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Inflation Greets Retirees Emerging From the Pandemic. Here’s How to Prepare.

By Gail MarksJarvis, Barrons.com

As the pandemic fades and the country reopens, retirees are emerging to the unsettling whiff of inflation. Gas prices are up more than 50% year over year. Grocery prices have climbed 2.2% overall. Airfares are up nearly 25%.

Even spring flowers are delivering an unpleasant scent.

“People are out at landscaping firms and the prices are a shock,” said Freddy Garcia, a financial planner in Naperville, Ill.  “Clients are complaining about everything from the flowers they are going to plant to the patio furniture.”

While the central bank has played down rising prices, insisting they will be temporary, it’s clear that inflation has surged in recent months as Covid vaccines have made it safer for vulnerable people to return to a semblance of normalcy. But the spike in inflation raises two questions for retirees: Is there a reason to be concerned? And if so, how can you prepare?

“There is now,” said Mary Johnson, an analyst for the Senior Citizens League, referring to cause for concern about inflation. For years she’s been using government data to track a basket of essential retiree spending. Now, she said, bread is up about 13.3% and electricity up 7.6% a kilowatt hour since January 2020.  “I’ve never seen such increases,” and retirees have little flexibility to avoid them.

The Bureau of Labor Statistics tracks the impact of inflation on retirees through an experimental index known as the CPI-E. It adapts the broader consumer-price index to more accurately reflect the difference in how retirees spend compared with working adults.  Generally, inflation has hit retirees harder than the general public because of healthcare and shelter.  People over 62 spend about 12.2% of their income on medical care, compared with 8.8% by the broad population.  Housing is higher for seniors too—taking roughly 46.5% of their budget compared with the general population’s 42.3%, according to recent data.

Yet the cost-of-living adjustments people get annually in their Social Security checks haven’t kept up with the way retirees spend, said Johnson. That’s in part because Social Security COLAs are established each year based on CPI-W, which measures the impact of inflation on worker prices. The 2021 COLA was based on the distressed 2020 pandemic economy, so retirees got a 1.3% bump to cover prices that the broad CPI recently said are now up 5% year over year.

Social Security provides about a third of elderly income, with 50% of married couples and 70% of singles depending on the monthly benefits for half of their income, according to the Social Security Administration. Even retirees less dependent on Social Security, however, can be vulnerable as they may need to live off savings for a retirement that could last 30 years or more and a sustained run of rising prices would threaten to erode future spending power or deplete savings sooner than anticipated.

While retirees may be able to delay some expenses and routinely spend significantly less than working adults on clothes, recreation, and transportation, they have little wiggle room to skip doctors or medicine.

Because of the particular inflation seniors face, people who retired 20 years ago have had their buying power fall 30%, said Johnson. Since 2000, Social Security COLAs have gone up 55%, yet the typical senior’s expenses have grown 101.7%, she said. That includes a 226% increase in Medicare Part B premiums, or the charge people pay each month to get Medicare. And the medical out-of-pocket expenses—not covered by Medicare—have climbed 142%.

Based only on the CPI—and without the extra medical expenses seniors face—a person who retired in 2000 would need about $156,000 now for the same standard of living $100,000 provided when they first retired.

This year, since many people deferred medical care during the pandemic, inflation in healthcare has been modest.  But through this decade, retiree healthcare spending is expected to face sharp inflationary pressures. Last year, economist Sean Keehan and colleagues from the Centers for Medicare and Medicaid Services estimated in Health Affairs journal that national healthcare expenditures will grow at 5.4% annually through 2028, and Medicare 7.6% a year—largely because so many baby boomers are retiring.

“It seems that the prudent thing to do is to plan 5% to 6 % out-of-pocket increases a year,” said Michael Chernew, a professor of healthcare policy at Harvard University.  But since Congress can change rules around Social Security and Medicare, actual out-of-pocket expenditures for retirees is difficult to predict, he said.

Currently, Johnson estimates the cost of living bump in Social Security next year may be 5.3% if inflation trends continue through this third quarter. But with or without it, the recent chill from inflation has caused some near-retirees to alter their plans.

