Tracking Retirement Inflation:
Inside the Consumer Price Index
When it comes to figuring out how much living expenses might rise in retirement, or helping the next generation achieve their retirement savings goals, many investors turn to the U.S. Consumer Price Index (CPI). This measure of inflation has climbed an average of 3.18 percent a year over the 102 years that the government has been tracking this data.
But keeping up with inflation using the CPI can become a challenging target; and for many investors, this statistical measuring stick has fallen short over the past five years. Consumer prices rose just 0.50 percent for the 12 months ended November 2015 — as the U.S. Bureau of Labor Statistics (BLS) reported in December — partly because energy prices have fallen sharply. And for the five-year period ended this November, overall prices were up just an average of 1.9 percent a year.
Recent lower overall inflation doesn't mean that current and future retirees should reduce their expectations about inflation over the long term, even as it has become much more difficult to generate income without substantially increasing risk.
A closer look at the components of the CPI suggests why. Many categories of consumer expenditures have continued to rise well in excess of three percent a year. Inflation in areas such as housing, rent, water utility bills, health care, childcare, and "back-to-school" expenses such as textbooks, rose by much more in the 12 months ended in November.
In calculating the CPI, the government takes a one-size-fits-all approach that doesn't account for the differences in spending habits of different age groups, cultures, family size, or include changes in income and sales taxes. Food, for example, is 14 percent of the CPI pie, and includes weightings for every category (see Current Major Weightings of the U.S. Consumer Price Index, for category weightings).
For retirees and near-retirees, a very small overall inflation number might not reflect the personal inflation people see day-to-day, since many Americans spend a greater percentage of their budgets on certain services that are not reflected in CPI weightings. Health-care services, for example, are just 5.93 percent of the CPI, while studies show that even healthy retirees typically spend 10 percent or more of their budget on medical care (source: AARP).
Low overall inflation numbers in recent years have made financial planning that much tougher for those nearing and in retirement since the overall CPI number is used by the federal government to calculate Social Security benefit increases (or decreases), interest rates on inflation-adjusted bonds, wage increases by state and local government employers and, for some, defined benefit pensions.
To see overall inflation relative to your individual needs and spending patterns, and to look back at how much the things you actually buy have gone up, go to the BLS' CPI databases page. Go to the "Tables" icon in the All Urban Consumers Current Series and then scroll down to the third section that says "Relative Importance of Items in the Consumer Price Index." You can then select the TXT or PDF link to view the list of items.
On the BLS Web page, the index has weightings for 357 consumer goods and services that you can compare with your personal budget. For example, tobacco and alcohol represent 1.7 percentage points in the CPI index even though everyone does not smoke or drink. Conversely, if you have multiple pets, your personal spending in this category may be higher than the government's standard 0.40 percentage weighting in the CPI index for pet food and pet care inflation. Adjusting index percentages to match your lifestyle can help you track your personal inflation rate now or in the future, and may make you better aware of areas in your budget that might need adjustment now.
Current Major Weightings of the U.S. Consumer Price Index
| Shelter |
32.8% |
| Food |
14.1% |
| Energy |
8.3% |
| Education/Communications |
6.4% |
| Medical Care |
5.9% |
| Transportation |
5.7% |
| Recreation |
4% |
| Household furnishings |
3.3% |
| Apparel |
3.3% |
| Alcohol and Tobacco |
1.7% |
| Personal Care |
1.7% |
| Other Products and Services |
12.8% |
Ease the Pain of Health Care Costs in Retirement
Health care costs are likely to be significant for many retirees. The more you plan for them, the better. Below, ICMA-RC CERTIFIED FINANCIAL PLANNERSTM Steve Taylor and Mark Huston share their thoughts on how these costs can add up and what steps you can take to minimize their pain.
Q. Some think medical costs are not a major concern once they become eligible for Medicare. What are they missing?
A. (Huston) We hear a variety of misconceptions about what Medicare will cover. Retirees should know that Medicare out-of-pocket premiums and deductibles and copays can really add up; in particular, costs for Medicare Part B, which covers doctor visits and specialized care; and Medicare Part D, which covers prescription drugs. And Medicare generally does not cover medical services like vision, hearing, dental, podiatry, and long-term care.
