We all hate taxes – most of us feel the government spends our tax dollars foolishly.  But government has a secret weapon – a silent tax that eats away purchasing power.  The secret weapon is the cruelest tax of all because it mostly hurts people living on fixed income, like most retirees.

Hello, I’m Dr. Shelby Smith of The Retirement Pros. I want to tell you about this silent tax and how it might affect you.  Thanks for your time.  My sole objective is to help you plan for and enjoy a better retirement – so I want you to relax and open your mind to new ideas.  Let’s get started.

First of all, what is this silent, cruel tax?  You know it by another name – INFLATION.  Inflation is like gravity – constantly pulling down on the purchasing power of your money.  Not too noticeable in the short term, but the long-term effect is astounding.  Let’s see what has inflation to do with retirement.

How long do you expect retirement to be?  According to retirement researchers, most people under-estimate their life expectancy.  And, the greatest fear of most retirees is outliving their money.  If your greatest fear is outliving your retirement money, you’ll want to pay attention because I’m going to show you how to get over the fear and have peace of mind.

Let’s say you and your spouse are both 65.  Actuaries predict that one of you will still be alive at 91½ years of age.  By the way, actuarial science is very amazing – they can’t tell when you’ll die, but they can accurately forecast the number of deaths per year in a given age range.  Actuaries are scientists who manage the risks taken by insurance companies.

Back to our couple: we know that one of them has a 50% chance of being alive at age 91½ – that’s 26½ years after reaching age 65.  Guess who is most likely to be the longest living spouse?  Correct!  Ladies, you’re the stronger gender but that’s a mixed blessing!  You’ll probably be your husband’s caregiver, but he’s not likely to be around when you need help – unless you married a much younger man.  Ever been to an assisted living center or nursing home?  If so, you saw mostly ladies.  Gentlemen, since you love your wife, you’ll want to pay attention because she’s in more danger of outliving the money.

To be on the safe side, our 65 year old couple should plan for a retirement of at least 30 years.  Understand it could be longer – people over 100 are not that rare anymore. 

I want you to go back thirty years – that’ll be to 1980.  Can you recall what prices were?
To refresh your memory, here are the prices of some common items:

Average New Home: $68,714
Average new car: $7,210
Gallon of gas: $1.03
Tailored Silk Blouse: $15.99
½ Gallon of Milk: $0.85
Postage Stamp:  $0.15
1# of White Bread: $0.48
Average Movie Ticket: $2.69
1 Liter Bottle of Coke: $0.94
15oz Package of Oreo Cookies: $0.99
19oz Box of Corn Flakes: $0.99
Average doctor visit: $42
Emergency Room Visit: $103

How do today’s prices compare?  If things were cheap thirty years ago, do you suppose that today’s prices will look cheap thirty years from now? 

Due to recent higher medical costs, an aging population and changes brought about by health care reform, current health care costs are rising at about 12% annually.  Who spends proportionately more for medical care?  Correct…retirees. 

Here’s some scary facts: at 12% annual inflation, prices will double every six years.  If this continues, what cost $1000 in 2010 will be:
$2,000 in 2016
$4,000 in 2022
$8,000 in 2028
$16,000 in 2034 – a 16-fold increase in only 24 years and you’re still in retirement.  The inflation trend continues – eating up your money’s purchasing power.  

What is the probability of future inflation?  You know the answer, but let’s review anyway.  Right now our Federal Government is spending a lot more money than they’re getting in taxes – the difference adds to the Federal Debt and becomes the Federal Deficit.  The Federal Government has been printing money like crazy in recent years and it appears such will continue.  This means more money is chasing the same amount of things to buy which will push prices higher – much higher.  Over simplified, but nonetheless true.

