By Guy Baker
Inflation is one of the most powerful long-term forces affecting our clients’ ability to retire, as it reduces the value of each dollar saved over time. This is why the amount of money we tell clients they need to save for retirement continuously increases.
However, this becomes problematic when retired clients depend on fixed income to sustain their lifestyle. Advisors must ensure that clients using fixed-income products supplement their income with sources that can keep up with and overcome inflation.
Healthy levels of inflation are good for the economy and help American families build wealth over generations. Let’s say your grandparent invested one dollar in the S&P 500 in 1926. With the historical average inflation rate of three percent per year, and the growth rate of the S&P 500 over time, that dollar would be worth $10,900 today.
Without inflation, it would only be worth $750. So, while inflation raises prices, it also creates an immense amount of wealth for Americans over time.
The problem with fixed-income products, like pensions, is they – by definition – cannot take advantage of this wealth-building potential. Fixed income annuities and pensions, for example, provide guaranteed income with the goal of facilitating stable finances. But inflation erodes the purchasing power of that income. When I was a kid, a gallon of gasoline was 10 cents. Today, that same gallon will regularly cost over four dollars in much of the country.
The same idea applies to all other necessities: groceries, toiletries, utilities, housing and healthcare. It also applies to entertainment services, travel, dining out and athletics. If inflation ran at four percent for 20 years after a client retired, a dollar would only have 44 cents of purchasing power compared to when that client’s retirement began.
Even the cost-of-living adjustments to Social Security benefits often fail to keep up with inflation. This means that clients cannot depend on fixed-income products to sustain their retirement. The math does not work.
Combatting Inflation’s Influence
The historical average inflation rate is three percent per year. For advisors and clients, this means there must be honest discussions about risk, return and value. This is especially the case for middle-income clients: they can’t depend solely on fixed income and the meager returns of savings accounts, but they may not have the funds for a regular brokerage account.
Equity-indexed insurance products can help fill the gap, as long as policyowners can manage the investment risks. Whether in the form of universal life insurance or an annuity policy, equity-indexed insurance provides guaranteed rates of return linked to the returns of a market index, like the S&P 500, and protection against loss during bad market years. This means that these products offer better protection against inflation than their fixed-income or fixed death benefit counterparts.
Universal life insurance, as a form of permanent life insurance, offers another benefit. Policyowners can invest extra cash into the policy, which will also grow with the market. Given enough time and investment, this cash pool can be big enough to cover healthcare or long-term care costs, educational costs for children and more. Policyowners can take out loans against the cash value that never have to be paid back while they’re alive, providing a tax-free form of income for later in life.
Not planning for inflation can be a financial sucker punch in the years when financial breathing room is needed most. By helping their clients build income streams that account for inflation, advisors will help them keep pace with the economic inevitable.
About the Author
Guy Baker has over 50 years of experience in the financial services industry and has qualified for MDRT 51 times; he is one of only 20 to qualify more than 44 times for the Top of the Table. In 2010, Guy served as the organization’s 84th President. In Guy’s recent book, “Why People Buy,” he details the seven-step seller’s process, the four-step buyer’s process and how to integrate them.