Q. How does this translate into dollars?
A. (Huston) It's not an easy calculation because there can be a big difference between the average costs and actual higher costs. The question becomes "How prepared do you want to be?" But you should at least know the basics. Industry studies suggest the average married couple will spend over $200,000 throughout their retirement on health care. And the average retiree spends about $5,000 per year for out-of-pocket medical expenses. Again, that doesn't include long-term care costs.
A. (Taylor) Individuals should have a specific budget for health-care expenses that starts with the average costs for various Medicare coverage and is then customized to their expected circumstances. Also, for years, health-care costs have risen higher than overall inflation. This reinforces the importance of managing these costs. A great source for Medicare cost information is www.medicare.gov.
Q. And how about the impact of aging?
A. (Taylor) Health care costs tend to increase for retirees as they age. For example, research from David Blanchett at Morningstar suggests these costs make up about 10 percent of household expenses at age 65 versus about 20 percent by age 85. So while other expenses tend to go down, not so for health care.
Q. Let's turn to current events. Have Medicare costs risen for 2016?
A. (Huston) Part D prescription drug premiums have increased sharply for millions of Medicare participants and Part B premiums have increased by about 15 percent for certain individuals, including those:
- with higher-income;
- enrolling in Social Security for the first time;
- not covered by Social Security, which may include various state and local government retirees; or
- who have decided to delay Social Security benefits beyond their full retirement age.
This increase is much less than originally thought due to the budget deal signed in November, but still a notable increase.
Q. Let's focus on a couple of these. First, let's discuss the impact on those delaying Social Security benefits.
A. (Taylor) We often discuss the pros and cons of delaying when to take benefits in order to receive higher payouts. For those who may live a long life and whose spouse would benefit from higher survivor payouts, the advantages of delaying can still be quite strong.
Q. Who is considered "high-income" and what do they need to know?
A. (Huston) High-income individuals, who have to pay extra for Medicare Part B and Part D premiums, are those with a modified adjusted gross income (AGI) of more than $85,000 (single filers), and more than $170,000 (married filers). Modified AGI is the AGI listed on the last line of the first page of your 1040 income tax return plus any tax-exempt bond interest. So, for example, for 2016, Part B premiums for those with high income will range from more than about $170 to around $390 per month rather than the normal $105. The income limits are based on two years prior, so the 2016 premiums are based on your 2014 income, and moves you make in 2016 that increase your income — like a profitable sale of some asset — can affect your 2018 premiums.
A. (Taylor) These surcharges will affect more and more individuals over time because they are not inflation-adjusted. If you can get your income just $1 below the thresholds, you can avoid the surcharges.
Q. So if you're impacted, it's a sizeable cost. What can individuals do to prepare? What should they be talking to a tax professional or financial planner about?
A. (Huston) Having Roth assets, whether in an IRA or 457, or other employer plan helps because qualifying withdrawals don't go against your AGI. Spending down non-retirement assets that you've already paid taxes on can help as well.
A. (Taylor) Also, check if you have access through your employer to a health-care savings vehicle, which can help you set aside tax-free assets for qualifying medical expenses.
A. (Huston) There are other strategies that can generate income without boosting your AGI, for example, borrowing against cash value life insurance or utilizing home equity such as a loan, line of credit, or a reverse mortgage. But each of those involves extra costs and restrictions that you would need to take into account.
A. (Taylor) And let's not forget overall investment risk. Limiting that risk is especially important for many retirees who are spending down their assets, but most individuals need to take some risk to keep pace with or outpace inflation, including health-care inflation. So it's a balancing act.
Q. What are other ways you can manage costs such as those tied to Medicare deadlines?
A. (Huston) Unless you have coverage through your or your spouse's employer, Medicare Part B and Part D premiums will generally increase by 10 percent and 12 percent respectively for every 12-month period that enrollment is delayed. For example, if you don't have insurance through a current employer, you must enroll within three months after turning age 65 or reapply the following year and be subject to penalties.
