There has been a lot of discussion about whether people are saving too much for retirement. Numbers like $4,000,000 are causing people to question the validity of recommended retirement savings.
A reason the number is so high is the effect of inflation. Inflation is the silent factor impacting savings and income needs. To illustrate, I have created tables that show the required income needed to maintain the same purchasing power of today's income of $25,000, $50,000 and $100,000 in 15, 25 and 40 years from now.
Here is the income needed in the future when inflation is 3% .
| Equivalent income at 3% inflation | |||
|---|---|---|---|
| Current Income | 15 years | 25 years | 40 years |
| $25,000 | $33,397 | $52,344 | $81,550 |
| $50,000 | $65,196 | $104,689 | $163,102 |
| $100,000 | $134,392 | $209,378 | $326,204 |
Here is the income needed in the future when inflation is 5% .
| Equivalent income at 5% inflation | |||
|---|---|---|---|
| Current Income | 15 years | 25 years | 40 years |
| $25,000 | $40,722 | $84,659 | $176,000 |
| $50,000 | $81,445 | $169,318 | $351,999 |
| $100,000 | $162,890 | $338,636 | $703,999 |
At 3% inflation, in 40 years, one can expect to need three times today's income to maintain today's purchasing power. At 5% inflation, one would need over seven times today's income in 40 years.
Based on this analysis, I am not surprised that people in their 20s are getting estimates in the single digit millions for their retirement savings targets. Inflation is the major factor affecting those estimates.
For more on The Practice of Personal Finance, check back every Wednesday for a new segment.
This is not financial advice. Please consult a professional advisor.
Copyright © 2007 Achievement Catalyst, LLC
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4 comments:
Dimes,
Agree from a retirement target point of view.
However, inflation can sometimes help, especially in real estate. I just looked up my parent's first house on Zillow.com and its estimated value is about 17 times what they paid for it when it was built. Amazing. Of course, past performance doesn't guarantee future results:-)
While I agree that the effects of inflation are mostly negative and it can be devastaing to many people, awareness of the issue can go a long way towards dealing with the issue. Also, as mentioned above, inflation can be exploited through the use of debt.
of course, with the government lying about inflation the 5% estimate might turn out to by on the low side.
remember how back in '73 we had digit digit inflation. i think we're currently seeing the same scenario.
Trainee Investor,
Inflation is a two edge sword. It can help with tangible assets or hurt cash. I'm currently betting on relatively low asset inflation for the next decade and am investing according to that belief.
Adventures in Money Making,
While I agree the inflation estimate is more complex than before, I still believe it is relatively low. For me, with the exception of gasoline and taxes, many of my costs (computers, wife's cell phone, high speed internet, furniture) are going down. And on an inflation/feature adjusted basis I think many more (e.g. baby diapers, cars, adult beverages) are going down.
Also, many companies (including the one for which I work) are not passing along the raw material cost increase as they did in the past.
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