The Only Inflation That Matters To Retirees

Last Updated Apr 3, 2011 8:23 PM EDT

One of the biggest threats to your retirement security is inflation. But the general rate of inflation reflected in the CPI isn't really the issue for retirees. There's really only one type of inflation that matter to retirees: health care.

Most other forms of inflation can be reasonably managed by either not using those goods or services, or making adjustments to lower your costs. But you can't control rising health care costs, which means you've got to plan to spend a lot more than you think.

General Inflation. The reason general inflation (the CPI) isn't that big of a deal is because it measures a hypothetical basket of goods and services, and you may not be using many of those goods and services. For instance, if you're retired, own your home, and the cost of housing goes up in the CPI, who cares? You already own your home, so your housing costs are fixed.

Or let's assume the price of autos goes up. Well, if you're retired, you probably don't drive as much as you used to. That means you may be able to put off buying a new car for a long time. And even if you have to buy a car, you could always trade down to a less expensive model to keep your transportation costs about the same. And if the price of gas goes up, you can buy a more fuel efficient car and most likely fully offset the price increase.

Let's say airline tickets go up. Well, you can always choose to skip that vacation. Another option is to monkey around with your travel times to lower the fare. If you want to go from Chicago to LA, and are willing to fly on a Wednesday, return on a Monday, go backwards to Newark first and then to Houston and then to LA, you'll most likely lower the cost of that ticket.

  • The point is that you can change the impact inflation has on your life by adjusting your buying habits and behavior.
Moreover, if the general rate of inflation is rising, then interest rates are probably rising. Rising rates should provide you with more income from your investments in bonds and Cd's.

Basically, you can manage the general rate of inflation by making adjustments to your spending habits and by getting some extra income as interest rates rise.

Health Care. But health care costs are different. Under our current system, you really can't manage the cost of retiree health care. For instance, if you think a health care service is too expensive, you can't go out and negotiate a cheaper service because Medicare essentially sets the price of heath care for retirees.

  • Also, many retiree health care needs aren't discretionary. Let's say you get cancer, have a heart attack or a stroke. Those things need to be addressed immediately, and you're going to want the best care the system can provide. You don't want a cheaper version of cancer treatment.
Once retired, your health care costs will come at you from two different fronts: insurance premiums and out-of-pocket costs. Even if you're pretty healthy, in today's dollars you could expect to spend somewhere between $10,000 to $15,000 a year for a married couple to cover these basic expenses.
  • For premiums, you've got Medicare Part B (doctor services) and Part D (prescription drugs), you'll need a Medicare supplemental policy and probably need some long term care insurance for you and your spouse.
  • For out-of-pocket, prescription drug costs can easily run a couple thousand dollars a year for maintenance medications; and if you do need any physician or hospital services, you've got deductibles and co-pays for all of those as well.
How fast could these costs rise? Well, that's any one's guess. The CPI doesn't do a great job of measuring health care inflation because of the fact that insurance companies and the government are the third party payers. That distorts the ability to accurately measure the escalation in costs.

But if I were you, I'd expect the costs that retirees have to pay for health care to increase at somewhere between 5% and 8% a year, assuming overall inflation stays below 3%. That means the $10,000 to $15,000 you might be spending in today's dollars could easily run $40,000 to $50,000 per year, per couple in 20 years.

When doing your projections for your retirement budget, I wouldn't worry too much about the price of airline tickets. I'd make sure you've got room to handle these health care costs. That's what will make or break your retirement.

Bottom line. Health care inflation will be the biggest challenge for most retirees.

Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.