By Mark Miller
Tribune Media Services
Higher prices at the gas pump and the grocery store have provided a reminder of an economic threat that hasn’t been front and center for most of us for quite a while: inflation.
But seniors haven’t forgotten about inflation. Many are living on fixed incomes and haven’t been able to earn much of anything on their savings in the current near-zero interest rate environment. What’s more, seniors are affected disproportionately by health care inflation, which continues to rise more quickly than other prices.
Over the long haul, inflation is a potential threat to retirement security, since a well-constructed plan looks out over a 25- to 30-year horizon. Yet inflation protection isn’t baked into nearly enough retirement plans, according to a new survey by the Society of Actuaries.
The study found that 72 percent of pre-retirees – and 55 percent of retirees – have a strategy to protect themselves against inflation in retirement. But the percentages probably are too optimistic, according to Steve Vernon, a prominent retirement educator and co-author of the report. “That’s higher than my experience talking with people at the seminars I teach. I think, there’s a say/do gap there, where people say they’re planning for inflation, but they’re not.”
“Other studies show that only half of pre-retirees have even calculated the amount of money they’ll need for retirement,” he adds. “So if that’s true, there’s no way 72 percent have thought about inflation.”
Indeed, the new 2011 Retirement Confidence Survey from the Employee Benefit Research Institute shows that just 42 percent even have tried to calculate how much they’ll need to live comfortably in retirement.
Inflation poses several retirement challenges. Healthcare costs are rising about four times faster than overall inflation; meanwhile, sources of guaranteed income are faltering. Social Security is replacing a smaller percentage of income due to the increasing full retirement age implemented in 1983, rising Medicare Part B premium deductions and more Social Security income subject to income tax. The near-disappearance of traditional defined benefit (DB) pensions in the private sector also hurts retiree purchasing power.
Here are three ways to add inflation protection to your retirement plan:
1. Maximize your Social Security income. Social Security provides important inflation protection. It’s one of the few retirement benefits around with a built-in cost-of-living adjustment (COLA), which is made using a formula set by federal law. Working at least until your Normal Retirement Age (currently 66) boosts your odds of receiving higher lifetime payments, and you’ll receive all the COLA adjustments from the intervening years.
The current yardstick used to measure consumer prices – the CPI-W – didn’t yield a COLA in 2009 or 2010 due to low inflation. However, the Congressional Budget Office (CBO) forecasts that a 1.1 percent COLA will be made in 2012, a 1.2 percent raise in 2013 and average increases of 2.1 percent from 2014 through 2021.
That’s the good news. Here’s the bad: AARP estimates that rising Medicare premiums-which are deducted from Social Security-will eat up most of those increases.
And deficit reform proposals call for changing Social Security’s cost-of-living adjustment (COLA) formula by adopting a new “chained CPI” that takes into account “substitution purchases” consumers make to avoid high prices. If adopted, the “chained” CPI is expected to rise 0.3 percent less annually than the CPI-W.
2. Factor inflation into your savings plan. Model your retirement portfolio to allow for an annual withdrawal rate of four percent, plus an additional bump for inflation starting in year two of retirement. Adjust that plan only if necessary to preserve assets in the event of a severe bear market. And consider adding Treasury Inflation-Protected Securities and higher-yielding bonds to the portfolio.
3. Buy inflation protection. An income annuity can protect against inflation if you purchase one with a cost-of-living feature that provides automatic increases in payments indexed to inflation.
Likewise, long-term care insurance should be purchased with a feature that adjusts daily benefit payments annually to protect against escalating nursing care costs.
An annual five percent compound growth option is typical, and can boost the benefit value of a long-term care policy significantly over time. The American Association for Long-Term Care Insurance calculates that a policy bought in 1995 by a 55-year-old couple with a $150 daily benefit amount and a five percent compound growth option would grow to a $508 daily benefit by 2020, when they’re both 80 years old.
Mark Miller is the author of “The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and LIving” (John Wiley & Sons/Bloomberg Press, June 2010). He publishes RetirementRevised.com, featured recently in Money Magazine as one of the best retirement planning sites on the web. Contact him with questions and comments at mark@retirementrevised.com
May 8, 2011 – May 21, 2011 Edition