Q. And once you're enrolled in Medicare? For example, we talked earlier about increases in 2016 out-of-pocket costs.
A. (Taylor) If you have Part D Prescription Drug coverage or a Medicare Advantage plan, spend time reviewing your plan options during the Medicare Annual Enrollment Period, which runs from mid-October to Dec. 7. Each year, shop around for coverage, focusing on expected total costs, not just up-front premiums, or what doctors and drugs are included. Plan terms can change and new plans become available. Consider any changes to your health or financial situation, too. Studies regularly suggest that those who do shop around can save meaningful amounts.
A. (Huston) As people age and health issues arise or worsen, prescription drugs can become quite costly. Exploring over-the-counter or generic options can lead to big savings. Talk to your doctor or pharmacist to explore your options.
A. (Taylor) And, if needed, check the fine print of your plan. My dad was prescribed a drug for his heart condition that cost $200 per month but was not covered by his plan. We were able to enlist his physician to write a letter stating the specific drug was necessary — and that there were no substitutes — and, in this case, we were able to get it covered.
Q. How about limiting health care costs by being as healthy as possible?
A. (Huston) Sure. Being socially active is key. A lot of studies suggest that. It keeps you physically and mentally active. Other studies indicate that retirees with part-time or temporary jobs can benefit from better health if they continue to work in their general field.
Q. And where you live can be a factor?
A. (Taylor) Yes, health-care costs can vary widely among different regions and states and this includes various Medicare costs. Of course, you want to consider more than just health-care costs in terms of where you live, but you should at least factor that into your decision. And you ideally would live where you have access to good health care facilities, which, along with your preferred doctors, are covered by your insurance plan.
Q. Now what if you retire early, like before Medicare eligibility at age 65?
A. (Taylor) The first question is whether you'll receive retiree health insurance through your former employer. Many more state and local government retirees have access than private sector retirees. You'd want to understand the total costs, determining how much your employer will subsidize, and coverage, including for a spouse or dependent child. If this is not available, COBRA and the Affordable Care Act provide more options. But they will most likely be costlier than what you were paying while working.
Q. Are there any specific tax benefits for public safety employees related to health insurance premiums?
A. (Huston) Public safety employees can take up to $3,000 a year in tax-free distributions for qualifying health insurance or long-term care insurance premiums, as long as the assets are deducted directly from your retirement plan or benefit, and if this provision is allowed under the plan's rules.
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Everything You Always Wanted to Know about RMDs
Beginning in the year you reach age 70½ you must take withdrawals, or required minimum distributions (RMDs), from your retirement accounts or be subject to a 50 percent penalty tax on the amount that you should have withdrawn but did not. Exceptions generally include Roth IRAs as well as retirement plans sponsored by your current employer, for which RMDs can be delayed until the year you separate from service. RMDs are a common source of concern and confusion. ICMA-RC CERTIFIED FINANCIAL PLANNERSTM Nancy Lange and Hortensia Perez discuss how RMDs work and steps you can take to manage them.
Q. Let’s start with the basics: how are RMDs calculated?
A.(Lange) There’s a formula that must be followed: in general, you divide the prior Dec. 31 account balance by a factor obtained from an IRS life expectancy table. It can get a little complicated if your spouse is more than 10 years younger than you or if you inherit a retirement account. In those cases, a separate IRS table is used to determine RMDs. Most financial services providers, including ICMA-RC, will automatically calculate your RMD. We’ll also automatically distribute RMDs for 401 and 457 plan accounts.
Q. The ability to delay the very first RMD is unclear to some people. What do they need to know?
A. (Perez) Although you can delay the very first one until April 1 of the following year, you still need to take next year’s RMD, too. So you’re looking at two RMDs, which could bump you into a higher tax bracket. In that case, you should compare your tax situations in each year and try to minimize the total tax bill across the two years.
Q. So the distributions are designed to be rather small, but rise over time?
A.(Lange) Yes, using the IRS’s standard life expectancy table, the first RMD represents approximately 3.6 percent of the prior year’s ending account balance. At age 80 it’s 5.3 percent. At age 90, it’s 8.8 percent.
Q. The 50 percent penalty is steep. What if someone misses an RMD?
A. (Lange) It’s important to take any past due distributions and then request that the IRS waive the penalty. Typically, it’s best to consult with a tax professional.
