Reading time: 5 minutes
On this page
For the past few years inflation has been well down the list of worries for retirees. But with the global economy continuing to recover from the COVID-19 pandemic, signs of rising inflation are appearing on the horizon.
In the past two quarters, Australia’s annual inflation rate, as measured by the Consumer Price Index (CPI), has started rising again. In the June 2021 quarter, the annual rate of inflation jumped 3.8%, followed by a rise of 3.0% year on year in the September quarter.
However, these figures were inflated by temporary factors such as the return of childcare fees after they were removed in the June quarter 2020. A more accurate guide to underlying inflation is provided by the Trimmed mean and Weighted median inflation measures that exclude large one-off price impacts. Both recorded their first annual movements above 2% in six years.
This could be a signal retirees need to start thinking once again about the potential impact of inflation on their post-work standard of living.
Why inflation matters in retirement
Although the quarterly inflation figures can be pretty dry and uninteresting, what they measure can have a significant impact on how much you get to enjoy your retirement and how much time you spend worrying about your finances.
The quarterly CPI published by the Australian Bureau of Statistics (ABS) measures changes in the price of a ‘basket’ of goods and services commonly bought by households. It’s a measure that has bounced around significantly over the past 70 years, reaching an all-time high of 23.9% in the fourth quarter of 1951 and a record low of -1.3% in the second quarter of 1962.
While you’re working, your wages generally rise as the cost of living rises, so inflation is less of a concern. But once you retire and start living off your savings, inflation eats away at your purchasing power as each dollar of savings today is worth less in future.
For example, the latest ABS data for the September 2021 quarter showed automotive fuel prices rose a record 7.1% due to higher global oil prices. Higher fuel prices mean retirees get slugged every time they fill up their car and they also pay more for other goods as more costly fuel lifts transport costs and inflates the price of other goods they buy.
This simple example shows why the impact of inflation is something you need to pay close attention to when working out how much you need in your super account to pay for a comfortable standard of living in retirement.
3 ways inflation affects your retirement savings
Although Australia’s inflation rate has been quite low over the past decade due to the economic impact of the global financial crisis and, more recently, the global pandemic, economists believe we may be approaching a turning point as the global economy recovers from the shock of COVID-19.
Retirees – and the wider community – are likely to face higher inflation at some point in the not-too-distant future as inflation begins moving back towards its longer-term average range.
For those in retirement or nearing it, that makes it important to understand how inflation affects your retirement savings. The three main impacts of inflation are:
1. Inflation erodes the value of your money
Over time, inflation is a thief when it comes to your buying power. As a retiree, the value of your assets slowly goes down as the costs of goods and services you need to buy to live on goes up.
For example, if you retired in 2000 with the healthy lump sum of $500,000, you would have been pretty happy. But a basket of goods and services valued at $500,000 in 2000 would have cost you $812,172.09 to buy in 2020.
That’s a 62.4% rise in costs in 20 years due to the average annual inflation rate of 2.5% over that period, according to figures from the RBA’s Inflation Calculator.
Another way to look at it, is to see how many years your lump sum will last given different inflation rates:
|Low inflation rate||High inflation rate|
|Annual inflation rate||1%||3.5%|
|Lump sum at retirement||$750,000||$750,000|
|Annual income drawn down in retirement||$55,000||$55,000|
|Return on investments||4% per year||4% per year|
|Years to lump sum being exhausted||18||15|
Source: Author using Noel Whittaker’s Retirement Drawdown Calculator
2. Government benefits generally don’t keep pace
The Age Pension and allowance rates are indexed twice a year to help retiree incomes keep pace with rises in living costs. Indexation of the Age Pension rate is linked to movements in prices and wages, while allowance rates are linked to the CPI.
Although this sounds good, it doesn’t mean full and part age pensioners are completely protected against the impact of inflation. Many observers believe the twice-yearly cost of living adjustments to the Age Pension don’t fully compensate retirees for the impact of inflation. It’s important to remember Age Pension increases lag any rise in prices, as your fortnightly payment only increases after the ABS has declared the inflation rate for the two preceding quarters.
According to research by the South Australian Council of Social Service (SACOSS), over the year to June 2021, the living cost index for SA age pensioners rose by 2.3%, compared to the generic CPI rise of 3.8% nationally and 2.8% in Adelaide. The 20 March 2021 increase in the fortnightly Age Pension rate, however, was only 0.9% for single age pensioners ($8.40 increase on the previous $944.30 fortnightly total rate, rising to $952.70).
Although the percentage difference is not large, over time age pensioners definitely feel the impact of inflation on their household budget.
SACOSS calculated the jump in inflation and the lag in indexation of the Age Pension during this period left a single age pensioner $6.66 a week worse off than in the previous year.
3. Inflation can make real returns negative
Inflation makes some investment assets less attractive, as it eats away the investment return you receive from them. The impact of inflation can even result in a negative real investment return.
When the impact of inflation is factored into the current low returns from term deposits and government bonds, for example, you may be receiving a negative real return on your savings. Say you only receive 1% for a term deposit (which is a good rate at the time of writing) and the inflation rate is averaging 2.6%, your real investment return is effectively negative (-1.6%) and your savings are eroding, not increasing.
Shares and property generally outpace inflation, but these investments come with more risk. Other investment options to fight the impact of inflation can include inflation-linked bonds. While inflation is only one of many investment risks to consider, and diversification is always recommended, retirees may need to review their portfolio if inflation takes off again.
Watch for inflation in retirement forecasts
Nearly all large super funds offer tools for calculating your likely future retirement balance and income. But it’s important to understand the assumptions used to create these forecasts, as they can vary.
Forecast from calculators should always be treated with caution as they are not crystal balls. They are only as good as the various assumptions they make about the future – particularly about inflation.
ASIC knows the significance inflation assumptions have for retirement forecasts, so it has tightened the rules in this area.
The regulator now demands super funds use uniform assumptions about future inflation rates used in their retirement calculators to help fund members better compare the forecasts provided by different calculators.
ASIC now publishes its own estimated annual rise in the cost of living as the inflation assumption super funds must use in their calculators. This rate is reviewed and updated each year.
If your super fund chooses not to use ASIC’s annual inflation estimate, it must clearly disclose this to you. It must also explain the implications of the inflation rate the fund has chosen to use in its place.