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5 Common Factors Affecting Retirement Income

5 Common Factors Affecting Retirement Income

When it comes to planning for your retirement income, it’s easy to overlook some of the common factors that can affect how much you’ll have available to spend. If you don’t consider how your retirement income can be impacted by investment risk, inflation risk, catastrophic illness or long-term care, and taxes, you may not be able to enjoy the retirement you envision.

1. Investment Risk

Different types of investments carry with them different risks. Sound retirement income planning involves understanding these risks and how they can influence your available income in retirement. Investment or market risk is the risk that fluctuations in the securities market may result in the reduction and/or depletion of the value of your retirement savings. If you need to withdraw from your investments to supplement your retirement income, two important factors in determining how long your investments will last are the amount of the withdrawals you take and the growth and/or earnings your investments experience. You might base the anticipated rate of return of your investments on the presumption that market fluctuations will average out over time, and estimate how long your savings will last based on an anticipated, average rate of return.

Unfortunately, the market doesn’t always generate positive returns. Sometimes there are periods lasting for a few years or longer when the market provides negative returns. During these periods, constant withdrawals from your savings combined with prolonged negative market returns can result in the depletion of your savings far sooner than planned. Reinvestment risk is the risk that proceeds available for reinvestment must be reinvested at an interest rate that’s lower than the rate of the instrument that generated the proceeds. This could mean that you have to reinvest at a lower rate of return, or take on additional risk to achieve the same level of return.

This type of risk is often associated with fixed interest savings instruments such as bonds or bank certificates of deposit. When the instrument matures, comparable instruments may not be paying the same return or a better return as the matured investment. Interest rate risk occurs when interest rates rise and the prices of some existing investments drop. For example, during periods of rising interest rates, newer bond issues will likely yield higher coupon rates than older bonds issued during periods of lower interest rates, thus decreasing the market value of the older bonds. You also might see the market value of some stocks and mutual funds drop due to interest rate hikes because some investors will shift their money from these stocks and mutual funds to lower-risk fixed investments paying higher interest rates compared to prior years.

*All investments are subject to risk and loss of principal. When sold, investments may be worth more or less than their original cost. Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

2. Inflation Risk

Inflation is the risk that the purchasing power of a dollar will decline over time, due to the rising cost of goods and services. If inflation runs at its historical long term average of about 3%, the purchasing power of a given sum of money will be cut in half in 23 years. If it jumps to 4%, the purchasing power is cut in half in 18 years. A simple example illustrates the impact of inflation on retirement income. Assuming a consistent annual inflation rate of 3%, and excluding taxes and investment returns in general, if $50,000 satisfies your retirement income needs this year, you’ll need $51,500 of income next year to meet the same income needs. In 10 years, you’ll need about $67,195 to equal the purchasing power of $50,000 this year. Therefore, to outpace inflation, you should try to have some strategy in place that allows your income stream to grow throughout retirement. (The following hypothetical example is for illustrative purposes only and assumes a 3% annual rate of inflation without considering fees, expenses, and taxes. It does not reflect the performance of any particular investment.)

Inflation Bar Graph

3. Long-Term Care Expenses

Long-term care may be needed when physical or mental disabilities impair your capacity to perform everyday basic tasks. As life expectancies increase, so does the potential need for long-term care. Paying for long-term care can have a significant impact on retirement income and savings, especially for the healthy spouse. While not everyone needs long-term care during their lives, ignoring the possibility of such care and failing to plan for it can leave you or your spouse with little or no income or savings if such care is needed. Even if you decide to buy long-term care insurance, don’t forget to factor the premium cost into your retirement income needs. A complete statement of coverage, including exclusions, exceptions, and limitations, is found only in the long-term care policy. It should be noted that carriers have the discretion to raise their rates and remove their products from the marketplace.

4. The Costs of Catastrophic Care

As the number of employers providing retirement healthcare benefits dwindles and the cost of medical care continues to spiral upward, planning for catastrophic health-care costs in retirement is becoming more important. If you recently retired from a job that provided health insurance, you may not fully appreciate how much health care really costs. Despite the availability of Medicare coverage, you’ll likely have to pay for additional health-related expenses out-of-pocket. You may have to pay the rising premium costs of Medicare optional Part B coverage (which helps pay for outpatient services) and/or Part D prescription drug coverage. You may also want to buy supplemental Medigap insurance, which is used to pay Medicare deductibles and co-payments and to provide protection against catastrophic expenses that either exceed Medicare benefits or are not covered by Medicare at all. Otherwise, you may need to cover Medicare deductibles, co-payments, and other costs out-of-pocket.