Q. Are there ways to simplify RMDs, or does an RMD apply to every single account?
A. (Lange) You can aggregate all your non-Roth IRA accounts and take your IRA RMD from just one IRA. For example, if you have three traditional IRAs, you can take the RMDs that apply to the total amount from just one IRA. But you must take an RMD from each 401 or 457 plan account that you own. And you can’t aggregate RMDs for accounts you own with those your spouse owns.
Q. When should individuals take RMDs during the year?
A. (Perez) There’s no one-size-fits-all answer. Some may value taking it as early as possible and getting it out of the way, or because they need the money anyway. Others may value receiving regular payments throughout the year to supplement ongoing expenses. Others may want to take care of it at the end of the year as part of their overall financial review.
Q. What if individuals don’t need the money?
A. (Perez) You don’t have to spend it. While you can’t roll it over to another retirement account, you can reinvest it in a taxable investment account.
Q. Speaking of taxes, RMDs can cause some unwanted tax bills, especially if the individual wouldn’t have otherwise made the withdrawal, correct?
A.(Lange) Yes, the distribution is generally taxable as ordinary income that can bump you into a higher tax bracket and lead to the taxation of Social Security benefits and to Medicare premium surcharges, as well as additional taxes on non-retirement accounts. For many individuals, it’s an example of why it’s important to work with a qualified tax professional and financial planner to create a tax-efficient withdrawal strategy.
Q. What steps can an individual take to limit the tax impact of future RMDs?
A.(Perez) It doesn’t always make sense to follow the rule of thumb to defer taxes as long as possible. If RMDs are likely to push you into a higher tax bracket, evaluate taking “additional” distributions in pre-RMD years that don’t push you into higher tax brackets that year. That way you smooth out your tax bill over time and can stay in a relatively lower bracket.
A.(Lange) Also, since Roth IRA assets are not subject to RMDs, they can help manage the tax bill. Even if you’re no longer eligible to make Roth contributions, you have the option of converting assets to Roth. With conversions, remember two key things: 1) it’s not all or none. You can convert small amounts over time, enough to remain in a low tax bracket; 2) larger conversions can make sense if, in a particular year, you have unusually low income or high deductions.
A.(Perez) And, for those still working who expect their tax bracket to decline in retirement, and who have retirement assets outside their current employer, they could roll those over to that plan with their current employer to delay withdrawing the assets until retirement. It’s important to crunch the numbers here to see if it makes sense, ideally consulting with a tax advisor.
Q. How about the ability to contribute your RMD to charity? Is that still available and does it make sense?
A.(Lange) This rule allows an individual to satisfy their RMD without it being included in their taxable income, which can be a meaningful economic benefit to those who wish to make charitable donations.
While the law expired at the end of last year, many tax professionals believe that Congress will reenact this provision and maybe even make it permanent. If you plan to donate anyway and you do a direct transfer from your IRA and the law is not renewed, you at least have a chance to qualify for an itemized charitable deduction. Regardless though, it’s important to remain in touch with your tax advisor and/or financial planner throughout the year so that you can be informed of any recent tax law changes.
Q. What should your beneficiaries know about taking RMDs?
A.(Perez) It’s a complex subject, but they should avoid three common mistakes, which are: 1) especially for younger beneficiaries, not taking advantage of the tax benefits available by stretching out the distributions over their life expectancy; 2) not titling the account properly; and 3) not meeting the IRS deadlines.
Q. Finally, RMDs don’t apply to certain annuities known as “longevity insurance” or “longevity annuities.” Can you elaborate on that?
A. (Lange) Sure. You’re referring to “qualified longevity annuity contracts” (QLACs) and the new government rules allowing owners of these policies to exclude their value in calculating RMDs. In exchange for a relatively small purchase amount up front, say 20 to 30 years in advance, you can receive a healthy payout later, like beginning at age 85. That way, you may need the rest of your assets to last only until that age. There are drawbacks, including the chance of not living to receive the payout; but these policies can make sense for those who want to protect against outliving assets late in life.