To get inflation under control, the Federal Deficit must be controlled. How likely is this?  There are three ways to fix the Federal Deficit, they are:

1. Government can default or go bankrupt. This has happened to other countries and the results were ugly.  This is not probable in America – at least not near-term – so let’s cross off this solution.
2. Taxes could be substantially raised.  But, the entire House of Representatives and one-third of the U.S. Senate are re-elected every two years.  Voters will not tolerate substantially higher taxes unless the waste is eliminated.  In fiscal year 2010 federal spending exceeded taxes by $1.3 trillion – that’s with twelve zeros.  You don’t want to even think about how much interest the Government will pay on its debt if interest rates go back to normal or higher – and heaven help us if rates match those the late 70’s and early 80’s.  Higher taxes alone are not the solution because the amount needed is astronomical.
3. Government spending could be cut.  Does Congress have the intestinal fortitude?  Social Security, Medicare and Defense account for most of the spending.  Would you vote for someone who cut your Social Security or Medicare benefits?  Not likely. Can you imagine the unemployment and political fall-out that would come with closing military bases if defense spending were cut?  In the foreseeable future Congress will not cut spending – forget this solution.

My belief is that the Federal Deficit will continue to grow, and along with it inflation.  This is actually a solution to the Federal Deficit:  Inflation makes the Federal Debt relatively smaller because it takes less purchasing power to pay it off. If you loaned me a dollar for a year and money you got back would buy less than the dollar you loaned me last year, you’d have a bad deal.  The Debtor – Government – benefits in inflationary times and Creditors – holders of the Government debt – are hurt.  I believe that inflation is just over the horizon – and it will hurt retirees just like a big hike in taxes. 

One American turns age 65 every 7½ seconds and people are living longer.  This growth trend will continue for the next two decades and means that “all things retirement” will be in higher demand.  How can you protect yourself?

This growing number of retirees has captured the attention of the insurance industry.  Insurance companies manage risk that is too large for individuals. For example, you buy insurance on your home at a fraction of the cost of the home because the probability it will be destroyed is small.  Most people are willing to buy this insurance, because should your home be selected by the destruction lottery, the financial costs could be staggering.    Those whose homes are not destroyed subsidize those who homes are destroyed with the insurance company acting as a middle man that manages the risk for a profit.  The growing number of retirees fearful of living too long has captured the attention of insurance companies.  Living too long is called “longevity risk” and you can now purchase an insurance policy to cover this risk. 

Insurance companies first started offering “longevity risk” coverage a few years ago in the form of guaranteed lifetime income.  This coverage was very unique because it was not a “use it or lose it” insurance policy.  You transferred some or all of your retirement money to an insurance company who paid you an interest rate but at your option the account could be converted into a guaranteed lifetime income you could not outlive.  The coverage worked like traditional insurance: those who live too long are subsidized by those who die too soon.  These policies are called fixed annuities.  Note the word “fixed”. This means you are guaranteed a minimum rate of return regardless of what happens in the economy or markets, but you have the opportunity to earn a higher rate of interest.  If you let your money grow a few years before exercising the guaranteed lifetime income option, you do not pay income taxes on the earnings until you actually take the earnings out.  So in effect you have triple compounding: interest on your principal, interest on interest you earn and interest on the money you would have ordinarily paid in taxes.  You earning are taxed at the end of the line rather than along the way – and this could be double good if you expect to be in a lower tax bracket in retirement.  This longevity risk policy eliminates the greatest fear many retirees have:  outliving their money. 

Insurance companies are now adding inflation protection to their longevity risk policies:  guaranteeing you a lifetime income that is inflation-proof.  This means you can now put your money into a fixed annuity and get a guaranteed inflation-adjusted lifetime income you cannot outlive. This is just like your Social Security benefits – a lifetime income that is adjusted annually for inflation.

So how do you take advantage of these new developments?  You simply do the following – but I recommend you work with your financial advisor:

1. Decide how much money you’ll need in today’s dollars to live the retirement lifestyle you’ve planned.
2. Determine how much Social Security you will get, or are getting.
3. Add to SS the other money you’ll get in retirement after you adjust it for inflation.
4. Subtract from the income you’ll need your SS benefits and other money. The result is how much you’ll need to receive from your annuity.

Once you know how much you need from the annuity, you’ll need to decide the following:

1. When will you need to start the income from the annuity?  Now or later?
2. Do you want coverage for you and your spouse, or just you?
3. Do you have enough money to buy the guaranteed income you need?

