There's only one way to battle inflation in retirement

While you are driving toward income independence, your money is driving in reverse.

Inflation is why.

As if you don’t have enough to worry about for retirement, the buying power of your money is likely to be significantly less than it is now, due to inflation.   Consider the buying power of $2,500 through the lens of 1991. In 1991, $2,500 would buy you $2,500 worth of stuff. Today, you’d need $4,371 to buy the same stuff. You need nearly 75% more money to buy the exact same stuff.

Retirement — or income independence, as I prefer to call it — is challenging because you must defer your income, grow it and then distribute it back to yourself at a sustainable rate. The three processes I just mentioned are not easy, but at least you have some control over them. Deferring your income requires not only sacrifice but discipline. The most common method of salary deferral is your employer-sponsored retirement plan, such as a 401(k). You decide how much you’re willing to part with now so that you can have a solvent later.

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Once you’ve decided you’re willing to part with a reasonable portion of your current income on a regular basis to fund your future, you must then find an effective way to grow it.  Growing your money, while paying homage to your risk tolerance, isn’t easy. You’re forced to play the averages and pray financial markets don’t decide to humble you at the wrong time. Again, you are somewhat in control of this particular process.

The final basic element to creating income independence is the distribution of what you’ve accumulated. You’ve squirreled away nuts in the tree, now you must determine at what rate they can be consumed. The financial industry calls this withdrawal rate or distribution rate. It’s a hotly debated topic wrought with rules of thumb that has virtually no one in agreement. Your financial adviser surely has an opinion about distribution rates, and I urge you to let it dominate an entire meeting with her.

Assuming you properly navigated this agility course like a border collie on his third cup of coffee, you’re in for a rude awakening. If you’re 67 now and have been planning on replacing the very comfortable $2,500 per month of discretionary income of 1991, you’re now beside yourself in frustration. In order to live the lifestyle you projected forward 25 years ago, you’d now need an after-tax income of $4,371 per month.

Inflation has a mind of its own. You don’t get a say.

And when you consider what you consume more of in retirement, you begin to wish you really were a border collie. Since 2000, health care prices have increased by about 80%. It gets worse. Sorry. Energy prices are also among the categories in which inflation has the most significant impact. Retirement is a period in which some consumer spending categories decrease, but you will always have exposure to energy costs, and your consumption of health care will increase.

If you haven’t taken into account the impact of inflation on your retirement lifestyle, you have made a horrendous mistake. Inflation is a silent assassin. It’s the primary reason why cash-heavy retirees are going backward, all the while they feel like they’ve outsmarted the volatile investment markets.

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Inflation has been uncharacteristically low over the last few years. Don’t find comfort in that. For long-term planning, consider figuring inflation at 2.5% to 3% per year.

Inflation affects your everyday life now, it will make your first days of income independence difficult, and it will make your 25th year of retirement incredibly difficult. The solution isn’t easy. You must continuously defer an increasingly larger amount of your current income and outpace inflation with your investments. The temptation is to ignore inflation because you can’t see it. Do not do that.

Unfortunately, inflation is often ignored because of a feeling. “$1 million feels like it will be plenty of money for retirement in 15 years,” one might assert. It’s not. Inflation is a big reason why. The buying power of $1 million 15 years from now will be significantly less than it is today.

Personally, my attention to inflation has significantly increased over the last several months. The more I study it, the more it scares me. All I can do is save more and invest more wisely. That’s all you can do too.

Peter Dunn is an author, speaker and radio host. Have a question about money for Pete the Planner? Email him at AskPete@petetheplanner.com