How much money will I need for my retirement? This, naturally, is an important question and one we regularly address with our clients. Any time we plan for the future, it is necessary to make a number of assumptions about the future. Of course, the closer our assumptions are to reality the better prepared we are for the future. One key assumption when planning for retirement is the retirement spending inflation rate.
The traditional method is to look at the historical inflation rate measured by the Consumer Price Index (CPI) and use that as a basis for projected retirement spending increases. When calculating average inflation based on CPI over more than 100 years in the US, the inflation rate is a little over 3%. For this reason, 3% has become a popular rate to assume for retirement spending increases.
There are number of flaws with this broad assumption, the main one being that this broad inflation rate assumption does not actually line up with the typical retiree’s spending pattern. When taking a more in- depth look at retirees’ actual spending increases over time, a number of studies have revealed that retirees’ spending tends to slow down as they age. Michael Stein, author of The Prosperous Retirement, describes retirement in three segments: the go-go years, the slow-go years and finally the no-go years.
Our current Income Architecture model decelerates spending increases over the first 20 years of retirement to more closely align with the typical retiree’s actual spending patterns. By reducing the retirement spending inflation assumption in our model, the projected amount of money needed at retirement is lower. We believe this better projects reality, and this unlocks assets to pursue other financial goals.
It is often easier to apply a general rule of thumb, like the 3% retirement spending inflation rate, to project our future; however, a more specific approach could allow you to make better decisions about your future. We believe that implementing the leading edge of academic research into our financial planning modeling and process gives our clients a more realistic look at their future. Ultimately, it is our desire to help our client pursue all of their goals and live a purpose-filled life.