Raise inflation projections for retirees, planner recommends

It’s a question advisors have debated for years: What’s the appropriate rate of inflation when creating financial plans for clients? At least one planner believes inflation assumptions are too low, particularly for retirees.

Peter Baigent, CFP, head of Kelowna,B.C.-based Money Minders Software, concedes there are logical arguments for both sides of the inflation question. Some advisors say that although clients will likely travel a lot in their early retirement years, their income needs will decrease as they get older, so it’s safe to use lower inflation projections.

On the flip side, those arguing for a higher inflation rate point out that as clients get older they will be unable to do as many things for themselves and may need home care or might move into a retirement facility. As a result their income needs will increase dramatically as they get older.

Baigent says he also has difficulties with Statistics Canada’s consumer price index, the benchmark for inflation in Canada. “For many years, I have felt that the CPI is meaningless to retired people,” he states. That’s because the basket of goods used by StatsCan to gauge the rate of inflation is largely inappropriate for retired people, he argues in his “Money Minders” newsletter.

“For example, mortgage rates are a large component of the basket but many seniors do not have a mortgage. Likewise, travel costs would be much larger for a retired couple than the weighting given to it in the CPI index. Ask any retired person what they think their personal inflation rate is and they will tell you it is far higher than the government’s CPI rate [currently at 2.2%].”

Baigent says a client retiring today will likely live to about the age of 90, so it’s more practical to use long-term inflation in a financial plan, since many people could spend as long as 30 years in retirement. Using that benchmark, Baigent favours 4% as an appropriate inflation target, which is close to the compound average rate of inflation as measured by the CPI index over the past three decades.

Using a lower figure leaves planners open to litigation from clients who may feel they were given poor advice with unrealistic expectations, he says. And even if the 4% rate proves to be too high in the future, the client can make gifts to their children or their favourite charity.

Baigent says he’s also found it useful to review other options if clients find themselves needing additional retirement income, such as using additional capital to purchase a life annuity, downsizing to a smaller home, deferring property taxes or considering a reverse mortgage.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com