It is undeniable that every one of us will retire one day, whether it is by choice or being forced. When it is by choice, a person decides when to stop working or chooses to keep a post-retirement job out of choice rather than necessity, in the presence of an adequate pension or personal savings. However, when physical conditions don't allow a person to work any more due to illnesses or accident, a person may have to take an early retirement, even in the absence of adequate personal savings.
Regardless of the types of retirement, we can plan ahead. Before we start planning for retirement, let us look into a few common factors that will impact our retirement.
Inflation
In the current high inflation era, most things have gone up in prices. Ever since Malaysia government increased the gas price to $2.70 per liter on June 5th 2008, the inflation pressure is building up in every aspect of our life. The following chart shows that in June 08, the year-over-year inflation accelerated by 7.7% and the month-over-month inflation accelerated by 3.9%.
It is clear that the low inflation era may be over and will not be back in the near future as long as the commodity prices are on the up trend. The current 2008 full year inflation forecast is 6.2%. Based on sources from the Statistics Department of Malaysia, the CPI weight is as shown below:
Transportation price index increases the most, 19.6% for y-o-y and 18.8% for m-o-m, due to petrol price hike in early June 08. Food item increases by 10% y-o-y. It is undeniable that the inflation has increased and it is impacting most people life. Food and transportations are inseparable from our daily life, right? So, how does it impact our retirement in the future? To study the impact of inflation towards required retirement fund, let us look into a case study.
Case Study
- Name: Jon Doe
- Age: 24
- Annual Salary: $36,000
- Estimated annual salary increment: 5%
- Desire Retirement Age: 55
- Expected life expectancy: 80
- Post-retirement investment return: 6% (moderate)
- Desire Post-Retirement income: 75% of Pre-retirement income
The retirement fund that Jon Doe should have at his retirement age of 55 is $2.46 million if the inflation rate is 4% p.a.; $2.74 million at an inflation rate of 5% p.a.; and $3.06 million at an inflation rate of 6%.
How much difference a 2% p.a. increase in inflation can make towards Jon Doe retirement fund? It is a huge $600,000 difference in this case study. Beside the additional amount required, the "real" value of the post-retirement income is also becoming less. At the age of 55, the projected annual income for Jon Doe is $163,369.42. After retirement, Jon Doe is expecting to receive annual income of $112,527 (75% of $163,369). However, due to different inflation rate, the spending power of this income is different.
The "spending power" of $122,527 (post-retirement income) is equivalent to today's value of:
- $36,324 @ 4% p.a. inflation rate
- $27,000 @ 5% p.a. inflation rate
- $20,126 @ 6% p.a. inflation rate
In conclusion, inflation rate will impact 2 things in our retirement planning. First, it will require us to prepare more money for the future, and secondly, the purchasing power of the post-retirement is less.
Labels: Retirement Planning
