There are countless expenses to consider as you prepare for retirement. Not only do you have to account for general living expenses, but it's also important to plan for healthcare costs, travel and hobbies, and long-term care expenses.
There's one cost-related factor, though, that many retirees overlook entirely. And if you're not prepared for it, it could take a serious toll on your retirement savings.
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The hidden trap that could cost you
As you're preparing for retirement, you may be making a list of all the expenses you can expect to incur. One factor that's easy to miss, however, is inflation.
Inflation won't show up as a line item in your budget, but it can have a dramatic effect on the numbers that show up there. It's easy to fall into the trap of thinking that you've saved enough because you have a hefty nest egg. But keep in mind that years down the road, your money won't go nearly as far as it does now. And over time, inflation could potentially cost you hundreds of thousands of dollars in the form of lost buying power.
To see just how much of an effect inflation can have on your savings, let's look at a hypothetical example. The median amount baby boomers have saved for retirement is $152,000, according to a survey conducted by the Transamerica Center for Retirement Studies. Say you're retiring today with $152,000 in your retirement fund. Like many retirees, you're conservative and put it all in a bank savings account earning only a tiny amount of interest. If the U.S. experiences a modest inflation rate of 2.5% each year, the purchasing power of that $152,000 will fall to less than $72,500 by 2050.
In other words, your savings would lose around $79,500 worth of buying power over 30 years. Inflation can cause your savings to run dry sooner than you expected, which can spell trouble for your retirement.
How to account for inflation in your retirement plan
Inflation can be tricky to plan for, because it's not exactly an expense you can include in your retirement budget. Also, nobody knows what future inflation rates will look like. But you can take steps to prepare as much as possible.
One way to account for inflation is to use a retirement calculator to determine your savings needs. Many calculators will include an input for inflation, so you can include this factor when figuring out how much you should save by retirement age.
Because of inflation, you'll likely need to save much more than you think. So don't be surprised if you run your numbers through a retirement calculator and end up with an exorbitant savings goal. Right now, you may think you don't need to save that much, but once inflation starts eating away at your savings, you'll be glad you did.
Another key is making sure your money keeps working for you after you retire. You won't want an extremely aggressive investment portfolio, but keeping everything in a bank account earning little or no interest won't fight inflation at all. Even a modest return can help keep inflation at bay.
Retirement is already expensive, and inflation can make it even more difficult for your savings to last. But the more you're able to prepare for this hidden trap, the better off you'll be.
