The election results are in and many are predicting that the results could add further fuel to Canada’s already concerning inflation rates.
Last month, Canada’s annual inflation rate accelerated to its highest level in 18 years - well above the Bank of Canada’s target. If the Liberal party manages to get support from one of the opposition parties and goes ahead with their continued big spending plans, our already high inflation rate will likely continue and could get even worse.
Why is this a big concern? In simple terms, inflation is the general increase in prices and the fall of the purchasing power of a dollar. Put another way, it refers to the cost of putting gas in your car or buying groceries increasing.
While nobody can predict exactly what the future will bring, it is likely this inflation will continue, and your retirement plan should be ready for it.
An inflation rate of 3% per year would nearly cut the purchasing power of your money in half over a 20-year period. This means that if you have $100,000 per year of fixed retirement income today, you would be living on the equivalent of $55,367 per year in 20 years if your income sources are not indexed and/or not growing.
But if the inflation rate was at five per cent over the same period, you would only have $35,688 of today’s buying power to live on.
So what should you do to be prepared? Take a look at your income sources in retirement. Government programs like CPP and OAS are indexed for inflation to the Consumer Price Index (CPI) which means the benefit amount you receive will go up in-line with the CPI.
Likewise, some pension plans will also feature an indexing option, but many others will not. It is important to determine if your plan includes indexing and it is very important to make the right selection of options when your pension starts. When you select pension options at retirement, you might be offered a reduced monthly benefit in exchange for a “cost of living adjustment” rider. This would give you a lower monthly benefit now, but that amount would increase with inflation.
When it comes to your personal investment portfolio, the protection of the future purchasing power is up to you. Some investors feel they want no risk in their retirement accounts and don’t realize the risk they are subjecting themselves to by going this route.
For example, let’s imagine a retiree who holds a non-registered portfolio entirely in GICs since they want no risk. The GICs earn a 2% rate of return and they pay a 40% marginal tax rate. At the end of the year, their GIC account has earned 1.2% after tax and with inflation at 2.5%, their real return (net of inflation) is -1.3%.
This means that the purchasing power of their portfolio has actually decreased by -1.3 per cent before they have even pulled out any money to live on for the year. With multiple years of these negative net returns, you may run out of money far faster than you’d expect.
Often, those that want no risk would be far better served by investing in a conservative portfolio that still holds some equity or other alternative investments that will offer a certain amount of inflation protection. These riskier assets can of course lose money as well, so it is imperative that the investor fully understands the plan they are putting in place.
You may also want to consider investments in sectors that benefit from inflation like real estate and commodities.
And for some fixed income investors, options like real-return bonds can add some protection as well.
A properly tailored investment plan should both protect you from inflation and other retirement risks while simultaneously stay in sync with your risk tolerance and comfort.
When planning for your retirement, ignoring the impact of inflation can have disastrous consequences. Whether you’re still working, about to retire or already enjoying your retirement years, take some time to review your retirement plan with a Certified Financial Planner (CFP) professional to make sure it can withstand inflation over time.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.