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Retirement Planning and Inflation

During our recent reviews of the popular pension schemes, we provided examples of the return on investment you could expect when selecting one or a combination of different retirement options. You most likely took the opportunity to use the Retirement calculators provided, if not you may wish to review those Retirement Calculators now and see what your Pension fund could look like:

Having established what your retirement fund may look like, lets now look at how your retirement fund can be affected by inflation.

Using the Retirement Fund Inflation Calculator

This calculator shows the Final Value of a retirement fund, as well as the effect of inflation on that amount, you can read further details about the various factors that effect your Retirement fund below the calculator.

To use this calculator, enter the current value of the fund (or opening payment if a new agreement), the number of years left until the fund matures, and the annual interest rate. The calculator will then illustrate the effects of inflation.

Explanations for each of the financial terms used in the calculator will appear below, the calculator as you roll your mouse over the input or start to type.

There are four example buttons below, each with a different retirement scenario and inflation rates, our aim here is to provide working examples so you can understand the basic components of the Retirement Fund Inflation Calculator before you use it to calculate the future value of your own retirement fund.

Retirement Fund - Inflation Effect Calculator
Calculator tips
[ Roll mouse over inputs for related information ]
Current Value of Fund - The value of the fund today, or at the start of the plan

Retirement Fund Inflation and Return Illustration

Why is inflation important to your Retirement Fund?

We need to first look at inflation and understand what inflation means to investments, after all, your Retirement fund is simply and investment in your future. Once we have covered what inflation is, we will look at how inflation affects investments over time. The aim here is to illustrate how your retirement fund grows and to illustrate what your retirement fund will mean in real terms when you come to spend it.

What is inflation?

Inflation provides a relative value of money (future, present and past), the current value of money is always considered to be 100%, its comparative value in the future or past is then measured accordingly either plus or minus a percentage.

The value that your money is worth dictates what you can buy with it. So, a couple of thousand dollars may get you a down payment on a new apartment, a hundred years ago you could have bought several properties. so what drives that change in the value of money, what makes inflation change and how often does it change?

Inflation is constantly in a state of flux as it is influenced by political, economical, social and technological affects (amongst others) both in the United States and externally across the globe. So, when people tell you they don't get involved with politics because it doesn't affect them... anyway, that's for a separate debate, back to retirement funds...

In a world with a growing population Inflation will only ever rise in the long term as increasing demand creates higher prices. demand can reduce when resources meet the demand or, when they exceed the demand, cause prices to fall, this leads to a negative inflation rate. whilst there can be periods or negative inflation they are typically short lived as the population keeps getting bigger (again, a separate debate but perhaps the biggest drain on our financial future as well as the future of the planet). Inflation is constantly reviewed as it provides a good benchmark for economic performance so governments pay close attention to their national inflation rate, basically hoping for a slight increase in inflation rates year on year (suggesting steady but controlled economic growth). Inflation is a big topic and there are far too many dynamics to cover any specific element in any detail here so let's turn our focus to the effect of inflation on the value of your future retirement fund.

The impact of inflation on Investments

So, we know understand inflation a little, what it is, what it does and why it changes. So, we're ready to work out our pension fund right? Not quite, the other key component of our Retirement fund is the annual interest rate at which our retirement funds grow. Almost everyone understands the concept of interest rates, interest rates are discussed and covered everywhere so we won't go into too much detail here, the key thing to remember is that, when you are an investor you want high interest rates. High interest rates mean you get more back for your money, right? Yes.. and sometimes no. This is where inflation becomes really important and, for you, this is the part you really need to digest. It is the relationship between the Annual Interest Rate (AIR) and Inflation (In) that directly affect what you savings are worth in the future.

For your retirement fund to be worth more tomorrow that it is today, AIR must be greater than In. If they are the same, you are simply getting your money back (even though it may look like its more). So, a simple snapshot:

The affect of Inflation (In) and Annual Interest Rates (AIR) on Retirement Funds
In greater than AIRYour retirement fund will be worth less that the money you invested
In equal AIRYour retirement fund is worth exactly what you invested
In less that AIRHoorah! Your retirement fund is worth more than you invested.

The above table provides a nice simple benchmark, sadly its not quite that straight forword. You also need to consider our favourite friend... tax. Of yes, tax, what a wonderful thing.

IF you are lucky enough to have a retirement fund that provides an income that will attract Federal and/or State Income tax, you also need to consider the impact of tax into this equation. This can seem complex but, lets look at a simple table which will allow you to provide a straightforward benchmark to use when reviewing your pension funds:

The affect of tax on future retirement funds
Tax Rate$1.00 Equivalent

So, if you expect to pay 60% tax on your retirement funds, you need to be savings $2.50 for every $dollar you want to spend in retirement. This is of course a very high number and purely there to illustrate, to help you understand what percentage of your income you do pay on income tax, we have added a percentage column to our Federal and State Tax Calculator, simply enter your income to get an estimate of your tax return and relevant deductions / percentage rates.. Most people choose to pay their taxes up front so their pension funds are tax free on maturity. Those who choose to pay tax later are those who are paying higher rates of income tax now and are likely to earn less from their pension and, therefore, attract lower rates of Federal and State income tax on maturity. If you are unsure of which is the best way to save, tax upfront or after retirement, you really need to take advice specific to your planed pension fund, this difference in approaches is likely to be in the thousands if not tens of thousands of dollars.

$1.00 Equivalent: The amount you need to invest now to get a $1.00 return on your investment when you pay tax at a certain tax rate.

Retirement Savings Fund: Summary

So, planning for retirement really can be quite tricky. It's not just about the size of your retirement fund, it\#s also about Inflation, Annual interest rates and when you pay the tax on your income that you invest in your retirement fund. We hope the examples above and our Retirement Fund Inflation Calculator have helped you get a good feel for how your retirement may look financially. We welcome your feedback below, we are more than happy to add further information, details etc. based on your comments. If you found this article and calculator useful, please share it with your friends, colleagues and family. Sharing helps us grow and continue to provide new developments to this calculator, the Tax Form Calculator and keep them all free for your use in future year.