Retirement Planner - Importance of Inflation?

GSP

I am nearing the completion of my planner. It’s very different to the ‘quick and dirty’ one provided by my IFA which contains just a few metrics.
I will ask him as I am sure it will come out when I show him it, but in an assumption why would he use growth of 3% less inflation of 2%, and apply that 1% growth rate for forty years?
 Surely in the first instance growth relates to your fund, inflation relates to and has an effect on your withdrawals so the two should be kept separate given the two different sizes?
Just how important is inflation in retirement planner’s? I see later on in life you need less money which should start to counteract increases in inflation.
Thanks

[Deleted User]

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

GSP

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

ukdw

Personally I find it less confusing to work in absolute terms.
My current cash flow planner spreadsheet is mainly absolute figures, with average annual growth rate of 5% for pensions and ISAs and 1.5% for cash.

I assume 2.5% growth for the state pensions, plus 5.8% on top of that for deferred years.  

I assume the up to age 75 minimum pension contribution limit stays at 3,600 - so the annual tax relief benefit stays at £720.
I assume the basic rate income tax rate stay at 20%, with the bands increasing inline with average 2.5% inflation. 

I assume spending increases by 2.5% annually for the first and last period of retirement, with spending in the middle years being flat.
I project out to age 99 - but focus most attention on average lifespan of age 84.
I do have a few extra columns that are back calculated into real terms values mainly as a sense check.

[Deleted User]

GSP said:

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

Yes, it is different. Your first approach is wrong. The second one is correct. Hence the difference. 

You cant apply inflation to one part of what you own but not the other. A pound is a pound, it inflates whether  you withdraw or not. 

Thrugelmir

GSP said:

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

The buying power of your existing fund is also diminished not just the current years growth. 

GSP

ukdw said:

Personally I find it less confusing to work in absolute terms.
My current cash flow planner spreadsheet is mainly absolute figures, with average annual growth rate of 5% for pensions and ISAs and 1.5% for cash.

I assume 2.5% growth for the state pensions, plus 5.8% on top of that for deferred years.  

I assume the up to age 75 minimum pension contribution limit stays at 3,600 - so the annual tax relief benefit stays at £720.
I assume the basic rate income tax rate stay at 20%, with the bands increasing inline with average 2.5% inflation. 

I assume spending increases by 2.5% annually for the first and last period of retirement, with spending in the middle years being flat.
I project out to age 99 - but focus most attention on average lifespan of age 84.
I do have a few extra columns that are back calculated into real terms values mainly as a sense check.

Thanks. So would you apply inflation to your withdrawals only?

GSP

Deleted_User said:

GSP said:

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

Yes, it is different. Your first approach is wrong. The second one is correct. Hence the difference. 

You cant apply inflation to one part of what you own but not the other. A pound is a pound, it inflates whether  you withdraw or not. 

Sorry, I still can’t get my head round this. 

Surely inflation would only become an issue to the money I withdraw. The money in the fund itself just grows or shrinks depending on how the investments are performing?

[Deleted User]

GSP said:

Deleted_User said:

GSP said:

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

Yes, it is different. Your first approach is wrong. The second one is correct. Hence the difference. 

You cant apply inflation to one part of what you own but not the other. A pound is a pound, it inflates whether  you withdraw or not. 

Sorry, I still can’t get my head round this. 

Surely inflation would only become an issue to the money I withdraw. The money in the fund itself just grows or shrinks depending on how the investments are performing?

Yes, the fund “just grows or shrinks“. If you want to know by how much, you need to account for inflation.

Say, your fund grows at the gross rate of 7%/year (nominal). And inflation is 7%/year. No withdrawals. In 10 years the nominal value of your fund went up by a factor of 2. Sounds great, right? But you don’t actually care about the number of bills in your pocket. You care about the purchasing power. How many dinners, cars, holidays can you buy with the money? That hasn’t changed. The real value stayed the same as 10 years ago. 

If you really want to, you can ignore inflation when projecting your assets but then you have to inflate your costs.  So, your withdrawal goes up by 2% a year as you did in the first calc. But then you can’t compare your  “growth” to the second calculation. Its not growth in real terms because it does not account for inflation. 

GSP

Deleted_User said:

GSP said:

Deleted_User said:

GSP said:

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

Yes, it is different. Your first approach is wrong. The second one is correct. Hence the difference. 

You cant apply inflation to one part of what you own but not the other. A pound is a pound, it inflates whether  you withdraw or not. 

Sorry, I still can’t get my head round this. 

Surely inflation would only become an issue to the money I withdraw. The money in the fund itself just grows or shrinks depending on how the investments are performing?

Yes, the fund “just growth or shrinks“. If you want to know by how much, you need to account for inflation.

Say, your fund grows at the gross rate of 7%/year (nominal). And inflation is 7%/year. No withdrawals. In 10 tears the nominal value of your fund went up by a factor of 2. Sounds great, right? But you don’t actually care about the number of bills in your pocket. You care about the purchasing power. How many dinners, cars, holidays can you buy with the money? That hasn’t changed. The real value stayed the same as 10 years ago. 

Sorry.
Using your %’s for 1 year.
£750k fund grows 7% in one year = £52,500.
£36k withdrawals with 7% = £2,520.
I see a difference there of £49,980.

Combining 7% growth with 7% inflation = zero growth?

[Deleted User]

GSP said:

Deleted_User said:

GSP said:

Deleted_User said:

GSP said:

Deleted_User said:

Some people use less money later on. Some more.  

Subtracting inflation from the assumed growth and assuming you will be spending  today’s pounds makes sense to me. Easier to count costs as we know them now. You are always free to change the assumptions if you disagree. 

Thanks. So if your fund was £750k and grew 3%, that’s £22.5k. If you calculate 2% inflation on withdrawal of £36k, that’s £720.
£22,500 less £720 = £21,780 growth.
This compares to 3% growth less 2% inflation = 1% ‘real return”.
1% of £750k = £7,500.
Quite a different outcome when you apply inflation to withdrawals only, rather than combining with growth?

Yes, it is different. Your first approach is wrong. The second one is correct. Hence the difference. 

You cant apply inflation to one part of what you own but not the other. A pound is a pound, it inflates whether  you withdraw or not. 

Sorry, I still can’t get my head round this. 

Surely inflation would only become an issue to the money I withdraw. The money in the fund itself just grows or shrinks depending on how the investments are performing?

Yes, the fund “just growth or shrinks“. If you want to know by how much, you need to account for inflation.

Say, your fund grows at the gross rate of 7%/year (nominal). And inflation is 7%/year. No withdrawals. In 10 tears the nominal value of your fund went up by a factor of 2. Sounds great, right? But you don’t actually care about the number of bills in your pocket. You care about the purchasing power. How many dinners, cars, holidays can you buy with the money? That hasn’t changed. The real value stayed the same as 10 years ago. 

Sorry.
Using your %’s for 1 year.
£750k fund grows 7% in one year = £52,500.
£36k withdrawals with 7% = £2,520.
I see a difference there of £49,980.

Combining 7% growth with 7% inflation = zero growth?

Yes, nominally it grows. In real terms you have zero growth. You can’t compare nominal growth with growth in real terms (net of inflation). Apples and pears.