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New Rules for Claiming Social Security Benefits
The new budget bill signed into law on Nov. 2, 2015, sharply limits two claiming strategies that allow individuals to boost their household’s potential lifetime Social Security benefits. These strategies have mostly benefitted married couples by allowing the opportunity to get:
- Spousal benefits sooner
- Higher benefits later by delaying them to beyond one's "Full Retirement Age" (FRA), which is age 66 for those born 1943-1954. Delayed retirement credits (DRCs), worth about eight percent per year, are earned each year an individual delays benefits up to age 70.
The two strategies modified by the recent legislation are generally available only once you have reached your FRA. They include:
- File-and-suspend, which allows you to file for, and then immediately suspend, your benefits so that you can earn DRCs, while your spouse (or dependent child) collects spousal or dependent benefits based on your earnings record.
- A restricted application, which allows you to file for spousal benefits only and later switch to your own benefits, which would have benefitted from the DRCs.
For example, you could file and suspend your benefit while your spouse, upon reaching FRA, could file a restricted application for spousal benefits only. Both of you would receive DRCs on your own benefits, which you could then switch to at age 70.
If you and your spouse are already using these strategies, the new rules do not impact you. But if you are not yet receiving benefits but are (or soon will be) eligible, the new law may be both important and time-sensitive.
- First, after Apr. 29, 2016, if an individual suspends their benefits, their spouse or dependent child can no longer receive benefits based on their earnings record.
- In addition, restricted applications are now only available to those born before 1954. For example, for an individual who is age 62 as of the end of 2015, a restricted application would be available beginning in 2019 when they reach FRA of 66. But restricted applications may be of less value after the April 2016 deadline, due to those new file-and-suspend limits.
As a result, spouses who are eligible for the claiming strategies before the end of April deadline should take the time to assess their options.
For others, the new law has not diminished the value of simply delaying benefits, which can still make sense for those who have a reasonable possibility of living a long life and/or wish to increase what their surviving spouse would receive. The approximate eight percent a year increase in benefits is backed by the U.S. government, is inflation-adjusted (though those COLAs don't always take place, as with 2016, for example), and is higher than any comparable savings or insurance vehicle.
It may continue to make sense for one spouse, usually the lower earner, to start benefits early while the higher earner spouse delays benefits.
Also, an individual can still simply suspend benefits at FRA, in order to earn DRCs, and then restart benefits at age 70 — for example, if they began benefits early but realized they made a mistake, or that they no longer needed the money. (Again, with the new law, it can no longer be used to generate a spousal or dependent benefit.)
Finally, widows and widowers are not impacted by the new rules. Those eligible for benefits based on their earnings and a deceased spouse will continue to be able to receive a:
- reduced survivor benefit starting at age 60, and then be able to switch to their own potentially higher benefit later; or
- reduced benefit based on their earnings, and then be able to switch to a potentially higher survivor benefit at FRA.
You should consult with a qualified financial professional to review your Social Security options, including as part of an overall financial plan that also considers other income as well as assets, debts, and goals. Your ICMA-RC CERTIFIED FINANCIAL PLANNERSTM or an ICMA-RC Financial Plan can provide more guidance. To learn more about Social Security options, visit www.icmarc.org/socialsecurity and www.ssa.gov.
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Professional Investment Advice to Help You in Retirement
 ICMA-RC’s Guided Pathways® program now provides advice on how to take withdrawals from your retirement accounts. The advice can be customized to consider your other assets, including your spouse’s, and other sources of income such as a pension or Social Security. Three levels of investment advice are offered depending on how much help you want in choosing and managing your investments.
Visit www.icmarc.org/gp to learn more. Note: as a member of Retiree Premier, the normal $20 fee for the Fund Advice level is waived.
Not all Guided Pathways services are available to all plans.
RMD Calculator
 Required minimum distributions (RMDs) generate a lot of questions from ICMA-RC investors, such as "What's my RMD?" and "How much money will I have to take out?" We calculate the RMDs for your ICMA-RC account and make it easy for you to specify when and how you receive them. If necessary, we'll automatically distribute 401 and 457 account RMDs to you. It's also helpful to plan for future RMDs, including tax bills. Our new RMD calculator determines your current RMD and estimates future ones. Test drive it at www.icmarc.org/rmdcalc. For more about RMD rules and strategies, and how we help you manage them, visit www.icmarc.org/rmd.
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