Thursday, February 21, 2013

Planning your retirement? Inflation can mess things up

"Inflation is taxation without legislation." - Milton Friedman, economist.

"Bankers know that history is inflationary and that money is the last thing
 a wise man will hoard."   -William Durant, industrialist.

Where I live, the Consumer Price Index had climbed to 230.81 by the end of 2012. That means a "market basket full" of consumer goods and services that cost $100 in 1982-84,  now costs $230.81. Ouch!
Certain items on that CPI list are increasing in cost at a much faster rate than the over all average.
For instance, according to the U.S. Bureau of Labor Statistics, medical care items --- everything from doctor and dentist visits to drug costs, nursing home fees and hospital charges --- jumped 5.1 percent in total cost in my area just last year. Rental housing costs were up 3. 1 percent, food purchased away from home (restaurants) rose 2.7 percent.
My region's over-all 2.1-percent annual inflation rate in 2012 (1.7 percent, U.S.) was pretty much in line with the annual average increase in the U.S. cost of living for the past 50 years, which have run at 2 to 3 percent a year.
Planning long term
Right now, inflation is relatively tame, thanks to our continuing weak economy. There's no sticker shock from month to month over the cost of living...yes, gasoline prices are up but grocery store prices have remained in check. And some energy costs, such as natural gas, have dropped.
But when planning for your retirement on a fixed income, the rising cost of living can be a huge negative. Ronald Reagan called inflation as "deadly as a hit man."
What is inflation?  It is a "rise in the general level of prices of goods and services in an economy over a period of time," says the online encyclopedia  Wikipedia.com. "When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money -- a loss of real value in the internal medium of exchange and unit of account within the economy."
When planning for retirement, just keep in mind that you will need to augment your income by at least 2 percent a year to stay even with a rising cost of living. Over 10 years (over 30 years), inflation can seriously eat into your buying power. Look at it this way:
---If you have a $60,000 a year lifestyle, a 3 percent inflation rate will require $80,635 of income a year in 10 years and $120,000 a year in 20 years. Shocking, huh.
Here's the real bad news. During some periods of the past 50 years, annual inflation has skyrocketed up as much as 10 percent in one year. As we come out of our current recessionary period, economists are warning us that inflation is going to be a real challenge and could eat into a lot of retirement nest eggs. Plan for it.
How to deal with inflation
So what to do? Here is what some experts say:
1. Consider investing in TIPS (Treasury Inflation Protected Securities). The principal investment in a TIPS bond increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS bond matures, you are paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate.
To learn more, visit www.TreasuryDirect.gov.
2. Invest in an immediate income annuity with an inflation rider. Income annuities are insurance contracts purchased with a single lump sum of cash that offer immediate income payments (usually monthly) for a specified period or for the annuitant’s lifetime. Price out annuities at www.fidelity.com or www.vanguard.com. Do your homework on annuities.
Financial advisers usually receive a big upfront commission on the sale contract. Get outside advice on what you're buying. For help, visit the Federal Deposit Insurance Corp. Web site, click here.
3. Consider a variable annuity with a guaranteed accumulation rider. This type of rider guarantees that the minimum amount received by the annuitant after the accumulation period, or a set period of time, is either the amount invested or is locked-in gain. This rider, in essence, protects you from market fluctuations. Find out more at www.sec.gov.
Consumer warning from the FDIC: It's important to remember that some annuities may lose value. These products are not insured by the FDIC or the FDIC-insured bank or savings institution that may offer them. On the plus side, guaranteed annuity payments can provide income. But, as with any investment, be aware of the potential pitfalls and make an informed decision. Know the key features and costs of the product and make sure they fit your needs. Read the literature to understand the most important facts and risks, including the potential for loss, if any.
4. One of the best ways to address the risk of inflation is to delay your Social Security, if possible, until age 70. Doing so, means you get the highest possible, inflation-adjusted, guaranteed stream of income from Social Security. Depending on your age, you could increase your annual benefit up to 8 percent percent per year.
And meanwhile, that $50,000 in cash savings you have stashed at the bank is actually losing value to the tune of $1,000 a year because it will take that much more money next year to buy the same stuff.
Keeping cash around even in these troubling economic times is actually costing you money.

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