Retirees face a number of risks and challenges that can chip away at their retirement savings. Some of these include:
Retiree spending and life expenses (or overspending)
Market volatility and issues related to sequence of returns
Catastrophic events that need insurance protection
Potential legislative changes related to Social Security, Medicare, and/or l tax law changes
But two other risks that may add even more stress to retirement savings are the risk of inflation and the possibility of living longer than anticipated.
We all think of inflation as a general problem of prices going up. But inflation is more than just a one-time price increase -- inflation is a rise in the general level of prices sustained over time. Consequently, it also means erosion in purchasing power of money -- a change that hits retirees especially hard.
There are a number of ways that inflation is measured. The most common is the CPI or Consumer Price Index. The Bureau of Labor statistics (BLS) collects price information and surveys consumers to issue its monthly CPI data. The 12-month percentage in the CPI is the most common measure of inflation.
Over the last few years, the inflation rate in the United States has been fairly low. In 2010, the Consumer Price Index (CPI) was only 1.6 percent, according to the U.S. Department of Labor Statistics, and in 2011, it was 3.0 percent. Though the general economic outlook on inflation by the Federal Reserve is relatively stable, when you take a closer look at the economic data and its potential impact of inflation on retirees, inflation and rising costs are a bigger concern for those in retirement than the general population.
This concern about inflation for retirees is due to their spending habits that are different from those of the general population. The "consumption basket" (a collection of goods and services used to measure spending trends) for retirees shows that they spend more of their money on health care costs and medical services than the general population. In fact, individuals age 60 and over utilize about one-third of all their spending on health care and medical expenses, which is three times more than that spent by those ages 20-29, says a 2001 report by Credit Suisse, Longer Lives, Changing Life Cycles: Exploring Consumer and Worker Implications.
The bottom line for retirees is that health care insurance and spending have risen at a much higher rate than the CPI. For the 12-month average between spring 2009 and spring 2010, says the 2011 Blackrock report Prepared for Retirement, health care insurance costs rose 4.7 percent, and health care spending rose 4.0 percentiv - all while the annual inflation rate was only 1.4 percent. That is an increase of about three times the actual inflation rate.
During your client's retirement, they can expect to spend from $200,000 or even more for medical expenses not covered by Medicare. The Employee Benefits Resource Institute (EBRI) Issues Brief published in December 2010 indicated that a couple with median drug expenses during retirement would need $271,000 in savings to have a 90 percent chance of having enough money to cover health care expenses in retirement. Keep in mind that these estimates are only averages and the amount needed could be much more depending on the individual's health.
Another potential health care-related concern for retirees is nursing home costs/expense. Keep in mind that Medicare does not cover nursing home costs. The average annual nursing home cost in the United States in 2010 was $83,585, says Blackrock's Prepared for Retirement report.
Now more than ever, retirees need to consider the number of years they might be in retirement. With better health care and longer life expectancies, someone retiring today at age 65 could expect to live at least another 20 or even 30 years, based on life expectancy tables. Even with a modest inflation rate of only 2.5 percent, costs would double in 28.8 years.
Strategies For Helping Clients Prepare For Rising Health Care Costs And Other Expenses
So how can you help your clients prepare for these increasing expenses during retirement? These strategies may be useful for dealing with the impacts of inflation in the future:
1. Help your clients understand how inflation could impact their retirement expenses. Determine their potential retirement income expenses and consider the impact of inflation on their consumption basket.
2. Work with them to estimate how many years they may be retired. Consider their current health status and potential life expectancy. If they are married, consider the possibility that one of them may live for 30 years or more in retirement.
3. Familiarize clients with their Medicare options. Keep in mind that Medicare does not cover everything and supplemental insurance may be necessary, which would add to their monthly expenses.
4. Review their retirement income sources. Determine whether cost-of-living adjustments are automatically applied to those sources of income.
5. Make sure they consider the impact of low interest rates and high inflation rates during retirement. Their total rate of return may be different than anticipated.
6. Manage clients' overall expectations of the impacts of inflation and help them focus on what they can control. Based on this information, help them develop a realistic plan for their retirement income.
Inflation and rising health care costs can be big issues for retirees. However, if you connect early with clients on these items, you will help them take an important step toward managing these issues.
Deb Repya, JD, CLU, ChFC, is vice president of Advanced Markets for Allianz Life. In this role she is responsible for the strategic direction of the Advanced Markets group and also oversees the development, promotion and quality of the group's services.