A PIECE OF THE CPI-E
With 71 million
baby boomers now filtering into retirement, the Social Security system
will begin to feel the weight of increased retiree payouts. Adjusted
once a year to account for inflation, the Social Security system is
designed to preserve the purchasing power of retiree benefits. Those
annual adjustments are currently tied to the Consumer Price Index for
wage earners (CPI-W), a measure released by the Bureau of Labor
Statistics that tracks “changes in the prices paid by urban consumers
for a representative basket of goods and services.”
Research now
confirms what retirees already know: that they spend their money
differently than the rest of the population. Because of that, many argue
that Social Security benefits should be adjusted based on another price
index, the Consumer Price Index for the elderly (CPI-E). The CPI-E has
been tracked since the early 1980s but, despite several congressional
measures, has never been adopted as the official gauge for adjusting
Social Security.
Let’s look at some
key differences between the CPI-W and the CPI-E. The first difference is
the rate of inflation. While the CPI-W is figured at 3% annual inflation
(the increase for 2007 will be 3.3%), the CPI-E is slightly elevated at
3.38%. Specific expense categories such as food, apparel,
transportation, recreation and education, all drop when moving between
the CPI-W and the CPI-E. There is an average 24% decrease in the amount
of money spent in those categories after retirement. In the categories
of housing and medical care, however, the CPI-E shows increases of 22%
and 102%, respectively.
So how does this
affect the individual? Let’s consider a retiree with $1 million, living
on $62,000/year (adjusted for inflation). Using the CPI-W, the money,
earning an 8% return, would last from age 65 to age 94.* If you switch
over to the CPI-E, however, the same scenario would have you running out
of money at age 90.5. There’s a 3.5-year difference when the increased
expenditures for housing and medical costs are factored in.
Contributing
heavily to the housing and medical expenses in the CPI-E is long-term
care. However, that index doesn’t fully represent all of the
inflationary cost long-term care brings with it. Long-term care cost,
currently increasing by more than 5% per year, doesn’t gradually
increase for retirees, but rather tends to arise unexpectedly at some
point late in retirement. For that reason, we took it upon ourselves to
create a third index, the Consumer Price Index for long-term care to
model a more realistic scenario. This time, the $1 million retiree
experiences CPI-E expenses from age 65 to age 80 (rising annually at
3.38% from $62,000 to $98,000). Then at age 80 (about the average age
for retirees entering long-term care), expenses jump dramatically to pay
for long-term care (that’s been growing at 5%). The long-term care cost
of $60,000 at age 65 is now a whopping $128,000 per year. That’s a
$30,000 jump in expenses, which forces the retiree to run out of money
at age 87.5. The effect of long-term care results in 6.5 fewer years of
retirement money available.
So how should
retirees calculate their retirement living expenses? The answer is
carefully, especially when taking into consideration the likely changes
in spending habits that will occur as they age. While the adjustment to
the CPI-E and consideration of the effects of long-term care
expenditures can benefit individual retirees—as it more accurately
reflects their cost of living—there is little incentive for the CPI-E to
become the standard when adjusting Social Security, as the change would
empty those government coffers a full 5 years earlier than already
expected.
The answer, of
course, is to develop a comprehensive financial plan and adjust it
annually based on investment portfolio return, inflation, savings and
spending. No one wants to be surprised in retirement and a periodic
financial reassessment will help ensure you’re on track and able to plan
for events such as long-term health care.
*The illustration
in this article is a simplified model used to support the concept. It
does not consider taxes and is not to be used for planning purposes.
