Inflation is a “hidden tax” that must be accounted for in your retirement plan.  For the 20-year period from 1991 through 2010, the average inflation was 2.6% according to the U.S. Bureau of Labor Statistics Consumer Price Index for All Urban Consumers (CPI-U).  While this calculation can be useful for some purposes, some care must be taken.  This index is merely the increase in prices of a standard “basket of goods” compared to what the same goods cost in 1982-1984.  And it is the average of major cities across the US.  Your mileage may vary, to say the least.

Take a 42-year old who intends to retire at age 65.  If inflation averages 2.6% per year over the 23 years until retirement, this will result in prices being 80% higher when he turns 65 than they are today.  And prices will continue to go up throughout his retirement.  If he lives to 85, that’s another 20 years of rising prices.

It is vitally important that inflation is built into your retirement plan to avoid the appearance that your nestegg will be large enough, when in fact, it may not be.