EBRI: Don't Forget Inflation Impact on Retirement Income

September 16, 2004 (PLANSPONSOR.com) - Calculations about what percentage of preretirement income a person will need to properly fund their retirement should give heavy emphasis to using the proper inflation rate in the analysis, a trade group said.

A new analysis from the Employee Benefit Research Institute (EBRI) touches on the issue of the adequacy of retirement income – often referred to as a replacement ratio. An EBRI news release said researcher Jack VanDerhei of Temple University raised the issue of inflation’s post-retirement role while reviewing recent studies by a number of retirement services providers.

“It is important to note that this assumption (inflation) makes a huge difference in target replacement ratios,” VanDerhei wrote. VanDerhei said that using a preretirement inflation rate of 0% and income of $60,000 produces a replacement target rate of 75% while a 3% rate pushes it to 84%.

Not only is the impact greater with higher inflation assumptions, but it is also affected by preretirement income levels, VanDerhei wrote. At 5% inflation, the replacement ratio is 15% at a $20,000 income level but goes up to 33% at $90,000. Lower income Americans will see a lesser inflation impact because they are likely to get more in retirement from Social Security, which is already inflation indexed.

The EBRI analysis also asserts that the continued trend of defined contribution participants taking out their assets as a lump-sum distribution can complicate the analysis. Those workers now have to calculate how much regular income a given lump sum would generate, EBRI said.

The report also cites two studies about the retirement income replacement ration from Aon Consulting/Georgia State University (See . Aon: Workers Expected to Contribute More for Comfortable Retirement ) and from Hewitt Associates.