inflation, Consumer Price Index, Retirement savings, Retirement Income, Jeremy Duffield, cost of living

What happens to retirement savings and income when inflation is high?

Inflation is having a major impact on most Australian households, affecting both young and old. Last week the Reserve Bank again raised interest rates, to an 11-year high of 4.1 per cent. You may not have a mortgage, but you could be living on retirement income. So what does stubbornly high inflation mean for retirees? Will inflation ruin your retirement? And are there any investments for retirees which can ride the ups and downs of inflation?

We talked to Retirement Essentials Director, Jeremy Duffield, to help us better understand how inflation can affect your savings and spending goals.

First, some background.

Assets and inflation

As measured by the Consumer Price Index (CPI), inflation in the last quarter (April) was 6.8 per cent, and the annual rate was 7.0 per cent. 

How your retirement will be affected by such persistently high inflation depends upon the nature of your assets and the mix. Different asset classes respond differently under persistent price pressures.

Here’s a brief overview of how the major Australian asset classes have performed over the past 12 months.

  • Cash – This has improved as an asset class over the past 12 months, but savings account and term deposit interest rates continue  to be well below the headline inflation rate of 7 per cent. 
  • Super – Superannuation returns tend to depend upon individual fund performance. You may be with a retail or industry fund or your own Self-Managed Super Fund According to industry analyst, Chant West, the median growth fund, in which the majority of people are invested, was 1.2 per cent higher for April, bringing the year-to-date performance to 8.1 per cent.
  • Investment Property – This again depends upon the nature of the property and where it is located. Post-Covid 19, commercial property has been a challenging sector, with sluggish returns.
  • Shares – It’s been quite a volatile year for the Australian Share Market, with the All Ordinaries up 3.4% year to date. This is lower than recent years, but a far better result than the overall loss in the previous financial year.

(NB  all above % changes are indicative only)

What insights does Jeremy have to offer?

First up, he reminds us of a fundamentally important point, and that is the protection from inflation offered by the Age Pension, which he describes as ‘truly terrific’.

“The Age Pension is a great hedge against inflation. It has increased by 7.9% in the past year as compared with 7% CPI. This is because of the mix of inputs for Age Pension indexation, using whichever is the highest indicator across the Consumer Price Index (CPI), Average Weekly Ordinary Time Earnings (AWOTE) and Pension Beneficiary Living Cost Index (PBLCI) measurements. This system of indexation provides a secure benefit for older Australians. This sentiment is supported by recent research from the CBA showing that spending has kept up for those aged 60+, but not so for younger people.”

Not all retirees are on a full or part-Age Pension, with about 30% more likely to be self-funded. This means that, without the protection of an inflation-adjusted Age Pension,  they are more likely to be exposed to movements in the markets.

Jeremy advises,

“It’s important to hold diversified portfolios. Over time, shares have beaten inflation by a hefty 5-6% per annum. They may be soft in the short term, but that never lasts. Shares are investments in companies which participate in the real economy. As such, profits will be made and dividends paid. It’s really important for investors to look past short term returns and to consider their longer term needs.”

Vanguard have a terrific chart on the performance of various asset classes over the last 20 years which you can find here.

As inflation forces interest rates up, deposit rates also increase. Jeremy urges those with savings deposits to shop around for the best rate. There are many comparison websites which take the hard work out of this exercise. You may also wish to negotiate with your current bank or institution, rather than moving your savings. One of our members, 95-year-old Betty, has done this by phone quite successfully!

And one important, but often overlooked point.  For the three-quarters of retirees who are homeowners, their family home remains the major pillar of their retirement wealth. The price of the home has probably increased over the longer run, and they are avoiding galloping rental increases, forced by inflation. They also retain a major source of equity, if and when needed.

Of course those who still have a mortgage on their home are paying higher interest due to inflation or the end of lower fixed term loans. Whilst this is less than ideal when you are living on a retirement income, there are actions that you can take to manage this, including using super to reduce the mortgage, downsizing, or negotiating payment schedules with your lender. There are many strategies for retirees to use their super in combination with a home mortgage.

Drawing down your assets, usually in an Account-based Pension, during a time of low growth can feel challenging. This, however, doesn’t mean that you are bound to run out of retirement funds so you must live more frugally. As we have mentioned before, the findings of the 2020 Retirement Income Review was that many retirees underspend, perhaps because they do not access accurate retirement spending forecasts and do not fully understand their options. 

What do you think?

Is high inflation keeping you awake at night?