Recently, inflation hit its highest rate of growth since the early 80s. Since there are two things Americans worry most about when it comes to retirement–the effect of inflation and taxes–the natural question is:
What should I be doing to combat rising taxes and inflation?
First, understand what you’re up against. As a financial strategist and retirement planning specialist now for over 45 years, I’ve discovered there are three big dangers that cause most people to outlive the money they’ve set aside for retirement:
- Taxes – When you withdraw money from traditional tax-deferred accounts like IRAs and 401(k)s, you’ll pay taxes. This is why the danger of rising taxes can be a threat. Taxes can erode anywhere from 25% to 33% of what you withdraw out of your IRA or 401(k) the rest of your life.
- Inflation – Inflation is like a hidden tax. As a general rule, the cost of living doubles about every seven to 10 years, which means you’ll need significantly more money 10, 20, or 30 years from now to cover the same things you’re paying for today.
- Market Volatility – With money invested directly in the market with traditional accounts like IRAs and 401(k)s, your money is vulnerable to economic downturns. Think of the folks who were looking to retire in the late 2000s. When the economy turned upside-down in 2008, millions of Americans lost 40% of their IRAs and 401(k) account values.
THE EFFECT OF TAXES
At the time of this article, President Joe Biden is proposing significant tax increases. He’s doing that because he has a lot of initiatives that, frankly, a lot of presidents have had where they spend, spend, spend.
When the government provides all of these stimulus packages and infrastructure bills, they tend to spend double what they bring in in revenue. Under Joe Biden, however, if all of his tax proposals and his initiatives go through, he’s going to be spending three to four times what the IRS collects in revenue.
Let me put this in perspective. If you were making $100,000 a year and you kept spending $300,000 or $400,000 a year, how long could you do that before you’d have to file bankruptcy?
When the government spends far more than they bring in, they have two choices. They either have to print more money, which they’ve been doing (and which causes inflation), or they have to raise taxes. Right now, it’s looking like they’re doing both.
For example, President Biden is proposing to increase income taxes, especially for individuals making over $200,000 and couples making over $400,000. He wants to change the rules for 401(k)s, so middle-income and higher-income earners will indirectly have to pay higher taxes, because they won’t get near the tax deductions or benefits from contributing to a 401(k).
He also wants to raise the corporate tax rate from 21% up to 28%. People say, “Well, that’s only 7% more.” But it’s actually 33% more in dollars. If a corporation paid $210,000 on every million dollars of profit under 21%, now they have to pay $280,000–that’s $70,000 more–which is a 33% increase.
Now, sometimes we have politicians who don’t understand economics, and they don’t realize corporations can’t afford to do that without doing what? It often means they’ll need to lay off employees, which can cause unemployment. Or companies will have to raise the cost of their goods and services.
And when you have another initiative like raising minimum wages, that pay raise is often gobbled up at the gas pump or at the hamburger stand because of inflation. All of this affects people who are on fixed incomes like those in retirement.
We also might see the estate or inheritance tax go up from about 46% up to as high as 67%. (As they say, they like to tax people who are six feet under because they can’t complain about it!)
INFLATION & MARKET VOLATILITY TAKE A TOLL
Now let’s look at inflation. If you were paying attention to the economy in the spring of 2021, you would’ve probably tuned into CNBC, Barons, Fox Business, Bloomberg, Forbes, The New York Times and Market Watch. They were all in shock because inflation had jumped to 4.2%–when it had been around 3% for quite a while.
For those who may know, back during the Carter administration in the late 70s, America got to around 13% inflation, and the government could not afford to pay Social Security recipients 14% raises (according to the Consumer Price Index). So they decided to change the way they report inflation. Instead of comparing apples to apples every year, they began comparing apples to oranges, which means the government can choose to compare the price of a filet mignon steak last year to hamburger this year and get away with it.
