indicatorInvesting and Saving

How a financial plan can help during high inflation

By Mike Winsor, CFP® 4 May 2023 2 min read

Periods of high inflation can impact your cost of living both immediately (like at the grocery store) and in the future (like the amount you’ll need to retire). In this article, we’ll review each impact and how having an up-to-date financial plan can help you to manage and mitigate them.

1. Impact on your ability to save


While inflation generally impacts salaries as well as expenses, the increase in wages hasn’t kept pace with inflation:

Source: Statistics Canada tables 14-10-023-01 and 18-10-0004-01

There is another element to this to consider though, as wages are expressed before tax, while expenses involve after-tax dollars. Let’s look at an example using the average year-over-year changes in 2022, rounded to the nearest per cent:

Assumptions:

Income: 3%

Expenses: 7%

table looking at the difference between the original dollar amount of salary, taxes, expenses and savings vs. the amount with inflation applied

Note: All taxes estimated using 2023 combined federal and Alberta rates.

While most economic conversations will focus on nominal versus real wage growth (i.e. wage growth as a percentage versus wage growth less inflation as a percentage), the actual cost of living comparison and impact on net savings can be overlooked. 

How a financial plan can help

  • As this only affects your plan going forward, this will impact you less the earlier you started saving (as higher inflation rates may continue, this is also a reason to start saving now instead of delaying).
  • Adjusting your plan sooner than later can help mitigate a savings shortfall (as opposed to passively accumulating a savings deficit).
  • You may be able to adjust your savings and/or retirement spending budget(s) to offset the impact of inflation.

2. Impact on your retirement savings needs

While governments are working hard to rein in inflation, another understated ramification is that even if inflation rates revert to the norm, the long-term increase to your retirement savings needs will likely have already changed. This is because after high-inflation events, prices generally fail to revert to their previous levels (as that would require significant negative inflation—also known as deflation, which is not the Bank of Canada’s stated goal).

Let’s look at a simplified example of this effect using the following assumptions: 

  • 30 years planned for retirement
  • Planned spending of $55,000/year
  • Long-term inflation of 2.1%1

What happens if inflation jumps by 7% to begin your first year of retirement before returning to 2.1% for the rest of retirement? How does this compare to your original plan from before the 7% increase?

table detailing the increase to annual retirement spending plan when a plan is updated with a 7% increase over the original plan

Future spending will look larger than it will feel in terms of purchasing power (a dozen eggs cost $2.57 in 20082). This table shows the impact of short-term inflation both in future dollars (what it will look like) and “today’s dollars” (what it will feel like - i.e. how much it would buy today).

While this will feel like an annual increase of $3,850/year ($115,500 over 30 years), when factoring in long-term inflation, the total increase over 30 years would be $158,657. Depending on your financial situation, a change like this may merit a review of your financial plan. 

It is also worth noting that this increase in retirement funding needed would be in addition to the reduced pre-retirement savings effect we discussed in the first section.

How a financial plan can help

  • Your plan may include some capacity to absorb expense increases of this nature.
  • Adjusting your plan sooner than later allows for greater flexibility to manage increased savings targets.
  • Reviewing your plan can help you properly evaluate to what extent offsetting increases in income due to inflation (i.e. pension indexing, investment growth, wage increases, etc.) help mitigate any shortfalls created.

Conclusion

Even a short-term increase in inflation can have long-term impacts on your retirement plan. Updating your plan regularly can help limit the amount of work to be done to offset any increases while helping to avoid surprises down the road. Don’t have a financial plan? Get in touch with a financial advisor to get started.

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