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Investing timidly may shield you against risk… but not against inflation.
When is being risk-averse too risky for the sake of your retirement? After you conclude your career or sell your company, you have a right to be financially cautious. At the same time, you can risk being a little too cautious – some retirees invest so timidly that their portfolios barely yield any return.
For years, financial institutions pitched CDs, money market funds and interest checking accounts as risk-devoid places to put your dollars. That made sense before the Federal Reserve took interest rates down to historic lows. As the benchmark interest rate is now negligible, these conservative options offer you minimal potential to grow your money.
In 2014, annualized inflation has vacillated between 1.1% and 2.1%. Yields on typical 1-year CDs, money market funds and interest checking accounts haven’t even kept up with that.1,3,4
The rise of the all-items Consumer Price Index doesn’t tell the whole story of inflation. Food and electricity prices rose 3.1% during the 12 months ending in October, for example.2
With the federal funds rate still at 0%-0.25%, a “high-yielding” 6-month CD might return 0.75% for you, and the yield on a 1-year CD might barely be above 1%. Looking at Bankrate’s survey of CD rates for 2014, that’s exactly what we see. A good yield on a 5-year CD is less than 2.5% right now. (Some history worth noting: on average, those who put money in long-term CDs at the end of 2007, the start of the Great Recession, saw the income off those CDs dwindle by two-thirds by the end of 2011.)3,4
Retirees shouldn’t give up on growth investing. Many people in their fifties, sixties and seventies need to accumulate more wealth for retirement – even with their current or imminent need to withdraw their retirement savings. Because of that reality, many baby boomers and seniors can’t refrain from growth investing. They need their portfolios to yield at least 3% and preferably more. Otherwise, they risk losing purchasing power as consumer prices increase faster than their retirement incomes. Do you really want to live on yesterday’s money? Could you imagine trying to live today on the income you earned back in 2003 or 1998? You wouldn’t dare try, right? Well, this is essentially the dilemma that risk-averse retirees face.
They realize that their CDs and money market accounts are yielding almost nothing; they are withdrawing more than they are earning and their retirement fund is shrinking. So, they must live on less.
In recent U.S. history, inflation has averaged 1.7%-4%. What if that holds true for the next 20 years?5
For the sake of argument, let’s say that consumer prices rise 4% annually for the next 20 years. That doesn’t sound so bad – you can probably live with that. Or can you?
Given 4% inflation across 20 years, today’s dollar will be worth 44 cents in 2035. Today’s $1,000 king-sized bed will cost about $2,200 in 2035, and today’s $23,000 coupe will run more than $50,000.5
Beyond prices for durable goods, think of the cost of health care. Think of the income taxes you pay. When you add those factors into the mix, growth investing looks absolutely essential. There is certainly a role for fixed income investments in a diversified portfolio – you just don’t want to tilt your portfolio wholly away from risk. Accepting some risk may lead to greater reward. As many equities can potentially achieve greater returns than fixed income investments, they may prove less vulnerable to inflation. This is especially worth remembering given the history of the CPI.
From 1900-1970, inflation averaged about 2.5% in America. Starting in 1970, the annualized inflation rate started trending higher and by 1979 it was at 13.3%; the 1970s saw consumer prices rise 102.91%. While we have only seen about 2%-3% yearly inflation since 1990, U.S. consumer prices still rose more than 80% from 1990-2012. So a coat you could have bought for $100 in 1990 would have cost you more than $180 in 2012.5,6
All this should tell you one thing: you can’t hide in fixed income. Even mild inflation has a powerful cumulative effect, so you might as well invest to keep pace with it or outpace it.
1 – investing.com/economic-calendar/ [12/4/14]
2 – bls.gov/news.release/cpi.nr0.htm [11/20/14]
3 – bankrate.com/cd.aspx [12/4/14]
4 – newsday.com/lifestyle/retirement/alternatives-in-a-low-interest-world-1.3615707 [3/24/12]
5 – us.axa.com/retirement/inflation-and-long-term-investing.html [2/2014]
6 – inflationdata.com/Inflation/Inflation/DecadeInflation.asp [4/15/13]
A rundown of the big and little alterations coming this year.
2015 will bring COLAs, changes and something new. Each year, the retirement benefits landscape looks a little different, and this year is no exception. Here’s a look at what will change, what might develop, and even what won’t change for 2015.