Jeremy Finger, a financial planner in Myrtle Beach, S.C., said he’s working with a couple that wanted to bolster their retirement savings by selling their large family home, saving several hundred thousand dollars, and then buying a smaller home for retirement. However, the plan got compromised as housing prices shot up more than 13% nationally and about 10% in Myrtle Beach over the past year.  While the couple did well on the sale of their home, they can’t find a home for the $700,000 they budgeted. As a result, they are renting and hoping for a slowdown in housing prices.

Regardless of whether higher inflation becomes ingrained or slows, financial planners say planning before retiring is wise because a retiree won’t be able to buy in 20 years what they buy now even if inflation is subdued. Here are some tips:

Select Inflation Protection

Zvi Bodie, a retirement consultant who previously did research on inflation strategies while a professor at Boston University, urges retirees to safeguard as much of the spending money they will need for two or three years in I bonds, instead of money market funds or bond funds. The U.S. savings bonds have an inflation rate that changes every six months based on inflation. It was set at 3.54% in May and six months later will go higher if inflation rises, or lower if inflation falls. The problem: individuals can buy only $10,000 a year through TreasuryDirect.Gov accounts so Bodie urges people to start before retiring to build up these holdings— $10,000 year after year, or $20,000 as couples. Although they mature in 30 years, they can be redeemed after one year.

For larger quantities of inflation protection, Treasury Inflation-Protected Securities, or TIPS, work. But Bodie suggests buying only the actual bonds through brokerage accounts that access U.S. Treasury auctions without a fee. The actual bonds, not TIPS funds, provide the best inflation hedge, he said, because when interest rates rise bond funds suffer losses. Also pay attention to taxes, and put TIPS in IRAs or Roth IRAs; not taxable accounts, said Bodie.

Delay Social Security and Avoid Debt

Another inflation-proofing strategy: Work longer if possible and delay Social Security until age 70. For each year that a person delays claiming up to age 70, his or her monthly Social Security check goes up 7% to 8%. As a result, monthly benefits claimed at 70 are at least 76% higher than those claimed at 62. And that’s not counting the COLAs.

People who work longer benefit from adding to 401(k)s or IRAs for additional years and letting the sum grow longer instead of eroding it each year to cover living expenses.

Workers who aren’t yet on Medicare may also have the option of contributing annually to a health savings account—savings that can be used tax-free during retirement to cover medical costs and long-term care.

Financial advisors also often advise people to pay off mortgages and other debt before retiring. In inflationary periods, with other costs rising, it can become harder to handle debt payments that were manageable when other expenses were less burdensome.

Longer-Term Investing

Recent inflation numbers have driven a discussion among financial advisors about investing strategies best for rising prices. History, however, doesn’t provide clarity, Bodie said.

Although retirees need to generate growth in retirement savings by investing in stocks, Bodie challenges a common argument that they are always an effective inflation hedge and notes that bear markets after periods of inflation can inflict long periods of loss.

The argument for stocks as an inflation hedge is that businesses can pass on extra costs to consumers and generate higher profits during inflation by raising prices. But Bodie notes businesses often can’t raise prices adequately to cover their costs and boost profits—a concern now among home builders as material prices have soared.

Commodities and real estate have sometimes been successful inflation hedges, but they haven’t been consistent. Research by Craig Israelsen, a finance professor and author of “7Twelve: A Diversified Investment Portfolio with a Plan,” indicates commodities on average do better than real estate and stocks during periods of high inflation of at least 6%, but not always. In 1975, with inflation about 7% the S&P GSCI Commodity Index lost 17.2 % and in 1981, with inflation about 9%, commodities lost 23%.

“Commodities run hot and cold”—averaging a 3.3 % loss in periods where inflation is under 3%, said Israelson.  And most of the return comes from oil, not commodities broadly.

Israelson’s solution since investors and economists are notoriously poor at forecasting inflation: In addition to indexes of large, small and international stocks, hold a real-estate index and commodity index routinely.

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