FedSmith has run articles on the chained CPI previously. In the past, it may not have been as of much interest to some as it could have been. When a proposal first surfaces, it seems like a remote possibility that will not have much of an impact.
But, as sometimes happens, a remote possibility can become a reality. And, when that reality hits, it could impact your future retirement income.
The chained CPI now looks more like a reality than it did a few short weeks ago.
The president’s budget proposal now provides for a chained CPI. His proposal follows a similar proposal by the House Republican Study Committee to adopt the chained CPI. With support in both parties for the measure, we can assume there is a possibility that this proposal has an increased possibility of becoming a reality.
What is the Chained CPI?
While the usual consumer price index (CPI) deals with the rise and fall in fixed items, a “chained CPI” would also consider choices people may make as a result of changes in their behavior. For example, if the price of beef goes up, many people will buy chicken instead because it may be a substitute that costs less. Also, when the price of a product goes up, people will probably buy less of that product.
The chain weighted CPI incorporates changes in both the quantities and prices of products. When it comes to calculating costs for multibillion dollar programs like Social Security, a chained CPI is likely to mean that benefit increases do not rise as much. Over time, benefits, payments, and pensions that are adjusted with CPI calculations could all fare differently under chained CPI rules.
Savings to the Government—and Less Money for Those Receiving Benefits
The savings to the federal government would be significant. The Republican Study Committee budget was projected to cost the federal government $9.2 billion less over ten years.
If you are a current federal employee or a retired federal employee, you would be impacted by a chained CPI when it comes time to receive your future retirement payments. Each year, federal retirees benefit from a cost of living allowance. In most years, this results in an increase in the amount of money received by a retiree. In 2013, this current COLA calculation resulted in an increase of 1.7% for most people receiving Social Security or a CSRS pension payment.
What would the impact of this change be on a federal retiree?
Robert Benson wrote an article recently to calculate this impact on a typical federal retiree. (To see the full discussion of this issue, read How Bad is the “Chained CPI”?)
Mr. Benson used as an example a newly retired Federal employee who is 62. He was in the FERS retirement system and he retired after 30 years, with a high-three salary of $57,272. His annuity would be 33% of $57,272, or $18,900 annually. Over a 20-year time span, this hypothetical employee received annual COLAs 0.3% lower than the full CPI. Under this scenario, his annuity would be 5.6% less. His cumulative loss over 20 years would be $17,197.
The actual decrease could be more or less but the decrease of 0.3% is a reasonable assumption to illustrate how it would impact a retired federal employee. Obviously, an employee with a higher or lower high three salary would be impacted differently.
The CPI and Retirees
The reality that faces many retirees is that the current method of calculating retirement payments does not reflect their true expenses. The chained CPI would accentuate this disparity between actual living expenses and the amount of money paid to the retiree.
Here is the problem for a retiree.
If you are about 70 and living on a fixed income (no promotions or within-grade increases after retirement!), you are unlikely to be buying the same kind of new products you did when you were in your 30′s and 40′s. If you are in the market for a new widescreen TV with the best high definition picture incorporating the latest in technology, a luxury car or new furniture built in a Chinese factory, prices may have gone down so inflation is lower. Lower prices expand your purchasing power and you may have more items to improve your standard of living.
On the other hand, the cost of health care has gone up. In 2013, Medicare Part B premiums went up, in some cases by almost 30%. Health insurance has gone up each year and, generally, the percentage of the increase is higher more than the average COLA increase. Retirees are likely to use medical services more than younger people. As a result, the cost of your health care and your expenses may have gone up after retirement.
Under the regular consumer price index, transportation is 18% of the index; education is 6% and medical care is only 6%. Retired folks are often more likely to be going to a doctor or a hospital or paying for prescriptions than that are paying for a college education or buying a new car.
So, in effect, if the chained CPI does become a reality, you may want to rethink the amount of money you will need to last for the rest of your life. The current method of determining a COLA may not reflect your true expenses. The chained CPI will likely accelerate this loss of purchasing power as you may be receiving smaller increases in the future than you had anticipated.
Why is This Happening?
Most of us think out daily lives will not change much from what we currently experience and consider to be normal. That expectation may be true but it does not have to be so. And, while we can expect soothing reassurances from our elected officials who want to stay in office, the reality may be that we will continue to experience unpleasant changes as a result of our overall economic situation and growing government debt.
Perhaps the current economic concerns are just a blip in the continuing success of the American economy. Or, perhaps, since we are now the world’s largest debtor, our standard of living will suffer if or when we come to grips with attempting to get our debt and spending under control.
In any case, since the future is uncertain, those who are retired or plan on retiring in the near future would be wise to preserve their assets and plan a financial future conservatively when nearing retirement.