Introduction
In the world of financial planning, ensuring that your money retains its purchasing power over time is crucial. One tool that helps in this endeavor is the "inflation adjustment" feature. But what does it really do, and how does it impact your financial forecasts? Let's dive in.
Description
The "inflation adjustment" feature is designed to help you understand how the value of money might change over time due to inflation. In simple terms, £100 today might not buy you as much in 10 years because of rising prices, and this feature helps account for that.
At its core, the "inflation adjustment" feature tweaks the starting value of a spending plan. All the following values then adjust based on a set inflation rate.
While it might seem like a small tweak, this adjustment can have significant implications, especially when planning for long-term financial goals.
Inflation-adjusted vs. Inflation rules
The 'adjust for inflation' checkbox determines how a specified amount will be adjusted for inflation until the point it's used. For instance, if you're 60 and plan to spend £50k at 65, ticking the box will adjust that £50k based on the cumulative inflation from ages 60 to 64. If unticked, the amount remains £50k at age 65. Once the spending starts, it's then adjusted according to the chosen inflation rule, regardless of the checkbox's status.
Example
John is currently 60 years old and has set aside £50k for a dream world tour he plans to embark on when he turns 65.
If John ticks the 'adjust for inflation' checkbox and we assume a steady 2% inflation rate each year:
By age 61, John's £50k would be equivalent to £51k in next year's money.
By age 62, it would be around £52k.
By age 63, roughly £53k.
By age 64, about £54k.
By age 65, it would be approximately £55k.
So, with the checkbox ticked, John would need around £55k at age 65 to have the same purchasing power as the £50k he set aside when he was 60.
However, if the 'adjust for inflation' checkbox is not ticked, John would still be planning to spend the original £50k at age 65, without considering the inflation that occurred over those five years.
Once John starts his world tour at 65 and begins spending, the amount he spends will then be adjusted yearly based on the selected inflation rule selected in the INflarion rules section in Plan Settings, regardless of the initial checkbox decision.