Inflation is so low that we have nothing to worry about, right? Wrong.
As long as we have inflation a dollar will keep losing purchasing power; just at a somewhat slower rate. A 3% rate of inflation will result in a dollar losing half its value in 24 years. If inflation is 2% it will take 36 years for the value of a dollar to be cut in half; but it still will be cut in half.
The fact that inflation has been low for the last decade or so, says nothing about what it will do in the future. Recent government monetary policy has kept inflation below its long-term average of 3%, but there’s no guarantee that the makers of monetary policy will continue to keep inflation in check.
I got to thinking about inflation recently when I was going through “stuff” in the house to prepare it for sale. I came across a brochure on the Tax Reform Act of 1986. It was that legislation that placed a limit on a taxpayer’s ability to deduct contributions to a traditional IRA if they participate in a retirement plan through their work. Beginning on January 1, 1987, taxpayers with income above a certain amount were not allowed to deduct traditional IRA contributions, and the amount was indexed for inflation. When the limits were introduced single filers with income below $25,000 were allowed to deduct their contributions and joint filers with income below $40,000 were allowed to do the same. Over 33 years (using 2020 numbers), the amount has grown 2 ½ times, to $65,000 (single) and $104,000 (joint). The inflation adjustments kept the percentage of those who can deduct their contributions about the same as it was back in 1986.
In 1987 the elective deferral limit (i.e., what you can contribute to the TSP and other employer sponsored direct contribution plans) was $7,000 and in 2020 it is $19,500.
Something else happened in the 1986; Social Security payments were made taxable (partially) for the first time. This affected those with an income above a certain level – but the income levels were not indexed for inflation. For those who file singly if their income is below $25,000, there is no tax on SS benefits. For those filing jointly, if their income is below $32,000, there is no tax on SS benefits. Over 33 years the amount has remained the same, resulting in many more Social Security recipients having to pay tax on their benefits.
Look at the difference in the dollar amounts and imagine how this affected taxpayers, especially those who pay taxes on their Social Security. Yes, 33 years is a long time, but it’s not at all out of the realm of possibility that an individual’s retirement will last that long. We need to remain aware of the adverse effect of inflation on our retirement income, especially on the sources of income that are not automatically adjusted for inflation (e.g., TSP, IRAs, etc.).