5. Taxes

The effect of taxes on your retirement savings and income is an often overlooked but significant aspect of retirement income planning. Taxes can eat into your income, significantly reducing the amount you have available to spend in retirement. It’s important to understand how your investments are taxed. Some income, like interest, is taxed at ordinary income tax rates. Other income, like long-term capital gains and qualifying dividends, currently benefit from special–generally lower–maximum tax rates. Some specific investments, like certain municipal bonds,* generate income that is exempt from federal income tax altogether. You should understand how the income generated by your investments is taxed, so that you can factor the tax into your overall projection. Taxes can impact your available retirement income, especially if a significant portion of your savings and/or income comes from tax-qualified accounts such as pensions, 401(k)s, and traditional IRAs, since most, if not all, of the income from these accounts is subject to income taxes. Understanding the tax consequences of these investments is important when making retirement income projections.

*Interest earned on tax-free municipal bonds is generally exempt from state tax if the bond was issued in the state in which you reside, as well as from federal income tax (though earnings on certain private activity bonds may be subject to regular federal income tax or to the alternative minimum tax). But if purchased as part of a tax-exempt municipal money market or bond mutual fund, any capital gains earned by the fund are subject to tax, just as any capital gains from selling an individual bond are. Note also that tax-exempt interest is included in determining if a portion of any Social Security benefit you receive is taxable.

Have you planned for these factors?

When planning for your retirement, consider these common factors that can affect your income and savings. While many of these same issues can affect your income during your working years, you may not notice their influence because you’re not depending on your savings as a major source of income. However, investment risk, inflation, taxes, and health-related expenses can greatly affect your retirement income.

 

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This blog has been developed by an independent third party. Commonwealth Financial Network is not responsible for their content and does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Commonwealth does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.
Engage with the entire Blakely Financial team at WWW.BLAKELYFINANCIAL.COM to see what other financial tips we can provide towards your financial well-being.
Blakely Financial, Inc. is an independent financial planning and investment management firm that provides clarity, insight, and guidance to help our clients attain their financial goals.
Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.
Blakely Financial Inflation Update June 2022

High Inflation: How Long Will It Last?

In March 2022, the Consumer Price Index for All Urban Consumers (CPI-U), the most common measure of inflation, rose at an annual rate of 8.5%, the highest level since December 1981.1 It’s not surprising that a Gallup poll at the end of March found that one out of six Americans considers inflation to be the most important problem facing the United States.2

When inflation began rising in the spring of 2021, many economists, including policymakers at the Federal Reserve, believed the increase would be transitory and subside over a period of months. One year later, inflation has proven to be more stubborn than expected. It may be helpful to look at some of the forces behind rising prices, the Fed’s plan to combat them, and early signs that inflation may be easing.

 

Hot Economy Meets Russia and China

The fundamental cause of rising inflation continues to be the growing pains of a rapidly opening economy — a combination of pent-up consumer demand, supply-chain slowdowns, and not enough workers to fill open jobs. Loose Federal Reserve monetary policies and billions of dollars in government stimulus helped prevent a deeper recession but added fuel to the fire when the economy reopened.

More recently, the Russian invasion of Ukraine has placed upward pressure on already high global fuel and food prices.3 At the same time, a COVID resurgence in China led to strict lockdowns that have closed factories and tightened already struggling supply chains for Chinese goods. The volume of cargo handled by the port of Shanghai, the world’s busiest port, dropped by an estimated 40% in early April.4

 

Behind the Headlines

Although the 8.5% year-over-year “headline” inflation in March is a daunting number to consider, monthly numbers provide a clearer picture of the current trend. The month-over-month increase of 1.2% was extremely high, but more than half of it was due to gasoline prices, which rose 18.3% in March alone.5 Despite the Russia-Ukraine conflict and increased seasonal demand, U.S. gas prices dropped in April, but the trend was moving upward by the end of the month.6 The federal government’s decision to release one million barrels of oil per day from the Strategic Petroleum Reserve for the next six months and allow summer sales of higher-ethanol gasoline may help moderate prices.7

Core inflation, which strips out volatile food and energy prices, rose 6.5% year-over-year in March, the highest rate since 1982. However, the month-over-month increase from February to March was just 0.3%, the slowest pace in six months. Another positive sign was the price of used cars and trucks, which rose more than 35% over the last 12 months (a prime driver of general inflation) but dropped 3.8% in March.8

Slower at the Core Inflation Graphic

Wages and Consumer Demand

For the 12 months ended in March, average hourly earnings increased 5.6% — not enough to keep up with inflation but enough to blunt some of the effects. Lower-paid service workers received higher increases, with wages jumping by almost 15% for nonmanagement employees in the leisure and hospitality industry. Although inflation has cut deeply into wage gains over the last year, wages have increased at about the same rate as inflation over the two-year period of the pandemic.9

One of the big questions going forward is whether rising wages will enable consumers to continue to pay higher prices, which can lead to an inflationary spiral of ever-increasing wages and prices. Recent signals are mixed. The official measure of consumer spending increased 1.1% in March, but an early April poll found that two out of three Americans had cut back on spending due to inflation.10-11

 

Soft or Hard Landing?

