Why inflation is always your greatest financial risk

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Why inflation is always your greatest financial risk

Inflation is one of the four major risks to your financial wellbeing. And even though it has fallen significantly since peaking in late 2022, its corrosive impact never goes away.

It erodes the buying power of money and disrupts future financial plans.

The incoming administration in the US promises to ‘go crazy’ on tariffs. As much as 25% added to the cost of imports from many countries. Other countries have promised they would retaliate with equal measures. In a nutshell, it would amount to a global rise in costs for families everywhere.

At the height of inflation in 2022, it peaked at just under 10% in Ireland. Tariffs of 25% on goods and services cannot be taken lightly. If implemented, it would have an immediate impact across many aspects of financial planning.

Your future needs

When planning for retirement, inflation is a major concern. All too often, families do not sufficiently factor it into their calculations. In too many cases, they focus on the tax-free accumulation of money. But over time, inflation severely erodes the value of money.

How money value falls!

The following graph illustrates the risk inflation poses to the value of money.

€50,000Buying power reducesBuying power reducesBuying power reduces
Today1 Year5 Year 10 Year
Inflation 1%€49,504€47,573€45,264
Inflation 2%€49,019€45,286€41,017
Inflation 5%€47,619€39,176€30,695
Inflation 7%€46,278€35,649€25,417

The graph illustrates the fall in the buying power of money over time based on various rates of inflation. Source: MoneyWhizz

Retirement planning

Many people do not fully understand how tax relief on pensions work. That’s normal. The language and mathematics of pensions is very confusing, even for those that pass the Q.F.A. exams to become financial advisers. Equally, many people fail to grasp the long-term impact of inflation on the value of money. No surprise there either. In most settings, financial advisers often struggle to explain this in any great detail, if at all to their clients. It’s little wonder so many people prefer to avoid discussing pensions altogether.

So, let’s see if I can explain how inflation impacts financial planning and how to factor it into future plans.

John plans to retire in 20 years time. What are his options?

John earns €75,000.

Gross Income€75,000
Total Tax liability €21,200
Personal Tax Credit €4,000
Net Tax Liability €17,200
Total Deductions (Tax, PRSI, USC) -€22,338
Net Pay€52,662

John spends all of his income, he is a big spender. He has never bothered with a private pension. But how will he manage in retirement on just the State pension?

Signing up for company pension, with minimum contribution of 5% with 5% company match. The following example demonstrates the growth of a pension fund for John.

Year2025
Age46
Retirement Age66
Salary€75,000
Annual Wage Growth1.5%
Inflation2.5%
Current Value of Pension Fund€0
% Invested (employee + employer)10%
Growth (annual)4%
Total Fund Value at Retirement€284,454
4% draw-down€11,378
Value of draw-down in today’s terms€6,944

By age 66, John’s personal pension fund would be valued at €284,454.

Assuming for a 4% annual draw-down (with no tax-free lump sum requirement), this amounts to an annual income of €11,378. However, factoring for inflation at 2.5%, the purchasing power of this money, today is €6,944. In other words, this is roughly how much John could afford in today’s value.

If inflation rises, the purchasing power of his pension fund falls and vice-versa.

The choices facing John

Because he has delayed saving towards his pension for so long, John must either slash spending or increase savings massively. In separate calculations, John was able to close his pension gap significantly.

Ireland is very generous with pensions

The current Irish tax code is extremely favourable when saving for a pension. The following scale shows the percentage of salary that can be saved into a pension from gross income:

Percentage of salary for pension limits

AgePercentage
<2915%
30 – 3920%
40 – 4925%
50 – 5430%
55 – 5935%
60+40%

The graph shows the percentage of gross salary that can be allocated into a private pension. Max income is €115,000.

Using AVC’s

Additional Voluntary Contributions are a very convenient means of increasing pension contributions. Taken from gross wages, the tax relief is applied at source so there is nothing else to do. It is also possible to backdate a pension contribution for the previous year. Here, the tax relief must be applied for from Revenue.

Inflation never goes away

Inflation is a constant risk. Even at the 2% range, it has a significant impact on the value of money. This is why it needs to be carefully considered as part of retirement planning.

Frank Conway is a Qualified Financial Adviser and Founder of MoneyWhizz

Master your money

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