Dear John: Great article on the inflation rate and possible underestimation.
You left out, though, the most obvious reason for it: The Consumer Price Index is used to set the coupon for TIPS securities, and usually inflation impacts the coupon rates of other US Treasury securities.
I say usually because, obviously, the Federal Reserve has gotten around that with 0 percent overnight rates for over five years now.
And of course we just buy the extra half-billion of debt issued every year to keep auctions in order.
If bondholders were paid what used to be considered normal — say, a 3 percent overnight rate — the US government would have to cough up an extra $210 billion on Treasury bills alone, and another $100 billion to $200 billion on other debt as it resets.
That is good reason to underestimate the real inflation rate.
I always joke to people that I can’t seem to find many things that go up only 1 percent to 2 percent a year. Many, like health care or tolls or restaurant bills, seem to be more like a 10 percent increase a year. B.T. (CFA)
Dear B.T.: You make good points. And while I didn’t include this in the column you are referring to, I have in the past.
Washington has gotten the US into a very big jam. Interest rates will rise someday — because the economy is improving, I hope — and the US government will not be able to afford the extra borrowing costs. And that will cause the government to cut back, which will hurt the economy.
Someday we will enter a vicious cycle — unfortunately.
Dear John: In the March 30 Post, you talked about 20-somethings opening 401(k) plans for themselves. You said that there is really no good place to entrust your money these days. I have been saving for my retirement with a 401(k) for the past 40 years. Most recently my wife told me about a 7702 Private Insurance Plan. Can you explain its value, if any? J.V.
Dear J.V.: “Be very careful about using these products as alternatives to accepted retirement plans,” says Victoria L. Fillet of Value Architects Asset Management in Hoboken, NJ. “They may have very high fees, and the amount of additional contributions are limited by the Internal Revenue Service code.”
Fillet says the IRS code section for this tax break is IRC 7702. “One of its components refers to the tax-advantaged growth of the cash value inside of a life insurance policy. If properly structured, an individual has the opportunity to both grow their investment money and access their money without ever paying taxes on the gains,” she explains.
Whole, universal and variable life insurance contracts allot part of your premium to death benefits, and the rest is invested in the cash value of the policy.
The question a 22-year-old should ask is, Do I need life insurance?
Fillet says that depending on the type of policy, its cash value may be invested in a variety of stock and bond accounts. This is similar to what someone can invest in through a 401(k) account.
The problem is, there are the same risks. If stock prices decline, the value of this insurance product will also go down.
The benefit is that this 7702 money will be professionally managed — but, of course, for a fee.
Fillet says that, “in addition to the basic premium required by the contract, additional dollars may be deposited.” There are IRS limits to the amount that can be added (based on age and amount of insurance), because Congress is aware of the tax-advantaged nature of the product. But Fillet says these limits tend to be much greater than the base premium.
For example, the premium for $500,000 of variable life insurance on a 40-year-old male (healthy nonsmoker) is $5,000 a year. Without violating the tax code, that same individual could invest an additional $17,000 in the contract ($22,000 total) — all of which is attributed to the investment side of the contract.
And, of course, most companies match 401(k) investments. You won’t get that automatic gain in this insurance product.