The Federal Open Market Committee (FOMC) of the Federal Reserve has laid out a plan to fight inflation by raising interest rates and tightening the money supply. After dropping the benchmark federal funds rate to near zero in order to stimulate the economy at the onset of the pandemic, the FOMC raised the rate by 0.25% at its March 2022 meeting and projected the equivalent of six more quarter-percent increases by the end of the year and three or four more in 2024.12 This would bring the rate to around 2.75%, just above what the FOMC considers a “neutral rate” that will neither stimulate nor restrain the economy.13

These moves were projected to bring the Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) Price Index, down to 4.3% by the end of 2022, 2.7% by the end of 2023, and 2.3% by the end of 2024.14 PCE inflation — which was 6.6% in March — tends to run below CPI, so even if the Fed achieves these goals, CPI inflation will likely remain somewhat higher.15

Fed policymakers have signaled a willingness to be more aggressive, if necessary, and the FOMC raised the funds rate by 0.5% at its May meeting, as opposed to the more common 0.25% increase. This was the first half-percent increase since May 2000, and there may be more to come. The FOMC also began reducing the Fed’s bond holdings to tighten the money supply. New projections to be released in June will provide an updated picture of the Fed’s intentions for the federal funds rate.16

The question facing the FOMC is how fast it can raise interest rates and tighten the money supply while maintaining optimal employment and economic growth. The ideal is a “soft landing,” similar to what occurred in the 1990s, when inflation was tamed without damaging the economy. At the other extreme is the “hard landing” of the early 1980s, when the Fed raised the funds rate to almost 20% in order to control runaway double-digit inflation, throwing the economy into a recession.18

Fed Chair Jerome Powell acknowledges that a soft landing will be difficult to achieve, but he believes the strong job market may help the economy withstand aggressive monetary policies. Supply chains are expected to improve over time, and workers who have not yet returned to the labor force might fill open jobs without increasing wage and price pressures.19

The next few months will be a key period to reveal the future direction of inflation and monetary policy. The hope is that March represented the peak and inflation will begin to trend downward. But even if that proves to be true, it could be a painfully slow descent.

Projections are based on current conditions, are subject to change, and may not come to pass.

 

1, 5, 8-9) U.S. Bureau of Labor Statistics, 2022
2) Gallup, March 29, 2022
3, 7) The New York Times, April 12, 2022
4) CNBC, April 7, 2022
6) AAA, April 25 & 29, 2022
10, 15) U.S. Bureau of Economic Analysis, 2022
11) CBS News, April 11, 2022
12, 14, 16) Federal Reserve, 2022
13, 17) The Wall Street Journal, April 18, 2022
18) The New York Times, March 21, 2022

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This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to ensure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Engage with the entire Blakely Financial team at WWW.BLAKELYFINANCIAL.COM to see what other financial tips we can provide towards your financial well-being.

Blakely Financial, Inc. is an independent financial planning and investment management firm that provides clarity, insight, and guidance to help our clients attain their financial goals.

Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser

What’s Driving Gas Prices Higher?

What’s Driving Gas Prices Higher?

Whether you’ve seen the prices at the pump, clicked on the headlines, or overheard discussions in the grocery store, you know the rising cost of gas has everyone talking. At the start of the summer driving season, the average price of regular gasoline in the U.S. reached an all-time high, surpassing $4.50 per gallon. Inflationary pressures, including strong demand, supply chain disruptions, and low inventories, have caused price spikes for many consumer goods. As the cost of filling your tank rises, you’re likely wondering which markets factors caused the spike in gasoline prices.

Costs and Taxes

Crude oil is the most important input cost for gasoline. This commodity is primarily refined into gasoline and other transportation fuels, including diesel and jet fuel. Ethanol, a fuel made from corn, is blended with crude oil to represent 10 percent of gasoline volume on average, according to the Energy Information Administration (EIA). Operating costs associated with refineries, transportation (e.g., pipelines, tankers, trucking), and gas stations, as well as federal, state, and local government taxes, contribute to gasoline prices. Differences in operating costs and taxes explain the wide range of gasoline prices across states.

Higher Gasoline and Crude Oil Prices

Figure 1 illustrates the strong correlation between the prices for gasoline and crude oil, which is currently around $115 per barrel for West Texas Intermediate (WTI), the U.S. index. Prices for both commodities have just about doubled since early 2021. Covid-19 lockdowns in China and plans by several countries to release strategic oil reserves helped ease oil prices in recent months. The price of gasoline, however, has continued to increase.

