Inflation is up to its highest rate since 2012 and the government’s decision to increase interest rates has shaken many people’s confidence in their pensions. Inflation, as measured by the Consumer Price Index (CPI), soared to 8.1% in June 2022 and is still hovering at 6.8% six months later and while inflation appears to be cooling off, the latest Bank of Canada Report expects prices to remain above its 3% target through 2023 and 2% going into 2024.
Retirement is a crucial stage of life that many of us look forward to, however, unexpected factors such as inflation can greatly impact the savings you have accumulated over time. In this blog post, we will take a look at how inflation affects retirement savings in Canada and what steps you can take to protect your savings.
What is Inflation?
Inflation is the rate at which the general level of prices for goods and services is rising and subsequently, purchasing power is falling. In simple terms, it means that the same amount of money buys less over time. For example, if you had saved $100,000 for your retirement, and the inflation rate was 2%, the value of your savings would decrease to $98,000 in a year. This may not seem like a big difference, but over the course of a retirement that could last 20 or 30 years, inflation can have a significant impact on your savings.
Impact on Fixed Income Retirees who rely on fixed income sources such as pensions or government benefits may also be affected by inflation. If the inflation rate is higher than the interest rate on your fixed income, the purchasing power of your income decreases, which means you will have to spend more to buy the same goods and services. This is particularly concerning for seniors who are on a fixed income and may struggle to keep up with the rising cost of living.
How to Protect Your Retirement Savings from Inflation
Diversifying your retirement income sources can also help to reduce the impact of inflation on your savings. This means spreading your money across different types of investments and income sources, so that if one investment or income source is affected by inflation, the others can help to make up the difference.
- One way to protect your retirement savings from inflation is to invest in assets that provide a return that is higher than the inflation rate. This includes investments in stocks, bonds, and real estate.
- Another way to protect your savings is to plan for a retirement income stream that is adjustable for inflation. For example, you can choose a pension plan that provides an annual cost-of-living adjustment or invest in an annuity that increases payments with inflation.
- Real estate investments can also be a way to supplement retirement income and protect savings from inflation. Renting out a property or investing in real estate investment trusts (REITs) can provide a steady stream of income that can be adjusted for inflation, and leverage can be used to generate income without using all of your savings. Additionally, owning a property that appreciates in value can also generate income when sold.
- In addition to the other strategies, it is also important to pay attention to changes in government policies such as tax laws and interest rates that can have an impact on retirement savings. Changes in tax laws can impact the way retirement savings are taxed and therefore affect the amount of money that can be withdrawn in retirement. It’s important to understand the current tax laws and plan accordingly for retirement.
- Interest rate changes can also impact the value of retirement savings, as interest rate changes can affect investments such as bonds and savings accounts. When interest rates rise, the value of bonds falls, and when interest rates fall, the value of bonds rises. Therefore, it’s important to pay attention to changes in interest rates and to diversify your investment portfolio to minimize the impact of interest rate changes.
Diversified Investment Portfolio
It’s important to keep in mind that diversification is key in investing, however it’s crucial to understand your risk appetite and have a diversified portfolio that can provide a balance of returns and security. One way to protect your retirement savings from inflation is by investing in stocks, bonds, and other securities that have the potential to provide a higher return than the inflation rate. For example, stocks have historically provided a higher return than inflation, and they can be a good option for retirees who are comfortable with some level of risk. Bonds, on the other hand, are generally considered to be less risky than stocks and can provide a steady stream of income, which can help to offset the effects of inflation.
Pension Plans and Tax Free Savings Accounts
Registered Pension Plans (RPPs), Tax-Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSPs) can provide a hedge against inflation and can help ensure that your retirement income maintains its purchasing power over time.
Registered Pension Plans (RPPs) are employer-sponsored retirement savings plans that are registered with the government. They provide a steady stream of income during retirement and often offer a guaranteed minimum benefit. RPPs can help protect your income from inflation by providing a fixed income stream that is adjusted for inflation.
Tax-Free Savings Accounts (TFSA) are savings accounts that are not subject to taxes on the interest earned or on withdrawals. Contributions to a TFSA are not tax-deductible, but the money in the account can grow tax-free. TFSAs can be used to invest in a variety of assets, including stocks, bonds, mutual funds, and GICs, which can provide a higher return than the inflation rate.
Registered Retirement Savings Plans (RRSPs) are tax-sheltered savings plans that are registered with the government. Contributions to an RRSP are tax-deductible, and the money in the account can grow tax-free until it is withdrawn. RRSPs can be used to invest in a variety of assets, including stocks, bonds, mutual funds, and GICs. The returns on these investments can help to protect your income from inflation.
