1,000 once inflation is taken into account

Amount invested
annually

Annual returns

Number of years

Inflation not taken into account

With inflation of 2.5 %

Impact of inflation

$1,000

4%

5 years

$5,633

$5,224

-7 %

$1,000

4%

10 years

$12,486

$10,841

-13 %

$1,000  

4%

20 years

$30,969

$23,378

-25 %

$1,000

4%

30 years

$58,328

$37,874

-35 %

One way of taking inflation into account in your retirement planning

There is an easy-to-use tool that will take only a few minutes of your time. Simply use our Mon plan, je le fais maintenant! calculator (in French only).

One you’ve entered the information (such as how much you’ve already saved in your RRSP), the calculator will indicate how much you need to save every year, taking inflation into account.

Insight

Are you familiar with the rule of 72+?

The “rule of 72” is a simple way to estimate the number of years it will take for your investment to double.

  • Enter the annual rate of return that you expect to earn. Let’s say 4%.
  • Divide 72 by this number. In our example: 72 ÷ 4 = 18.
  • The answer is the approximate number of years it will take for your money to double. Therefore, if you invest $1,000 at 4%, your investment will be worth about $2,000 after 18 years.
  • This is an approximation. If you had used our calculator, the answer would have been $2,026.

What’s the problem with this method? It doesn’t take inflation into account! There’s a solution: the rule of 72+.

The calculation method is the same as for the rule of 72, but you subtract inflation from the annual returns.

Let’s suppose that you expect inflation of 2% and returns of 4%. Your actual return is 2%, (4% - 2%). Instead of dividing 72 by 4, you divide 72 by 2. The answer is 36. Therefore, it would take about 36 years for the actual value of your investment to double.

The rule of 72+ is accurate enough to be useful, although it has a margin of error of less than 5%. If the answer you obtained is “20 years,” you should consider the actual answer to be somewhere between 19 and 21 years.

End of the insight