 

Figure 1. U.S. Gasoline and WTI Crude Oil Prices, 2007–2022

U.S. Gasoline and WTI Crude Oil Prices, 2007–2022

Source: Bloomberg

 

Decreased Refinery Capacity

Demand for transportation fuels, such as gasoline, dropped sharply early in the pandemic when consumers stayed home, causing several refineries to close permanently. Global refinery capacity fell in 2021 for the first time in 30 years, according to the International Energy Agency (IEA). U.S. refinery capacity dropped to 2015 levels, as shown in Figure 2. Additionally, existing U.S. refineries have limited spare capacity with utilization rates above 93 percent, the highest since December 2019. Meanwhile, refiners are generating record profits from strong demand, capacity constraints, and a higher spread between prices for oil and refined products, such as gasoline.

 

Figure 2. U.S. Refinery Capacity, 2007–2022

Figure 2. U.S. Refinery Capacity, 2007–2022

Source: Bloomberg

 

Lower Inventory and Higher Demand

Both U.S. gasoline and oil inventories are at low seasonal levels compared to the five-year range, as shown in Figure 3, which highlights U.S. gasoline inventories. Gasoline and oil demand recovered faster than supply over the past two years while the economy bounces back from the pandemic. Refineries typically boost output before demand peaks during the summer; however, capacity constraints limit supply increases. Although the U.S. still imports oil because its refineries were initially designed to process heavy crude produced from other countries, such as Canada and Venezuela, higher U.S. exports have reduced inventories as Europe seeks to reduce its reliance on Russia for energy imports.

 

Figure 3. U.S. Gasoline Stocks, 2020–2022

U.S. Gasoline Stocks, 2020–2022

Decline in Oil Supply

Global oil producers quickly cut capital expenditures early in the pandemic to preserve cash for debt servicing and other operating expenses amid highly uncertain oil demand and plummeting prices that fell to around $20 per barrel. Figure 4 illustrates the decline in oil production from the OPEC and the U.S., the world’s two largest groups of producers. Supply from Russia, the world’s third largest oil producing country behind Saudi Arabia, also declined after its invasion of Ukraine.

 

Figure 4. OPEC and U.S. Oil Production, 2012–2022

Figure 4. OPEC and U.S. Oil Production, 2012–2022

Source: Bloomberg

 

Oil Production Constraints

Global oil production is slowly recovering as producers have been more cautiously investing in long-term projects, such as offshore drilling, due to a highly uncertain demand outlook for oil. Traditional automakers, for instance, are investing heavily in electric vehicles amid policy support and plans by several countries to phase out internal combustion engines (e.g., gasoline, diesel) in the coming decades.

Furthermore, shareholders have forced publicly traded oil and gas producers to focus on capital discipline, profitability, reducing debt, and investor returns through dividends and stock buybacks. Production growth was the prior objective from a capital allocation standpoint, but producers struggled to generate positive cash flow and earnings following the 2014–2016 crash in oil prices.

Several other market developments have contributed to a slow recovery in oil production:

  • S. oil producers focused on drilled but uncompleted wells (DUCs) to limit costs when oil demand began to recover after the pandemic. In other words, producers sacrificed future supply growth by completing existing wells at a faster rate than drilling new wells.
  • A large portion of U.S. oil supply is produced from shale regions, such as the Permian Basin. Compared to conventional wells, shale wells have high depletion rates that average around 70 percent by the end of the first year, according to asset manager, GMO. This requires continuous capital expenditures to maintain or increase production levels by drilling new wells.
  • Small private oil producers have been the main source of production growth in the U.S. as opposed to larger publicly traded producers given shareholder demands for capital discipline.
  • Inflationary pressures and shortages for labor and materials, such as steel, reduced the operating capacity for oil field service companies, which supply oil rigs and other equipment to producers.

 

U.S. Production Forecasts

The U.S. is the world’s top oil-producing country with supply averaging 11.9 million barrels per day over the past two months. Forecasts from the U.S. EIA imply moderately higher production of about 200,000 barrels per day for the remainder of 2022. Oil production growth is expected to accelerate in 2023 and reach an all-time high, averaging more than 12.8 million barrels per day.

A Look Ahead

For the immediate future (this summer), it looks like gas and oil prices will remain high due to global supply issues, low inventories, and increased travel. There is hope for an ease or decline of prices later in the year with the potential for more supply and lower demand. Please contact my office with any questions or requests for more information on current prices or future forecasts.

 

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This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to ensure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Engage with the entire Blakely Financial team at WWW.BLAKELYFINANCIAL.COM to see what other financial tips we can provide for your financial well-being.

 

Robert Blakely is located at 1022 Hutton Ln #109 High Point, NC 27262 and can be reached at 336-885-2530

Securities and Advisory Services offered through Commonwealth Financial Network®,

Member FINRA/SIPC, a Registered Investment Adviser. Fixed insurance products

and services are separate from and not offered through Commonwealth Financial Network®.

Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, at Commonwealth Financial Network®.

© 2022 Commonwealth Financial Network®