It’s important to note that while RPPs, TFSAs and RRSPs can provide a hedge against inflation, they also come with different rules and regulations and it’s important to understand the benefits and limitations of each option to determine which one is the best fit for your retirement savings strategy.
Government Retirement Benefits
In addition to personal savings and investments, many Canadians also rely on government retirement benefits such as the Canada Pension Plan (CPP) and Old Age Security (OAS) to supplement their income during retirement. However, the impact of these benefits on retirement savings can vary depending on the individual’s circumstances.
One of the benefits of the CPP and OAS is that these programs provide a guaranteed income stream that is adjusted for inflation, which can help protect retirees from the impact of inflation on their savings. However, the amount of CPP and OAS benefits that an individual is eligible for is based on their income and contributions throughout their working life, and may not be enough to fully support them during retirement.
For example, let’s say John is a 65-year-old retiree who has saved $300,000 for his retirement. He also receives $800 per month from CPP and $600 per month from OAS. Although these government benefits provide a steady stream of income, they may not be enough to fully support John’s lifestyle in retirement, especially if the inflation rate is high. Therefore, John needs to find ways to supplement his retirement income in order to maintain his standard of living.
It’s important to note that Government benefits aren’t designed to provide a comfortable retirement, but rather to provide a basic minimum to those who may have not had the ability or opportunity to save as much as others. Additionally, The CPP and OAS are not indexed to inflation, and there’s a risk of future benefits being reduced, In order to ensure that your retirement savings are sufficient to meet your needs, it is important to consider government benefits as part of your overall retirement income strategy and complement those benefits with your own personal savings and investments.
Real Estate Investment Income
Real estate investment can be another way to supplement retirement income and protect savings from inflation. There are several ways in which real estate investments can generate income during retirement, including:
- Renting out a property: A rental property can generate a steady stream of rental income that can be used to supplement retirement income. Additionally, rental income can increase over time as rents are typically adjusted to keep pace with inflation.
- Selling a property: Another way to generate income from real estate investment is by selling a property that has appreciated in value. The proceeds from the sale can be used to supplement retirement income.
- Leverage: Real estate investments can also be financed using leverage, which means using borrowed money to finance a property purchase. This allows investors to generate income from rental properties without having to use all of their own savings.
- Real Estate Investment Trusts: Investing in a pool of properties through a Real Estate Investment Trust (REIT) allows individuals to earn income from these assets. REITs are companies that gather funds from investors to purchase and manage real estate properties. They function similarly to mutual funds, but instead of stocks, a REIT portfolio comprises of income-generating properties. For example Morguard North American Residential is a REIT in Canada that specializes in multi-suite residential properties. The REIT holds ownership of 43 residential properties across North America, including 16 properties in Ontario and Alberta, and 27 properties in nine U.S states.
It’s important to note that, like any investment, real estate investment comes with risks and returns can be affected by market conditions, location, and the state of the property. Additionally, real estate investments can come with additional costs such as property maintenance, insurance, and property management, which should be factored into the investment decision.
Tax Laws and Interest Rates
Changes in government policies can have a significant impact on retirement savings in Canada. For example, changes in tax laws can affect the amount of money that individuals can contribute to their retirement savings accounts and the amount of tax relief that they can receive on their contributions. Similarly, changes in interest rates can affect the returns on retirement savings accounts, such as Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA), and may influence the decisions of individuals regarding when to withdraw their savings.
For instance, if the government increases the tax rate on contributions to retirement savings accounts, this would make it less attractive for individuals to contribute to these accounts, and they may choose to save their money elsewhere. Similarly, if the government raises interest rates, this may make it more attractive for individuals to withdraw their savings, as they would receive higher returns on their investments.
In conclusion, inflation is a hidden threat to retirement savings for Canadians. It erodes the purchasing power of savings over time, which means that retirees may not have enough money to cover their expenses during retirement. To combat this, it is important to invest in assets that provide a return that is higher than the inflation rate. Options like RPPs, TFSAs, and RRSPs which can help to protect your income from inflation as well as diversifying your investment portfolio and understanding your risk appetite can help you make better investment decisions. It is also important to stay informed about changes in government policies and inflation rate and adjust your savings strategies accordingly.
Additional Resources and References
- Government websites such as Service Canada and the Canada Revenue Agency provide information on government benefits such as CPP and OAS.
- Books or articles on retirement planning and investing, such as “The Smartest Retirement Book You’ll Ever Read” by Daniel R. Solin, and “The Simple Path to Wealth: Your road map to financial independence and a rich, free life” by JL Collins.
- Information on consulting with a financial advisor or planner can be found through organizations such as the Financial Planning Standards Council or the Investment Industry Regulatory Organization of Canada.