Article provided by Liberty Corporate & Mentenova Consultants and Actuaries
A major consideration when saving for retirement is the impact of future inflation. This is particularly critical in times when inflation is high or accelerating, as we are seeing now.
In December 2021, South Africa’s headline Consumer Price Inflation hit its highest peak of 5.9% since March 2017. The price of food and non-alcoholic beverages increased by 5.5% year-on-year and transport increased by 16.8% due to the rise in petrol and diesel prices.
Rising inflation, combined with a subdued economy that has been adversely impacted by the COVID-19 pandemic, have placed considerable pressure on the cost of living.
Inflation has been relatively low over the past few years, and is expected to be much higher in the near future. This is concerning as inflation can take a toll on your standard of living by decreasing the purchasing power of your income. Inflation is defined as the general increase in the average price level of a basket of selected goods and services in an economy, and when there is a rise in this general price level, each Rand purchases less goods and services.
Higher inflation also leads to relatively higher increases in medical aid contributions, which is a critical expenditure for people who have retired.
It is important for individuals to factor in the effects of higher inflation when planning for retirement and making critical financial decisions. These decisions include:
- The type of annuity product chosen at retirement – typically a living annuity or a life annuity, or something in between such as a with-profit annuity which provides a regular income for life, with increases to this income based on investment performance.
- The most appropriate investment strategy, and income draw down rate, if investing in a living annuity.
- The planned lifestyle and, consequently, income requirement after retirement.
- The initial levels of income provided by the annuity product and how the income levels increase each year – this is critical in times of high inflation and as the cost of daily expenses increase.
In the case of a living annuity, if the initial income is not set at a level that accommodates future inflationary increases, the capital value of the annuity will deplete sooner.
In the case of a life annuity, a fixed income annuity may initially provide a high level of income, but in a high inflationary environment, the purchasing power of the fixed payments will erode quickly.
One needs to consider the detrimental effects of inflation, and its impact on the cost of living, especially for future years to come. Financial advisers should be mindful of the above when providing individuals with sound financial advice in making these complex decisions.