Retirement plan Inflation assumption

Cobbler_tone

That’s why I use today’s money. From all of the above you are unlikely to be disappointed, although you would prefer to refer to it ‘extreme pessimism’. Unless your stash of retirement cash is kept under the bed.

MeteredOut

leosayer said:

I use 2.5% in my model however here are a few thoughts:

• I just model flat inflation, not periods of high, low or negative inflation
• My model doesn't take account of tax thresholds not rising with inflation
• My model doesn't take account of the variable way in which slices of my DB pension will increase / are capped once in payment
• My model doesn't take account of the impact on my bond returns that a period of high or low inflation might have
• The numbers become very high after 15-20 years of inflation has taken effect, making them not relatable to our current spending

How complex is your model? If not then there's a lot to be said for calculating everything at today's prices. 

Mine is very similar, but I have modelled tax thresholds increasing from 2030 at 1.5% (complete guess) . I've assumed a lower return on my bonds compared to my equities, but the bond rate is also not tied to inflation. With my DB pension I've assumed also it rises no more than inflation, not the CPI/RPI/5%/2.5% accrual rules written into the scheme.

I agree that after 15-20 years the numbers increase quite rapidly, so will likely be well removed from what actuality will be at that time.

grumpsthegit

leosayer said:

I use 2.5% in my model however here are a few thoughts:

• I just model flat inflation, not periods of high, low or negative inflation
• My model doesn't take account of tax thresholds not rising with inflation
• My model doesn't take account of the variable way in which slices of my DB pension will increase / are capped once in payment
• My model doesn't take account of the impact on my bond returns that a period of high or low inflation might have
• The numbers become very high after 15-20 years of inflation has taken effect, making them not relatable to our current spending

How complex is your model? If not then there's a lot to be said for calculating everything at today's prices. 

Probably too complex:-)

I spilt my outgoings into various columns and apply a level of Inflation based on gut feel IE for the essentials (food bills etc) I apply the 2.5% pretty much till the end, but for things like Car budget and clothes and discrecionary spend it tapers past age 75. I also have my Cash buffer growing at 2% and my Pension/ISA at 3% after fees.

I do also cater for the nil rate band going up from 2028 and State pension going up by 2.5% (that might be optimistic as I get the feeling it will get capped at some point for those with good private pensions)

I think I will tweak the 2.5% to 3% just to be pessimistic. And maybe as you say I do another model and with everything at today prices and compare the results.

Thanks for the replies all much appreciated 

MeteredOut

Cobbler_tone said:

That’s why I use today’s money. From all of the above you are unlikely to be disappointed, although you would prefer to refer to it ‘extreme pessimism’. Unless your stash of retirement cash is kept under the bed.

My model also has a "use todays money" option, and my total assets last longer in that model compared to each of my low, medium and high investment return models.

Time4T_Accounts

For me, it boils down to periodically stress testing (nowt scientific) the margin between growth and inflation against a range of longevities.

In other words, if I were to peg it at x years old, what margin do I need to stay solvent?  And is that reasonable?  I hope that, on my eventual deathbed, I’ll have a bit of head space to say “ok, that worked” …

OldScientist

The following table shows historical annualised UK CPI inflation over rolling periods of 10, 20, 30, and 40 years from 1872-2023 at various percentiles: 1st (i.e., best case), 25th, 50th (i.e., median), 75th, and 99th (i.e., worst case)

Years   1       25      50      75      99

10      -2.9    0.4     2.7     4.7     13.1

20      -1.4    1.3     3.4     4.7     9.6

30      -0.3    2.0     3.2     5.2     8.0

40      -0.1    2.0     3.4     6.4     6.8

Since the end of the Bretton Woods agreement (i.e., US gold standard) around 1970 the inflation values were

Years   1       25      50      75      99

10      2.2     2.4     3.0     5.8     13.2

20      2.6     2.7     3.4     6.1     9.6

30      2.7     3.2     3.7     6.0     7.7

40      3.4     3.8     4.8     6.1     6.5

Using the tables, a middling sort of inflation value of 3% to 4% might be reasonable while a worst case might be simulated using 7% or 8% over longer periods such as 30 years . To look at the impact on guaranteed income affected by inflation (e.g., a DB pension with capped inflation increases or a level or fixed escalating nominal annuity) a short-term (perhaps 5 or 10 years) burst of 10 to 13% inflation at the start of retirement might be a useful, but unpleasant, stress test (one of the problems of using, say, 4% constant inflation is that the model would, unrealistically, never erode the real value of a DB pension capped at 5%).

FWIW, I also model real values (i.e., in today's money) since it is much more meaningful than nominal amounts. It is easy enough to include both calculations in your spreadsheet.

MK62

Unfortunately, like returns, inflation also carries sequence risk, so it can be misleading to use a constant eg 3% in drawdown projections -  different sequences, which all still average to 3%pa over 30 years, can have quite different outcomes.

Hoenir

The problem with the headline inflation numbers is that differs considerably to what people personally experience. Depending on their own expenditure. 

Here's an overview of what's included. 

• Food and beverages (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
• Housing (rent of primary residence, owners' equivalent rent, utilities, bedroom furniture)
• Apparel (men's shirts and sweaters, women's dresses, baby clothes, shoes, jewelry)
• Transportation (new vehicles, airline fares, gasoline, motor vehicle insurance)
• Medical care (prescription drugs, medical equipment and supplies, physicians' services, eyeglasses and eye care, hospital services)
• Recreation (televisions, toys, pets and pet products, sports equipment, park and museum admissions)
• Education and communication (college tuition, postage, telephone services, computer software and accessories)
• Other goods and services (tobacco and smoking products, haircuts and other personal services, funeral expenses)

RogerPensionGuy

Nice interesting thread here. 

I think it's very easy to possibly under estimate/guess a persons actual inflation and can be hard to put right in the twilight years if it all falls awkwardly. 

There is much reference and information on people not understanding and planning for possibly higher than wanted inflation, I don't think this subject is high enough up the list of what we collectively should be well aware of. 

Many people I chat to say UK inflation is okay now, maybe just 2 or 3% sounds okay in their head, I remind them that over the last 3 or 4 years food inflation for example is up maybe 25%(guessing) over the period, very different to 2 or 3%

They also often don't under prices inflation verses net cash income. 

Like many on here, I plan with plenty of scope for strong headwinds for long periods. 

An analagy I like is I could buy range rover and keep filling it with fuel and it will hopefully get me to the moon from a cost, fuel and time points of view. 

But I would rather buy a Toyota Land Cruiser and feel a lot more comfortable on my way to moon will plenty of scope if anything unplanned or unexpected occurred on my journey. 

The link below is a nice read. 

***

https://www.investopedia.com/articles/07/consumerpriceindex.asp#:~:text=There are at least three,a different measurement of inflation.

coyrls

I don't think you'll get to the moon in a Range Rover or a Toyota Land Cruiser.