Retirement Planning – Lifestyle Inflation Factors to Consider While Planning for Retirement

Retirement Planning

People are likely to spend more money as their income increases, even when they don’t necessarily need to. This phenomenon is known as lifestyle inflation. Lifestyle inflation refers to increased spending on luxuries or other expenses that could raise your standard of living, as a result of an increase in income. This implies that every time you receive a raise in your income, your spending increases, making it difficult for you to meet your financial goals such as saving for retirement or simply paying off your debt. Lifestyle inflation does not necessarily hamper you from meeting your everyday expenses. However, it can limit your ability to build wealth, which is vital for a financially secure retirement.

Lifestyle inflation can result in living one’s life paycheck to paycheck. According to recent Charles Schwab’s Modern Wealth Index Survey, 59% of U.S. adults were living paycheck to paycheck. Surprisingly, even those earning six figures are struggling to make their ends meet. Another study by a global advisory firm found 18% of employees earning more than $100,000 annually had little to no savings. This is nearly one-fifth of Americans with a six-figure income. The results of these studies clearly show that some high-income earners fail to save enough, despite having more financial resources. These numbers have worsened since the onset of the COVID-19 pandemic. As per a survey conducted by Information Technology Company Highland Solutions, 63% of Americans, i.e., nearly two-thirds of the working population, have been living paycheck to paycheck since the COVID-19 pandemic hit in 2020.

Lifestyle inflation can be difficult to avoid as it is not easily detectable. However, if you are planning for retirement, it is wiser to be wary of how it can impact your savings. It is recommended that you factor in these simple strategies in your retirement planning to minimize the impact of lifestyle inflation:

    • Challenge your mindset: The primary reason for lifestyle inflation is the general tendency to spend more if you have more. It is not uncommon for you to feel drawn towards your friend’s or business associates’ buying habits and lifestyle. For instance, if everyone in your company drives a BMW to work, you might feel the urge to invest in an expensive car if you have more money at your disposal. However, you might not need to make this investment at that point in your life. While buying a new car may not hamper your ability to meet your current expenses, it could affect your retirement savings. You could avoid this expense by using your money wisely and saving for your retirement needs instead. Try to not base your decisions on how you think others perceive you. Be rational in your spending habits, achieve your savings targets, and meet your retirement goals rather than trying to maintain your status quo among your peers. Lifestyle inflation may not hurt you initially. However, it can become unsustainable and cause problems during your non-working years or during a financial emergency.


    • Track your spending habits: A wise retirement planner always aims to budget prudently and spend consciously, accounting for the present as well as saving for the future. This is possible only when you track your spending habits and do not give in to lifestyle inflation. Knowing how you spend every dollar helps combat the impact of lifestyle inflation. You can do this by creating a zero-based budget, where each dollar has a defined purpose. You divide your requirements into discretionary and non-discretionary expenses and allocate a defined sum for each expense item. It is advisable to limit your discretionary expenditure, such as ordering take-out or dining out, signing up for media entertainment subscriptions, etc. Following this will enable you to keep a strict tab on your inflows and outflows on a weekly or a monthly basis, and avoid falling for the urge to spend more because of rising income, peer pressure, etc. Prioritizing expenses or creating budgets does not mean you have to live with restrictions. Instead, it implies being more mindful in the present to ensure a secure financial future.


    • Automate your savings: It is found that people often regret not having saved more for their retirement in their younger years. One way to overcome this is by automating your savings. You will not feel the temptation to spend money if you have already saved it through automated savings. One of the best ways to save automatically is to invest in employer-sponsored tax-advantaged retirement accounts, such as a 401(k) or a 403(b) account. Alternatively, you can also direct your money into an IRA (Individual Retirement Account), Roth IRA, SEP-IRA (if you are self-employed), or any other retirement savings plan. You could also automate your savings by setting up recurring deposits from your salary or checking account. Innovative apps and savings tools are also options that you can use to automatically save your money. For instance, round-up apps invest your spare change from everyday purchases. So, if you spent $4.25 for coffee, the app will automatically transfer 75 cents to the account of your choice. Adding these small changes to your spending habits will help you curb the strong influence of lifestyle inflation and help you save more prudently for your retirement.


