Boost Your Savings for Low Inflation

The government has a good news/bad news announcement about Social Security, a reminder of the need to use sensible inflation projections in long-term savings and investment plans.

The good news is that the portion of income subject to Social Security tax will not rise in 2011. The tax, which costs 6.2% paid by the employee and 6.2% paid by the employer, will apply to the first $106,800 of income earned. In most years, this figure increases to reflect inflation.

Now for the bad news: Social Security checks will not increase either. Because inflation has been so low, the law prohibits a cost of living adjustment.

For many retirees, this will sting especially hard because there also was no COLA in 2010, for exactly the same reason, (although there was an outsized 5.8% benefit increase in 2009, due to a spike in energy prices, which quickly pulled back).

COLAs are figured by comparing the Consumer Price index for the third quarter of the year to its level in the third quarter of the last year in which there was a COLA increase. Although inflation has been running at about 1% for the past year, there was no COLA in 2009, so the comparison looks at the third quarter of 2008, and the index is essentially flat since then.

Unfortunately, many Social Security recipients face costs that rise faster than the overall inflation rate, due to health care costs and other expenses that hit older people harder. And older people who have much of their assets in safe bank savings and bonds are receiving rock-bottom yields.

Many older folks will simply have to tighten their belts. Younger people should build inflation expectations into their long-term plans. A key part of that strategy: don’t let your guard down just because inflation is low.

Over the long term, inflation averages around 3% a year, but it can fluctuate wildly. Though it is all but non-existent now, it hit double digits in the 1970s and early 1980s. It hit 4.7% after hurricane Katrina in 2006, and 5.6% during the oil spike in 2009. Periods of deflation, when prices fall across the board, are rare.

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