Who Is Affected More by Inflation: Retirees or Workers?

Does inflation impact a retiree more, the same or less than it does a working adult? Or, put differently, is it possible that the consumer price index (CPI-W) misrepresents the actual inflation faced by retirees? For those of you retired or about to retire, I am sure this question is of great interest, so I decided to do some research.  Here's what you need to know.

Retirees receive an annual increase of their Social Security that is based on an index called the consumer price index (CPI-W). It measures the price changes in the average set of goods purchased by urban wage earners and clerical workers.  More precisely, this index measures the price variations of thousands of items which are grouped into 8 major categories, each weighted differently.  These are: food and beverages (18%), housing (37%), apparel and upkeep (4%), transportation (19%), medical care (5%), recreation (5%), education (5%) and other (6%).  As you can see, housing (37%) and transportation (19%) account for more than half of inflation. But, who is impacted more by this? 

Retirees don't typically commute, and their house is often paid for, so one could argue that inflation affects them less.  On the other hand, the current inflation index weights the impact of medical care at only 5%.  Retirees know that this expense represents a far larger share of their budget than that of a worker, so medical expenses should account for a larger share of the inflation index, if it were to better represent retiree's actual expenses. 

Some people, like me, argue that Social Security benefits should be increased using a price index that reflects the spending habits of the elderly rather than those of workers.  The argument is that the current CPI-W underreports the actual inflation rate retiree's suffer, and therefore, the annual increases in Social Security are not enough to compensate them for the actual inflation.

The government has calculated a new index to better reflect a retiree's purchasing habits, and this is called the CPI-E (inflation for elderly) .  What are the chances that Social Security will start using this index to increase annual benefits? Close to zero, in my opinion.  Why?  Some researchers have looked into this question and have concluded that the adoption of the CPI-E would accelerate the projected insolvency of the Social Security Trust Fund, known officially as the Old-Age and Survivors Insurance (OASI) Trust Fund.

These researchers found that between 1984 and 2001, annual inflation under the CPI-E was on average 0.38 percent higher than it was under the CPI-W, with medical care accounting for much of the difference.  Accordingly, they estimate that if the CPI-E had been adopted in 1984, the average benefit in 2001 would be 3.84 percent higher, or roughly $408 more per year per recipient.  These calculations also reveal that if the index were adopted today, the OASI Trust Fund could become insolvent five years sooner than the currently projected 2043, provided that inflation for the elderly continues to exceed inflation for workers at the average annual rate observed between 1984 and 2001.

In conclusion, the current measure of inflation under reports the actual rate of inflation that affects retirees.  You can expect, therefore, that the annual increases to your Social Security will not keep pace with the inflation you will experience during retirement.  Your investments need to compensate for this shortfall, so this is a great time to look at them. I can certainly help you do this.  To contact me, just reply to this contact me by email or call me at 714-771-6000.

And by the way . . . If you have a friend who needs help with their retirement or investment planning, please contact me with their name and number.  I will be happy to show them how they can maintain their lifestyle and financial security throughout retirement.