    • Invest beyond retirement accounts: Lifestyle inflation can cause you to believe that your luxuries are now part of your needs. This tricks you into making lifestyle upgrades that you most likely do not need. While updating your lifestyle might seem tempting in the present, it can affect your future savings and lifestyle. This is especially applicable for high-earners. In this situation, it is important to remind yourself that even though you might have a higher income, your contribution limits for retirement accounts such as a 401(k) or an IRA are the same as an individual who earns significantly lower.


Maintaining an above-average lifestyle also requires a higher savings rate. Hence, even if you have maxed out your 401(k) or your IRA, avoid giving in to the lifestyle inflation. Instead, consider supplementing your retirement savings with a brokerage account. The money you invest in a brokerage account is readily available when you need it. Note that money invested in a brokerage account is not as easily accessible as a cash account. So, if you have $2,000 per month as extra income, you could save about $536,000 after 15 years, given a 15% tax rate and 6% return rate annually. Additionally, if you use the dollar-cost averaging method and direct your savings into your brokerage account monthly, you will be more financially secure under turbulent market situations.

    • Contribute to other tax-advantaged accounts: Apart from encashing your 401(k), IRA, and any other retirement account, you can also invest in other tax-advantaged accounts, such as a 529 college savings plan or a Health Savings Account (HSA). Parents can consider investing in a 529 college savings plan for their children. 529 plans are state-sponsored, tax-advantaged plans that help you to cover higher education costs. This plan invests your after-tax money into bonds and low-cost stocks. You can withdraw your money tax-free for eligible education expenses, such as tuition, room, boarding, and books. These plans offer tax deductions, tax-free money growth, and tax-free withdrawals. The triple tax advantage can help you fulfill your long-term goal of funding your child’s education expenses without hampering your retirement planning.


Furthermore, if you have spare money owing to a rise in income, you could invest in an HSA, which is a highly beneficial medical fund. HSA allows you to make tax-deductible contributions every year, subject to the upper limit specified by the Internal Revenue Services (IRS). For 2020, the upper limit for self-only HSA was $3,550 and for a family was $7,100. In the Revenue Procedure 2020-32, new limits were announced in 2021 according to which you can contribute up to $3,600 for self-coverage and $7,200 for a family. You can choose to invest in an HSA plan sponsored by the employer or have a different plan altogether. In the case of employer plans, some companies make a contributory share and subtract your contribution from the before-tax paychecks. Apart from the tax-free contributions, the interest on your HSA is also tax-exempt. So, irrespective of whether you own an individual HSA account or fund one for your family, you can maximize your annual contributions. This is important because you can enjoy tax benefits in the present and can also afford healthcare costs during your retirement. According to a Fidelity Retiree Health Care Cost Estimate, an average, healthy, 65-year-old couple will need $295,000 to cover healthcare costs in retirement apart from long-term care expenses. Hence, it is wiser to save more in your HSA instead of splurging on more superfluous needs.

    • Make gradual changes to your lifestyle: Lifestyle inflation, on the whole, may not be unavoidable. However, as a prudent retirement planner, you need to realize that every spending decision you make affects your future financial security. While there may be times when increasing your spending over time might make sense, conscious spending should ideally be the aim. For example, you might need to move into a new house because of the birth of a child. However, you can use this opportunity to choose a house that fits your budget but does not exceed it. Investing in a house beyond your financial capacity can result in debt, mounting interest, etc., all of which can hamper your retirement finances. A certain amount of lifestyle inflation is expected as your work and family obligations evolve. However, you can still work on combating drastic lifestyle inflation by making conscious, gradual, and modest changes.


To conclude

An income boost is an event to be celebrated. However, if you are not careful with your savings and investments and mindful of the difference between your needs and wants, you might end up falling prey to lifestyle inflation. Reversing your lifestyle habits may seem challenging at first, but the long-term results are worth it. It is recommended that you seek guidance from a professional financial advisor on how to best use an additional influx of money towards optimum retirement planning.