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Longevity's Evil Twin: Inflation

Pension benefits worth about $40,000 today would be valued at $14,200 in today's dollars after 35 years of inflation estimated at 3 percent a year.
Pension benefits worth about $40,000 today would be valued at $14,200 in today's dollars after 35 years of inflation estimated at 3 percent a year. (By Daniel Acker -- Bloomberg News)

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By Martha M. Hamilton
Sunday, October 28, 2007

First of all: Happy 94th birthday to my mother, Evelyn Sims McNeil.

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At $1.50, the Sunday newspaper is cheaper than a birthday card. But I'm not using this forum as a birthday wish to save money.

Rather, it's because her longevity is both wonderful and worrying.

Wonderful because she's still in reasonably good physical shape and mentally alert, and because I enjoy having her around. But worrying when I think about the implications for my own financial security in retirement.

For the past 20 or 30 years, when my thoughts about financial planning for retirement were both vague and infrequent, my rough mental calculus was that I needed to save enough to last until age 90. My grandmother died at 91, my aunt at 89. My daddy died much younger but smoking, hard drinking and hard physical labor probably helped cut short his life expectancy.

Now it's looking as though I may have been aiming too low. Some experts say you should take the age suggested by your family's history of longevity and tack on another five years in anticipation of medical advances. Century mark, here I come!

Take my stash of savings, figure it has to last 20 years, and I look secure. Stretch it another 10 years, less so. Add another 10 years -- well, maybe I'd better keep working.

At least I don't have to worry about running out of money entirely. I'm among the fortunate but diminishing number of people retiring with a traditional pension that will send me a monthly check till I die. But longevity's evil twin, inflation, means that check may not be worth much by the end of my life.

Assume someone is receiving $40,000 in pension benefits today. Not fabulous, but not too shabby. Assuming 35 years of inflation at 3 percent a year (which is close to what we've experienced over the past 25 years), that money will be worth just $14,200 in today's dollars when the future rolls around.

And it could be worse if we returned to the double-digit inflation rates of the 1970s, said Ron Gebhardtsbauer, senior pension fellow for the American Academy of Actuaries. One year of 12 percent inflation would mean either cutting back spending by 12 percent or digging into savings, he said.

One of my plans to offset the anticipated erosion of my pension's value is to delay taking Social Security as long as I can. If I put it off till I'm 70, I can draw $2,816 a month, compared with $1,587 a month if I start taking it when I'm 62. Social Security is adjusted for inflation, and I want those cost of living adjustments to be on the biggest base possible.

Even those cost of living adjustments won't be enough to keep me whole, though, because inflation rises faster for the elderly than it does for the rest of the population. The Labor Department's Bureau of Labor Statistics has been computing the consumer price index-E (for elderly) with figures going back to December 1982. What they show is that through September 2007, the CPI-E had increased by 124.9 percent compared with a 108.1 percent increase in the CPI-W (for working).

The reason is that the elderly spend more of their income on the component of the CPI that is going up fastest -- medical care. According to the CPI-E, as of the end of 2006, the elderly spent more than twice as much of their income on medical costs as wage earners. And compared to a 29.7 percent increase in the cost of all items in the CPI-E for the 10 years ending in December 2006, the cost of medical care went up by 47.8 percent. The one category that has gone down in price over the past 10 years is apparel, which the elderly buy relatively less of than workers, which means they benefit less from that decline in prices.

Moshe A. Milevsky, a finance professor at York University in Toronto and an expert in financial risk management, makes the point that inflation risk is also highly individual. Maybe, he said, we need to calculate a CPI-ME for individuals. "Depending on where you live, how you spend your money, how old you are and even your gender, inflation is different," he said. Even among the elderly, defined by the Bureau of Labor Statistics as households in which an individual householder or at least one of two householders is 62 or older, spending patterns differ over time, with medical expenses typically rising with age.

In an article this year Milevsky suggested that one way to hedge against inflation might be to tilt one's portfolio toward sectors and companies that may benefit from your personal inflation rate. Of course, you might run the risk of picking the assisted living company that runs into trouble with the Securities and Exchange Commission or the drug company that has to recall its hottest selling product.

Still, it's an interesting idea. I'm thinking: Who makes knee replacements?


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