The cruelest tax of all

By Mike McGlothlin

“Fundamentals eliminate ways to fail, ways to lose. The greatest fundamentalists — in coaching, warfare, in theology, in business — were and always have been more concerned about losing than winning.
— Bob Knight “The Power of Negative Thinking”

When you talk to some of the most successful coaches in any sport, they focus on eliminating mistakes. At Indiana University, we felt that if we eliminated mistakes (turnovers, giving up offensive rebounds to the other team, giving up easy baskets, or committing too many personal fouls), we gave ourselves a better chance to win any game.

In retirement planning, we tend to focus on rates of return and how to maximize the return. In reality, the successful retirement plan eliminates the potential risks. I rarely hear advisors talking to clients about the impact of inflation, for example. Inflation may be the cruelest tax of them all. It is hidden and largely undisclosed until after the fact, and grows exponentially. When clients are concerned about living a long time, inflation is a risk that gets larger every year, and it must be addressed.

Our typical solution is to earn a higher return. In order to do that, you must take greater risks. Unfortunately, you cannot afford to take greater risks with your nest egg as you get closer to distribution or during distribution.The inflation risk on your income can be transferred to an insurance carrier. Annuity distributions can be tied to a number of consumer indices or set to grow at 3 percent to 5 percent annually. While you may start at a lower payment initially, it is easier to gain more return early in your retirement years when your life expectancy is longer and your time horizon is longer. Over time, these inflation-adjusted income checks increase to well beyond the initial payout structure. Health care costs, food, gas and consumer goods will continue to cost more.

Your retirement income needs to produce more in later years. Look at annuities to shift the risk of longevity and inflation away from your clients' portfolios.