Calculate the Effects of Compound Inflation
Retirement planning is difficult enough with all the variables of personal health, stock market returns, interest rates, Social Security and all the other contingencies you need to provide for in your retirement. But in addition to all that, once you have calculated how much money you will need in retirement, you find out that because of inflation the amount you need is like a moving target.
For instance, let’s assume that in your planning you calculate that you will need $50,000 per year to cover your retirement expenses in today’s dollars. Based on that, you can estimate what you consider a reasonable rate of return on your investments and feel relatively comfortable in your plan for retirement.
For instance based on current expenditures lets assume that you decide you will need $50,000 per year during your retirement to cover your living expenses.
Next based on your tolerance for risk you might estimate that you could expect a 5% rate of return on your investments during retirement.
With these two numbers you could easily calculate that you need to have a $1 Million dollar retirement nest egg to provide an annual retirement income of $50,000.
($1,000,000 x .05 = $50,000.00).
But your calculations don’t stop there. You also need to plan for the loss of purchasing power of your money and this is where the calculations get a bit more difficult.
This is where our Retirement Planning Calculator comes into play.
Retirement Planning Calculator Example:
In the first field of the Retirement Planning Calculator, you simply put $50,000 as the Current Annual Living Expenses.
In the second field of the calculator you put the number of years until you retire let’s say 10 years.
In the third calculator field you Estimate what the Annual Inflation Rate will be over the term between now and when you retire.
You may estimate that you expect it to average 4% over the next 10 years.
Retirement Calculator Example Values:
Current Annual Living Expenses: $50,000
# Years until Retirement: 10
Estimated Annual Inflation Rate: 4%
When you press the “Calculate Retirement Amount” button the retirement calculator will provide two very useful numbers for your retirement planning.
The first number is the current purchasing power of your planned retirement income. In other words, this is how much purchasing power that amount of money would have today.
So in our retirement example above, you arranged to have $50,000 in annual retirement income.
After losses in purchasing power (at 4% per year for 10 years) you would only have the purchasing power that $33,778.21 has today.
So even after careful retirement planning without taking this additional step, you would still be forced to reduce your lifestyle during retirement.
The second result given by our Retirement Planning Calculator is even more useful.
This is the number you would need to have as your actual retirement income in order to have your desired retirement lifestyle.
In other words, in the example above, if you wanted to have the equivalent of $50,000 of current purchasing power 10 years from now you would actually need to provide for $74,012.21 in annual income in your retirement plan. (Depressing isn’t it?) But it is better to know now than to wake up one day unable to retire when you thought you could.
The Trickiest part of this Retirement Planning Calculator:
Calculating your estimate for the third field may be the trickiest part of using this calculator. how do you decide what to use?
You have several choices:
1) Use 3.24% because the average inflation rate over the long term (from 1913 – 2012) was 3.24%
2) Use the current Annual Rate
3) Try several numbers to get a feel for the difference various numbers make in your retirement income requirements.
Over the years various decades have had rates that varied widely from -1.94% to +8.7%. (see Inflation by Decade for more details)
For more information on calculating Inflation see: Inflation Calculators
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