Inflation may be low, but it’s higher for retirees. And even with inflation at its current level of just under 1% year over year, per the March 2016 report from the Bureau of Labor Statistics, it remains a threat to a secure retirement.
The biggest reason is that older Americans experience must devote a substantial amount of their budget to healthcare, the cost of which is rising much faster than inflation overall. Current figures from the Centers for Medicare and Medicaid Services show that healthcare spending per person for people ages 65 and older averaged $18,424 in 2010—three times that of a working age adult ($6,125) and five times that of a child ($3,628).
All told, healthcare expenditures increased 5.3% in 2014, according to CMS. While that’s greatly improved from the 1990’s, when double-digit increases were common, it’s still several times the current inflation rate.
The findings in LIMRA’s Secure Retirement Institute’s 2015 Retirement Income Reference Book show that retirees also spend relatively more than other groups on housing, the cost of which has also been increasing more than the general inflation rate—although less markedly.
The 2% threat
Even an inflation rate of 2% can significantly erode purchasing power over the course of a 20-year retirement. Using a fixed monthly income of $1,341 (the average monthly benefit paid by Social Security), and assuming that monthly expenses increase at a 2% annual rate from $1,341 to $1,993 at the end of the 20-year period, LIMRA calculated that this would lead to a shortfall of $73,376. When the calculation is run for 3% inflation, the shortfall jumps to more than $117,000.
Illustrations like this can help retirees and those approaching retirement age better understand the importance of retirement products that make adjustments for inflation. Social Security’s Cost-of-Living Adjustment (COLA) was designed to provide such an annual increase in benefits, but does not always do so.
The COLA is based on the Consumer Price Index, which measures the spending of all Americans. In the course of a year—even though the costs facing retirees may have risen—the overall CPI may still be flat and Social Security recipients will not receive a COLA. In the recent past, this was the case in 2010, 2011 and 2016.
By working with a financial adviser, retirees and those nearing retirement can better deal with the risk of inflation by developing a formal written plan that addresses those risks and helps them guard against even gradual increases in their cost of living.
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