So just keep in mind that when they say the Consumer Price Index went up 4.2%, it’s usually two to three times that. At the time of this article, gasoline has gone up 50% to 100% in many states.
So when inflation went to 5% and then 6% a couple of months later in 2021, the reports were saying the cost of living will double in 10 years. But by my estimation, it’s more like the cost of living will double in five years.
When we talk about inflation, I like to use the Rule of 72. If you don’t know what that is, if you take the number 72, and you take any interest rate you’re earning and you divide that interest rate into 72, it will tell you how many years it takes to double your money. (That’s on a one-time lump sum.)
So if you are earning 5%, you can use the Rule of 72 to estimate that you’ll double your money every 14.4 years. If you’re earning 8%, you divide eight into 72, and you know your money doubles every nine years; if you’re earning 9%, your money doubles every eight years.
What if you were to earn 7.2%? I like to use that rate as an average, because that’s the lowest rate of return I earned using my favorite financial vehicle, a properly structured, maximum-funded Indexed Universal Life policy (what I call The Laser Fund), during the worst decade since the Great Depression, 2000 to 2010. This was at a time when most Americans with money in the market were still down 38% at the end of those same 10 years. During that same devastating decade, my $1 million in a LASER Fund doubled to $2 million.
So let’s look at an example. Let’s say you start out with $125,000, and you don’t add any money to it. Let’s say you’re earning 7.2%, and your money doubles in 10 years to $250,000. In another 10 years, it doubles to $500,000, and in another 10 years it doubles to $1 million.
So now we’re in the 30th year, and you have a $1 million nest egg for retirement. You’re still earning 7.2% on that $1 million. You might be thinking you could pull out $72,000 a year without depleting your principal, right?
Well, not so if you have an IRA of 401(k), because you’ve got to pay tax. And if you’re like most Americans living in 41 out of the 50 states, you have state income tax on top of your federal taxes. So let’s say your average tax rate is about 33%. That would mean you’re paying $24,000 in taxes out of the $72,000 you withdraw from your IRA or 401(k). You’re only netting $48,000 to buy gas, groceries, prescriptions, golf green fees, and the like.
That’s about $4,000 a month. Sometimes people say, “Ugh, I thought I was going to get $6,000 a month. I’m only really netting $4,000. I guess we can tighten our belt.”
But that’s just taxes. What about inflation?
YOU’LL NEED MORE MONEY TO COVER THE SAME COSTS
If you have $1 million at 5% inflation, the cost of living will double every 14.4 years, so about every 15 years. (Again, using the Rule of 72 here, when you divide the rate of inflation, 5%, into 72, it tells you how fast the cost of living will double.)
That means that $4,000 a month in 15 years will only buy what $2,000 a month buys today. So you’ll have to have $8,000 a month to buy what $4,000 used to buy 15 years earlier.
The disturbing truth is, you’re going to need twice the income to get by in the future. This is why so many people deplete their nest egg before they die.
Now that’s at just a 5% rate of inflation. What happens when inflation is rampant like it is now, and it’s in the double digits? The cost of living would quadruple in 30 years. You would need $16,000 to buy the same gallons of gas and loaves of bread that $4,000 bought 30 years earlier.
This is what we call the tax and inflation power curve, and it causes many Americans to jump the retirement rails.
What can you do to protect yourself?
SAFEGUARD YOUR FUTURE
Use financial vehicles that can provide safety from market volatility so you don’t lose money when the market tanks. You also want those vehicles to provide predictable rates of return. And of course, you want vehicles that can provide tax-advantaged growth and tax-free income when you access your money during retirement.
That, my friends, is the description of a LASER Fund. I invite you to explore how it can help you combat rising taxes and inflation.
WANT TO LEARN MORE?
Watch the Video – Watch the related YouTube video to see me explain “What Should I Be Doing to Combat Rising Taxes and Inflation?” (and while you’re there, be sure to subscribe to my YouTube channel so you don’t miss a thing!).
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