Inflation And Longevity: The Two Biggest Risks To Your Lifestyle In Retirement

One of the biggest riddles for retirees today is how to make their nest egg last through their retirement years. This is a question that is becoming more difficult to answer as advances in health and medication increase the period for which retirees must plan. Alone this creates a big enough conundrum when investing toward retirement, but when the effects of inflation are added in the swamp suddenly turns to quicksand. Indeed, the probability of living longer and the effects of inflation are the two biggest risks to planned retirement lifestyle.

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Or book a free Strategy Session through the form on the right and you’ll get access to our Successful Retirement series “Can You Really Afford to Retire?”

The inflation risk to your retirement nest egg

Conventional wisdom tells us that by withdrawing 5% of a nest egg each year after retiring, the nest-egg should last through to the time it is no longer needed. Under this calculation, a super fund of $300,000 (which, by the way is a lot more than the current super average) will provide an income of $1,500 per month. That’s only $18,000 per year, but even if it were possible to live on this amount (which is less than considered necessary to meet basic needs today), inflation will decimate it spending power over the next twenty years.

The RBA inflation calculator shows that what cost $1 twenty years ago now costs $1.66. If it is assumed that long term inflation will replicate the last 20 years, that $1,500 per month income today will only buy the equivalent of $1,000 in 20 years’ time.

At present, many Australians are living under the false hope that social security payments will make up any shortfall in retirement planning. But demographics is a ticking bomb: every year there are fewer working and tax paying Australians to cover the needs of rapidly ageing population. Older Australians are becoming increasingly income poor, and this won’t change until retirees have a lifetime of super contributions under their belt.

As if this doesn’t sound bad enough, the latest HSBC Future of Retirement study shows Australians expect their retirement to last 23 years but concludes that their savings and investments will run out after just ten years.

The longevity risk to your retirement nest egg

The increase in Australia’s aged population is largely caused by increasing life expectancy. In the early 1980s, a retiree could expect to live for between 14 and 18 years in retirement (depending on whether male or female respectively). That figure has now risen to 21 years, and, as the HSBC study found, Australians believe it will rise further.

Clearly, even disregarding the effects of inflation what may have been considered a reasonable nest egg just thirty years ago is no longer a viable amount. The overriding concern of today’s retirees is that they will run out of money.

Inflation and longevity combined: mitigating the risk

The risk to a happy retirement posed by the double whammy of inflation and longevity is that a person’s retirement nest egg will not be large enough to last their lifetime, and the income produced will dramatically fall in value. (Here it is worth noting that the AFSA Retirement Standard estimates the spending requirements of a 70 year old in relatively good health to be around $21,000 per year.)

Fortunately, and even through the doom and gloom of the risks of inflation and longevity to a happy retirement, there are ways in which investment and retirement planning can mitigate these dual risks.

A retiree may allow for inflation by increasing the amount withdrawn from the retirement nest egg each year. If inflation is expected to rise by an average of 3%, for example, each subsequent annual withdrawal will need to be 1.03 times larger than the previous top maintain spending power. However, this will increase the rate at which the nest egg runs down to zero.

Most Australians, while being cash and income poor, are asset rich. They own their own homes, and typically with the mortgage repaid by the time they retire. Such equity may be accessed, and there is always the possibility of something from Centrelink.

The real answer to mitigating the risks of inflation and longevity, of course, is to plan early. Accepting that the responsibility for income in retirement will fall increasingly on the individual, rather than the state, is the first step to creating a nest egg which will support the desired lifestyle through retirement. Then consider the following:

• Life expectancy increases by one year every six years
• A male aged 60 today has a 50% chance of living to 90
• At an average inflation rate of just 3%, $48,200 today will have the equivalent spending power of only $19,857 in 30 years

Be prepared for retirement

Being prepared for retirement is the key to a successful and fulfilling life in older age. That’s why we have produced a set of reports which will help you to achieve the retirement lifestyle you desire. As well as looking at the inflation and longevity risks to your retirement in more detail, these reports also cover areas such as:

• How to calculate your super needs
• The risks of the SMSF
• How big does your nest egg need to be
• Living tax free in retirement

Look forward to a brighter, and earlier, retirement by getting our full report:

The Impact of Inflation and Living Longer

Or book a free Strategy Session through the form on the right and you’ll get access to our Successful Retirement series “Can You Really Afford to Retire?”