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News of the Day ... In Perspective

07/12/2006

Retirement savings overestimated

In a Sunday, July 2, feature report in the Arizona Republic, the projected retirement nest eggs from 24 different savings scenarios were tabulated.

For example, the table showed that if a 25-year-old worker were to invest $250 per month for 40 years in a tax-deferred retirement account, he would have an account balance of $989,896 at the age of 65, based on the assumption of an 8% annual investment return.

However, as Craig Cantoni points out, the $989,896 is a nominal amount, not an inflation-adjusted amount (“real dollars” in financial parlance). Cantoni calculated a nominal amount of $810,541 (the discrepancy possibly resulting from use of a different financial model). But with 3.5% inflation, the account would have the purchasing power of $204,698 in today’s dollars.

If the worker invested in a non-tax-deferred account under the assumptions above, at a 15% tax rate he would have a nest egg of only $148,924 in real dollars at age 65. Even with a tax-deferred account, taxes would eventually have to be paid.

Failure to account for inflation, Cantoni writes, “is a far more serious oversight than misspelling someone’s name in an obituary or misquoting someone in a news story.” If someone were to rely on this table for retirement planning, he would probably fail to save nearly enough.

The special report did mention that Social Security has funding problems and that two fixes are possible: higher payroll taxes, or reduced benefits. It failed to mention the third, more likely fix, Cantoni observes: cranking up the printing presses.

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