Figuring out how much to save for retirement can be tricky; you’re dealing with a set of factors you can’t be sure about. You don’t know your life span or future health status, and you can’t predict inflation rates or changes in social security payments. However, in spite of all these unknowns, it’s still possible to make a good guess at how much to set aside for retirement.
There are two steps to using inflation rates to calculate how much you need to save. The first is to estimate how inflation will affect the growth of your pre-retirement savings. The second is to figure out the annual amount of future (inflated) dollars, which you will need to live on after you retire.
Step 1: Estimate how inflation affects your savings
You probably have several methods of saving for retirement; you may have an IRA through your employer, as well as CDs or other personal investments. You may even own real estate that you plan to sell someday. With the help of a financial advisor, you can estimate the amount of interest you will earn on all these accounts. For example, let’s say all your retirement savings are expected to net you an average interest rate of 5 percent per year.
You can look at an inflation table online and see both current and historical inflation rates. In recent years, inflation rates have ranged between about 1 percent and 3 percent per year. Let’s say you plan conservatively, and estimate that inflation will be a steady 3 percent per year. That means you will subtract the 3 percent inflation from your 5 percent interest earnings, giving you a real net increase of 2 percent each year.
Step 2: Estimate inflation on your future annual living expenses
Let’s say that you are 50 years old, and feel that you could live on $50,000 per year. You aren’t going to retire for 17 years, however, so you need to estimate how much money will be needed during those future years to buy the same amount of goods that $50,000 will buy today. Again, you can find an inflation calculator and plug in the numbers. According to such a calculator, you would need $82,642 in 2032 in order to cover the same expenses as $50,000 pays for in 2015.
Remember that your salary and social security will continue to increase during your earning years, so you will be more than able to keep up with inflation as you save for retirement. Financial advisors can help you by using inflation calculators, and they can suggest the best ways of dividing up your savings among different investment vehicles to maximize your interest.