Don’t forget about the impact that inflation can have on your retirement planning strategy.
Inflation can be a quiet threat to those invested in annuities for retirement—particularly when purchasing them in low interest rate environments. Not only could you lock yourself into lower rates of return, since these rates are often tied to current interest rates, but your income payments may cover less of your living expenses as you age.
We’re not the only ones saying it. In fact, many investors are realizing that their structured annuity payments can’t buy what they used to buy. Many investors need purchasing power to sustain retirement, and an annuity could be a hurdle rather than a help in achieving and maintaining those financial needs.
Retirement Planning and Purchasing Power
Inflation over the last 20 years has averaged 2.3% annually*. As a percentage it may not seem like much, but that is exactly why it’s a silent threat. For example, consider a yearly $50,000 annuity income payment. If the prior 20 years was any indication of long term future rates, investor purchasing power could be cut by 36% in 20 years (Exhibit 1).
Exhibit 1: Inflation’s Impact on Purchasing Power
*Estimated purchasing power was calculated using average annual inflation based on the Consumer Price Index (CPI)—adjusted from 2000 dollar prices.
Sources: Factset as of 6/22/2015. Information as of 12/31/2014.
That’s only part of the story. Aging investors typically have increased health care expenses—5x more annually for a 65 year old ($7,702) than a 20 year old ($1,255) todayi, and the inflation rate of aggregate health care costs have increased by 4.3% over the same 20 year period** (Exhibit 2). When combined, we see just how much health care expenses can eat away at an annuity’s income payment over time.
Exhibit 2: Inflation’s Effects on Health Care Expenses
**Estimated inflation rate and expenses for Health Care were adjusted for inflation using the weighted average change of the following Consumer Price Index sectors: Hospital Services (45.1%), Doctor Services (26.6%), Drugs (16.3%), and Medical Care (12%)—adjusted from 2000 dollar prices. Starting estimated expense for Health Care and weighting of the sectors were providing in a study by the Health Research & Educational Trust.
Sources: Factset as of 6/22/2015. Information as of 12/31/2014. “The Lifetime Distribution of Health Care Costs,”Berhanu Alemayehu and Kenneth E Warner, Health Services Research, Section: Results, Paragraph 1.
Another element to factor into the inflation equation is an investors’ life expectancy and years spent in retirement. The life expectancy for someone born in 2010 has increased by more than 10 years relative to one born in 1950, and by 19 years for one born in 1930 (Exhibit 3). Furthermore, the life expectancy for those retiring today at 65 is almost 83 for males and 85 for females, with an average retirement age being 62 years old according to the most recent Gallup survey—making a +20 year retirement a very-likely reality for most. That leaves a lot of time for inflation to grind down an income payment’s purchasing power.
Exhibit 3: Life Expectancy at Birth
Source: “National Vital Statistics Reports”, Vol. 63, No. 7, November 6, 2014, Table 19. Estimated life expectancy at birth in years, by race, Hispanic origin and sex: Death-registration States, 1900-29, and United States, 1929-2010, page 45-46.http://www.cdc.gov/nchs/data/nvsr/nvsr63/nvsr63_07.pdf
Today, many annuity contracts don’t factor inflation into payments or terms, and unfortunately it may not even be brought up in the sales process. As a result, you could be left with a long-term income payment that doesn’t meet your income needs.
But, there is another option…
Retirement Planning and Inflation Protection
The annuity industry has created inflation protected contracts in more recent years. However, taking advantage of an inflation protected annuity contract could reduce your initial annuity payments by 25-30% relative to an otherwise comparable unprotected annuityii. And it could take years before an inflation protected security’s income payments break even with its unprotected counterpart.
In our view, both products have been created by a team of actuaries—paid to pinch pennies, and minimize risks for the insurance carrier—leaving little chance that one contract is marginally better than the other over your life expectancy. And in our view, investors looking to maintain purchasing power throughout their retirement have better options.
For more information on how to build a safe retirement planning strategy, contact Fisher Investments today.
i“ National Vital Statistics Reports”, Vol. 63, No. 7, November 6, 2014, Table 3. Life table for females: United States, 2010—Con., page 14.
ii Source: Schirripa, Felix, Immediate Annuity Fixed vs. Inflation-Protected: A Cost Comparison, Elm Income Group, (April 2009), 4.