First Person: Using Inflation to Plan for Retirement

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It's hard to know exactly what our expenses will be in retirement. Figuring out exact numbers can be even more difficult for those like me who still have 30 years or more to go until we start nearing retirement age. However, while we all have our own situations -- both financial and personal -- there are some ways to get a general idea of where we'll be with retirement numbers well before we ever get there. Personally, I find that using inflation rates is one of the best ways to determine what our expenses will be several decades from now as we enter retirement.

A simple inflation based example

To give an example of how we utilize inflation to plan for retirement, let me provide a simple example. Let's say that our current family expenses are $30,000 a year, our annual inflation rate is 2 percent, and we have 30 years to go until we retire. By using a simple online future value calculator, I can see that at this rate (all things remaining constant) our costs in retirement would be closer to $54,000 a year.

Tracking expenses plays a key roll in preparing for retirement

However, to make such an easy calculation as the one presented above, it is key that we know our expenses now and how they change over the years. By having tracked expenses over the course of multiple years, we can see not only where we spend our money and in what amounts, but determine the rate with which the costs for these budgeted areas increase from year to year, thereby enabling us to determine an individual inflation rate for our family. This is particularly helpful when it comes to things like food, entertainment, transportation, medical and healthcare costs, and other expenses that tend to change regularly.

Income estimates are critical as well

But it's not all about expenses when it comes to being able to utilize inflation information to better prepare for retirement. We also need to estimate income when it comes to how inflation can affect our retirement planning. Knowing how things like Social Security can be affected by inflation through cost of living adjustments (COLAs) and how future income will compare to future expenses can mean the difference between retiring too early or with too little in retirement funds to maintain a certain lifestyle.

Therefore, we not only consider things like dividend payments, potential income from part-time work, interest from savings, and Social Security benefits, but how these sources of income themselves might change due to things like inflation. Looking forward in these ways can take much of the guesswork out of retirement planning.

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Disclaimer:

The author is not a licensed financial professional. The information provided in this article is for informational purposes only and does not constitute advice of any kind. Any action taken by the reader due to the information provided in this article is solely at the reader's discretion.

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