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Income

Income variables: Deposit indexation and annuity valorisation

When creating financial reserves for retirement, it is useful to know two concepts. Knowing them can save you a lot of bitter disappointment.

It is necessary to have sufficient discipline to put money into retirement. Regularity and longevity are key conditions for maintaining a similar standard of living to your old age. Of course, provided you have a precisely created financial plan.

Basic definition

We will show the whole process, from the very definition of the thought to the determination of the pension plan. Suppose 40-year-old Zuzana wants to responsibly prepare for old age. Each month, it is able to defer a predetermined amount, which according to simulations should be enough to draw a life annuity when reaching retirement age.

Saving and investment indexing

If you are interested in responsible savings or investing in old age, you should regularly index your monthly deposit. Indexing means increasing the amount of a deposit over time. Inflation is most often used, by which everything increases. If Zuzana’s regular monthly deposit this year is set at five thousand dollars and inflation reaches two percent this year, the monthly deposit will rise by one hundred dollars to $ 5,100 next year.

Increasing the amount is obvious. It is about maintaining the preservation of the value of funds across the entire investment horizon. Failure to follow the indexation will negatively affect the resulting amount, which may be lower. This is especially true for savings, where interest rate yields may not cover inflation plus the declining value of the deposit. Conversely, when investing, indexation will have a slightly lower effect.

Valorisation of annuities paid

The second concept is the increase in paid annuities. The increase is basically maintaining the value against the effects of inflation. The mechanism is the same as in the case of state-paid and valorised old-age pensions. The valorisation of pensions is increasing by both inflation and wage growth. In our case, we will valorise rents only by inflation.

To regularly valorize annuities, you need to do two things. Either save more or leave part of the funds in old age in more profitable and thus riskier products.

For example, if you leave money on term deposits, you will most likely retain its value, but you will not create a sufficient cushion for possible future valorisation.