First time poster with a question

bigpun87 · #1 (**permalink**) 01-27-2008, 09:03 PM

Hey guys, I'm new to finance and so far I'm enjoying the material. I have this question as part of a bunch of assigned problems and I'm wondering if I can get some help/feedback. Thanks.

Oh yes, we forgot to ask about inflation and what it will do to our pension. We are going to buy a monthly annuity with our million dollars, but that will only happen when we retire in 25 years. Could you give us a simple example by working in annual amounts (Just multiply our monthly pension cheque by 12 to get the annual amount and that will be close enough for us, monthly pension cheque is $6054.24) that would help us understand how much that annuity would be in today’s dollars if there were 3% inflation per year between now and then?
Yikes, does this mean that we will be poor towards the end of our retirement? What will our situation be like after 20 years of retirement? We’ll be 85 years old then; I don’t even want to think about that. Maybe the kids will help. This is so upsetting.

Hermes · #2 (**permalink**) 01-28-2008, 05:55 AM

I think is is a bit dangerous to try to make such calcualtions because you have so many unknown variables. I would also suggest that you reconsider buying annuities and only rely on them. If you really like them you can make them part of your overall portfolio but to put all your money into one annuity is not really a smart financial move, in my opinion.

Should you put all you have in one monthly annuity your overall payment will be worth less over time not just because of inflation but because of dollar deterioration as well. Over the past years U.S. Dollar denominated assets have lost purchasing power at a fast pace and will continue to do so.

Maybe you want to rethink your strategy and look into other options as well and then decide again. It really depends on what you think will work for you. Whatever choice you make you need to be satisfied with it.

Mynion · #3 (**permalink**) 01-28-2008, 11:30 AM

Hermes, it sounds like when they say, "as part of a bunch of assigned problems" that this may be a case scenario for a class...

You can do all the calculations with a financial calculator like an HP 12C. You can also use an Excel spreadsheet to make all the calculations as well, assuming you understand the same variables used for the calculator.

For example, $72,000 per year 25 years from now would be worth $34,388 per year in today's dollars. After 20 retirement years that drops to $19,040 in today's dollars.

The biggest mistake with inflation is assuming a rate like 3%, because it is based on CPI. The problem is, everyone has their own personal inflation rate. If you buy a lot of technology, for example, your rate might be upwards of 5%. College is rising at a 6% clip. If your assumption in this area is wrong, you could severely cripple your retirement savings (or, at least, have a lot less money than you thought you would).

Once you retire, in the USA you typically have considerable healthcare costs throughout retirement. Most retirees here are experiencing 5 or 6% inflation rates when all retirement costs are considered (some even higher than that). So while that $35k annual payment might even be doable, the fact is that at 6% inflation that $19k is more like $11k. Try living on that! So much for being a millionaire...!

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