The 401(k) contribution limit expands $500 to $18,000 this year. The catch-up contribution limit for plan participants 50 and older also rises by $500 to $6,000. If you are in the 25% tax bracket and put $18,000 in your 401(k) this year, you will save $4,500 in 2015 federal income taxes as a result. That tax savings comes with a regular 401(k), not the Roth version.1
IRA contribution limits will stay the same, but phase-out ranges are changing. The contribution limit for Roth and traditional IRAs will again be $5,500 in 2015, with an additional $1,000 catch-up contribution allowed for IRA owners 50 and older.2
Adjustments have been made to the phase-out ranges for the deduction of regular IRA contributions. If you own a traditional IRA and contribute to a retirement plan at work, you can claim a tax deduction for your traditional IRA contribution this year until your adjusted gross income is between $61,000-71,000 (single filers) and $98,000-118,000 (married filing jointly). Those ranges are respectively $1,000 and $2,000 higher than they were in 2014. If you own an IRA and don’t put money in an employer-sponsored retirement plan but your spouse does, you can claim a full tax deduction on traditional IRA contributions until your spouse’s AGI reaches the phase-out range of $183,000-193,000 in 2015.3
The phase-out ranges regarding eligibility for Roth IRA contributions have also moved a bit north. In 2015, the ranges start $2,000 higher at AGIs of $116,000-131,000 (single filers) and $183,000-193,000 (married filing jointly).3
Charitable IRA gifts may return (if not for 2015, then for 2014). On December 3, the House approved a 2014 tax extenders bill and sent it towards the Senate for a final vote. If it is made law – and Treasury Secretary Jack Lew says President Obama is “open” to approving such a short-term bill – it would reinstate 55 expiring tax credits retroactive to January 1, 2014.4,5
Among them, according to USA TODAY: the IRA charitable rollover, the provision that permitted many IRA owners age 70½ and older the chance to donate up to $100,000 from their IRAs to public charities while excluding the donated amount from their gross incomes. (The enhanced deduction for contribution of appreciated property for conservation purposes – attractive to more than a few retired farmers – would also be put back into place.)6 Social Security incomes will rise. A 1.7% COLA kicks in this year, and the maximum possible monthly benefit for those who claim Social Security at full retirement age increases $21 to $2,663. Social Security recipients younger than full retirement age at the end of 2015 will have $1 of benefits withheld for every $2 of income (AGI) they earn above $15,720. Recipients who reach full retirement age in 2015 will have $1 of benefits withheld for every $3 earned past $41,880. When you turn 66, Social Security doesn’t impose this withholding any longer.7
America’s retirement program will also start sending out paper statements again, but only to those who haven’t created online accounts to track their earnings history and expected benefit. They will be sent annually to Social Security recipients older than 60.7
Medicare premiums and deductibles are alternately rising and falling. The Part A hospital stay deductible grows $44 in 2015 to $1,260. The standard monthly Part B premium will still be $104.90 for 2015; the Part B deductible will still be at $147. As for Part D premiums, a joint study conducted by the Kaiser Family Foundation, Georgetown University and the University of Chicago sees them averaging $38.83 this year, about 4% higher. Part D deductibles will max out at $320 for 2015, though many Part D plans charge smaller deductibles or no deductibles.8
Many retirement savers could get a bit more help. Eligibility limits for the saver’s credit (the federal tax break created to help offset part of the first $2,000 of voluntary contributions to IRAs and workplace retirement plans) are going up. In 2015, workers can claim the credit if their AGI is below $30,500 (single filers), $45,750 (heads of household) or $61,000 (married filing jointly). The credit can be as big as $1,000 for singles and $2,000 for couples.1 We are also supposed to see the rollout of the myRA in January. This is a new retirement savings vehicle, basically a federally-backed Roth IRA whose value is guaranteed to increase over time (albeit not dramatically). Individuals with incomes under $129,000 and couples with combined incomes of less than $191,000 are eligible for myRAs; when the myRA turns 30 or when its balance reaches $15,000, the balance converts to a private-sector Roth IRA. (Account holders can opt for that conversion prior to those conditions.) Annual myRA contribution limits are the same as for regular and Roth IRAs.8,9
1 – money.usnews.com/money/retirement/articles/2014/12/01/how-to-max-out-your-retirement-accounts-in-2015 [12/1/14]
2 – irs.gov/Retirement-Plans/COLA-Increases-for-Dollar-Limitations-on-Benefits-and-Contributions [10/23/14]
3 – Irs.gov/uac/Newsroom/IRS-Announces-2015-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$18,000-to-their-401%28k%29-plans-in-2015 [10/23/14]
4 – reviewjournal.com/news/nevada/us-house-votes-extend-50-tax-breaks-another-year [12/4/14]
5- marketwatch.com/story/lew-says-white-house-would-strike-short-term-deal-on-taxes-2014-12-02 [12/2/14]
6- usatoday.com/story/news/politics/2014/12/02/tax-extenders-congress/19798289/ [12/2/14]
7 – money.usnews.com/money/blogs/planning-to-retire/2014/10/22/5-social-security-changes-coming-in-2015 [10/22/14]
8 – money.usnews.com/money/retirement/articles/2014/11/24/how-retirement-benefits-will-change-in-2015 [11/24/14]
9 – myra.treasury.gov/about/ [11/24/14]