Inflation and retirement: which income keeps pace and which doesn't

Why inflation matters more in retirement

While you're working, wages often rise over time, which helps offset higher prices. In retirement, much of your income may be set in advance, so rising prices fall directly on your budget.

The Bank of Canada targets inflation of 2%, the midpoint of a 1% to 3% control range. Actual inflation can sit above or below that target for stretches of time, and the prices that matter most to you, such as food, rent, property taxes or travel, can rise faster or slower than the overall average.

Because retirement can stretch over decades, small differences add up. A pension that feels generous at 60 can feel tight at 85 if it never rises.

Today's dollars: how the planner handles it

The planner reports every figure in today's dollars. Rather than showing a nominal amount that looks large in 2050, it converts returns into returns above inflation and shows what future amounts would buy at today's prices.

For example, a 5% nominal return with 2% inflation becomes a real return of a little under 3%. Spending entered as $46,000 means $46,000 of today's buying power in every year of the plan.

This approach makes it easier to compare a retirement budget with your current spending. It also makes the effect of a non-indexed pension visible: its value in today's dollars shrinks each year, even though the cheque stays the same.

The same idea applies to savings. If the planner assumes a 5% return and 2% inflation, only the part above inflation adds to buying power; the rest simply keeps up with prices. That's why nominal returns are converted before the projection runs.

Which income sources keep pace

Inflation protection varies widely between income sources. Here's how the main ones compare in general terms; your own plan documents and Service Canada are the places to confirm the details:

• OAS: adjusted quarterly for inflation. The maximum for ages 65 to 74 is $762.50 a month for the October to December 2026 quarter.
• CPP: adjusted for the cost of living, and the planner treats it as keeping full pace with inflation. Confirm the indexing details with Service Canada.
• Workplace defined benefit pensions: some are fully indexed, some partly and some not at all. Check your plan booklet or annual statement.
• Annuities: many pay a level amount; some offer indexing at a cost. The annuities guide covers the trade-offs.
• RRSPs, RRIFs, TFSAs and non-registered savings: they keep pace only to the extent their investments earn more than inflation.
• Tax brackets: the planner treats them as indexed, so rising prices alone don't push you into a higher bracket in the projection.

Bernard's pension without indexing

Suppose Bernard, 60, lives in New Brunswick and is retiring this year with a defined benefit pension of $30,000 a year that isn't indexed. He also has $200,000 in his RRSP and $50,000 in his TFSA. His CPP estimate is $1,000 a month at 65, and he plans to start CPP and OAS at 65. He wants to spend $46,000 a year after tax.

With an illustrative 5% return and 2% inflation, his pension's value in today's dollars falls to about $27,172 at 65, $24,610 at 70, $20,189 at 80 and $16,562 at 90. The cheque never changes; what it buys does.

His savings have to make up the growing difference. Under these assumptions, they run out at 84; by 85, his spending falls about $11,503 short of his target each year. The calculator estimates his highest steady spending to 95 at $43,400.

The same pension with full indexing

Now suppose the same pension rose with inflation every year. In today's dollars it stays at $30,000 for life, so Bernard's savings only need to cover a small, steady gap once CPP and OAS begin: about $4,412 a year from his RRSP at 65 and 70.

On that path, the plan lasts to 95 with about $163,710 left after tax. His highest steady spending to 95 rises to $48,500, which is $5,100 a year more than with the non-indexed version.

Indexing isn't usually a choice a retiree gets to make after the fact; it depends on the plan. But knowing which kind you have changes how much your savings need to do, and how much cushion it makes sense to plan for. The pension comparison guide explains other features worth checking.

Testing a higher inflation assumption

Bernard's non-indexed plan can also be run with 3% inflation instead of 2%, keeping the same 5% nominal return. Two things change at once: the pension loses value faster, and the return above inflation shrinks.

At 3%, his pension is worth about $25,878 at 65, $16,610 at 80 and $12,360 at 90 in today's dollars. His savings run out at 78 instead of 84, and his highest steady spending to 95 falls to $40,300.

A sensitivity test like this isn't a forecast. It shows how much of a plan's strength depends on inflation staying close to target, and which parts of the plan absorb the hit when it doesn't.

Lower inflation would work in the other direction, stretching a fixed pension further. Running a low, middle and high case side by side is a simple way to see the range without committing to any single forecast.

Questions to check in your own plan

A few questions help pin down how exposed your own retirement is to rising prices:

• Is your workplace pension indexed, and is the indexing full, partial or conditional?
• What share of your spending is covered by indexed sources such as CPP and OAS?
• Do your savings carry the burden of keeping pace, and what return above inflation does your plan assume?
• Which of your expenses tend to rise faster than average, such as property taxes, insurance or care?
• How does your plan look at 3% inflation? The retirement plan tool lets you change the inflation input, and the plan summary shows the result at a glance.