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Missed Fortune – Retiring As a Millionaire May Not Be Enough

Posted on | March 11, 2012

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The Tax & Inflation Power Curve

The thought of retiring with a million dollar nest egg is enough to put a smile on almost anyone’s face.  But if you don’t understand how the tax and inflation power curve can affect your savings, you may be in for an unwelcome surprise.

The Congressional Budget Office (CBO) has stated that middle income Americans during the next 20 years will be paying an average of more than 50% of their income in taxes.  So, at 7.2% inflation, how much will a nest egg of $1 million earning 7.2% or $72,000 per year or $6,000 per month be worth in a 50% tax bracket?

  • a. $3,000 per month
  • b. $2,000 per month
  • c. $1,000 per month
  • d. $750 per month

Most people would be shocked to learn that the answer is “d.” How could a million dollar nest egg end up amount to such a low monthly retirement income? The tax and inflation power curve are the reason.  Here’s why:

According to the rule of 72, at a 7.2% inflation rate, the cost of living will double every 10 years.  Therefore, 20 years from now, a million dollar nest egg earning 7.2% or $6,000 per month will be only worth $1500 per month.  And that’s just the effect of inflation.

Add in the impact of a 50% tax bracket and of that $1500 per month, you’re only getting to keep half of it.  Suddenly that million-dollar nest egg isn’t quite sufficient.

If you haven’t planned for the effects of taxes and inflation, you could find yourself outliving your retirement money.

Growing Your Money vs. Playing the Market

If, during the last 60 years of U.S. stock market history, you would have eliminated all of the loss years and only captured 25% of the gain during the up years, you would have made more money than those investors who tried to time the stock market.

How is this possible?  In a word: indexing.

Indexing is a way of tying your returns to a particular market index such as the S&P 500 or Dow Jones whereby your money isn’t actually at risk in the market but benefits from any market growth.

To put it another way, during down years you don’t lose any money, but when the market rebounds and experiences growth, you immediately benefit from any upside potential.

Indexing protects your money during the down years and while it may not grow during those years, you won’t lose a dime.  During up years, your money grows up to a certain capped rate.  This way any gain you realize becomes newly protected principal as your money grows.

These examples illustrate the importance of not only understanding the effects of taxes and inflation on your retirement nest egg but also the importance of learning how to position your serious cash to protect it.

Instead of putting your money in tax-deferred vehicles and being exposed to the tax and inflation power curve, your money needs to accumulate, distribute and transfer tax-free.  Your return should be linked to those things that inflate during times of inflation to ensure that your money outpaces inflation.

And with indexing, your money safely grows during the up years without risking loss during down years in the market.

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*Life insurance policies are not investments and, accordingly, should not be purchased as an investment

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