The “enough money” part can only be determined if you do the homework.  If you have “too little” money this would be good to know because you can scale down your retirement plans now rather than be surprised later. If you have more than enough, you can buy a margin of safety or just leave that money invested where it is today.  But, you need to go through this process with your financial advisor – I think you’ll be surprised with how little money you’ll need to lock-up a guaranteed lifetime income that will give you peace of mind.

The end result, if you follow my advice, is that you and your spouse will have a guaranteed lifetime income from Social Security, or other pension plan, and your fixed annuity income that will be adjusted for future inflation. The inflation protection may not be perfect but it will beat having no protection. 

I strongly recommend that you work with a financial advisor – call the advisor that invited you to watch this video and get started.  Insurance is something we cannot live without, so please don’t close your mind to this innovative idea because it can only help you have a better retirement.  And the best part, it costs you nothing to find out more…so don’t procrastinate, call your financial advisor.

That’s it – now you know about the silent cruel tax called inflation – and what it can do to retirement.  Thanks for your time and have a wonderful day and an even better tomorrow.    

Shelby J. Smith, Ph.D.
The Retirement Pros  

Let’s consider a married couple, both aged 65. Actuaries say that at least one of them is likely to be alive at age 91.5. Since ladies are the stronger gender, they’re more likely to be the last survivor. This means that conservatively our hypothetical couple should plan retirement for at least 30 years. Think back to 30 years ago and compare the prices in that world to the present one. Inflation is especially hard on retirees living on fixed incomes. At an annual inflation of 8% [current inflation for medical care], what cost $1,000 today will cost $8,000 in 27 years – years before our couple’s retirement will end. What is the outlook for future inflation, in general, and for retirees specifically?

It is an economic fact that raising taxes in recessionary times will make matters worse; thus, the money presses are working overtime to end the current economic recession. The federal debt is exploding. A Social Security system that cannot continue on the same financial footings as in the past and Medicare programs whose costs are rapidly rising with an aging population, serve to widen the gap between federal spending and taxes collected. Complicating the tax-spending imbalance are the war on terrorism, crumbling infrastructure like highways, high unemployment and needy non-federal governments on the brink of bankruptcy. These all point toward the certainty of much higher general inflation for the future.

Retirees are the fastest growing segment of the population and this means even more inflationary pressure on “all things retirement”. The retirement safety net is Social Security and, thankfully, benefits rise with inflation. Granted there is some concern about its survival, but given the large voting bloc that would be alienated, stopping Social Security is not politically feasible. Yes, there may be more taxes on benefits and future retirees may be shortchanged, but today’s retirees are assured of continued benefits and inflation adjustments. Unfortunately, Social Security is not enough for the lifestyles of most retirees; thus, how can retirement purchasing power be protected against future inflation?

As life expectancy has risen and more than 75 million baby boomers have reached retirement age, the insurance industry, which manages risk of all kinds, has developed new products to protect purchasing power in retirement. Your purchasing power can be safeguarded by giving an insurance company a fixed amount of money today in exchange for the guarantee of a lifetime income that keeps pace with inflation. How much money is needed for your lifetime inflation-adjusted income depends on the age when you’ll start receiving it and the amount of income you choose. Smart retirees will determine the fixed purchasing power (inflation-adjusted income) needed in retirement for their planned lifestyle. Subtracting the amount of Social Security and other income you’ll have from this needed amount yields the guaranteed lifetime income required. It is now a matter of deciding at what age the income should start.

Those that die prematurely will subsidize those that live too long: the same concept as homeowners’ insurance where those whose homes do not burn help pay those whose homes do. Since the insurance company is managing the risk of uncertainty, you and your loved one get the security of a guaranteed inflation-adjusted lifetime income you cannot outlive. Eliminated are market risks, future inflation, changing future interest rates and all things uncertain. You can forget about the greatest fear of most retirees: outliving your money. How do you get started on this guaranteed lifetime income pathway? Talk to your financial advisor about your needs and how best to meet them: there are many options and great flexibility. Unless you investigate this solution, inflation will be a retirement concern.

Shelby J. Smith, Ph.D.
October 2010