Deep in the fine print describing retirement in the prepandemic world was some language about inflation being one of the risks to your financial well-being.
Yadda yadda, right? With living costs up an average 1.8 per cent over the previous three decades, inflation seemed a spent force.
After clocking in at 4.4 per cent in September, inflation is back as a retirement risk. But not everyone experiences higher living costs the same way after leaving the work force. In a world of rising inflation, some retirees are more vulnerable than others.
Everyone who receives Canada Pension Plan benefits has some protection against inflation in retirement. Pension consultant Doug Runchey estimates a 2.6-per-cent inflation adjustment for CPP payments in 2022. “That’s what CPP benefits would go up by in January,” he said.
CPP inflation adjustments are based on how the average reading for Statistics Canada’s consumer price index for the 12 months to Oct. 31 compares with the same period a year earlier. Inflation was mild last fall and winter and started to take off in April – that’s why the 2.6-per-cent estimate is below the most recent inflation rate. We’ll find out the actual 2021 cost-of-living adjustment after Statistics Canada reports the October inflation rate later this month.
Old Age Security benefits are reviewed quarterly to ensure they reflect rising living costs. The federal government has already announced a 1.4-per-cent increase for October through December.
Even before inflation kicked higher, you had a big advantage in retirement if you were a member of a defined-benefit pension plan at work. DB plans offer monthly cash for life based on your salary and years worked. Some, primarily those offered to government workers, also offer annual inflation indexation for retired members.
Simon Nelson, a principal at the actuarial consultancy Eckler Ltd., said DB plan cost-of-living increases typically cover between 50 and 100 per cent of any rise in inflation. These adjustments are made, in some cases, only if the plan is in financially solid shape.
Mr. Nelson wonders whether people fully appreciate the inflation protection in some DB plans. “The reason why a lot of private-sector defined-benefit plans have moved away from offering this feature is that it’s exceedingly expensive to provide,” he said.
The retirees most vulnerable to inflation in retirement are ones who don’t have a DB pension, including those who have a defined-contribution pension or a group registered retirement savings plan. DC pensions and group RRSPs are really just vehicles for encouraging employees to save for retirement, with matching money from employers in many cases. When you retire, you have to navigate inflation and volatile financial markets on your own as you draw income from your savings.
The first question in inflation-related retirement planning is how long prices will keep rising. More and more, there’s a feeling that the economic disruptions feeding inflation in the pandemic will linger.
“I think it’s reasonable to expect that the average of inflation over the next 20 years is going to be higher than it’s been over the past 20 years,” said David Wolf, a portfolio manager at Fidelity Investments and a onetime adviser to the Governor of the Bank of Canada. “Whether that’s 2.5, 3 or 3.5 per cent, I don’t know and nobody else does, either.”
I asked financial planners and investment advisers in my LinkedIn community how they’re changing their inflation estimates in their retirement plans for clients. Several said they have bumped up their inflation estimate from the 2-per-cent range to 3 per cent.
This is important because a higher inflation rate requires you to save more to preserve your purchasing power in the years after you retire.
Let’s say you can live in retirement on $75,000 a year. The Ativa Interactive inflation and retirement calculator shows that with 3-per-cent annual inflation over 25 years, the purchasing power of this income would fall to $35,820 in today’s dollars.
To put it another way, 25 years from now, 3-per-cent annual inflation would mean you need $157,033 to preserve the purchasing power of $75,000 today.
A planner who is sticking with a 2-per-cent inflation estimate for now is Natasha Knox of Alaphia Financial Wellness. She noted that the Bank of Canada aims to keep inflation at a 2-per-cent midpoint between its targeted range of 1 to 3 per cent. Also, the official 2021 planning assumptions set out for financial planners to use in making long-term estimates specify an inflation rate of 2 per cent.
“I can’t really look at what’s been happening in the last couple of months and then embed that into a plan,” Ms. Knox said of recent inflation trends. “These are projections that are meant to be for the next 30 or 40 years.”
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