Is CPI indexation sufficient?

michaels

So I run my cfiresim scenarios looking at maintaining a real retirement date income for say 40 years.

Suppose the desired income is average wage 26k currently, sounds OK to maintain this is real terms?

But if you had retired on average wage, price inflation indexed 40 years ago your income would now be 17k, is 2/3 of average income and that is actually much better than normal due to the recent wage stagnation, for the 40 years up to 2008 you would have been on only 50% of average income after 40 years, 13k sounds pretty poor to me when average income is 26k :eek:

So my question so for those hoping to retire in their 50s like me is are we being unrealistic when looking to maintain CPI indexation?

Linton

I have detailed and comprehensive expenditure data going back since retirement over 13 years ago. Over that time period total average annual expenditure on essential living expenses eg food, council tax, utilities, insurance, clothing, has matched cpi very closely.

hugheskevi

I base my future income needs starting with current expenditure, and increasing that by by forecast earnings growth in the short term and by CPI+2.2% (forecast long-run average earnings growth) until age 70, and then by CPI thereafter.

Traditional thinking is that retirement expenditure is U-shaped, ie, highest at start of retirement when still very active and at the end of retirement when care is needed. There is no reason to think that years before a 'normal' retirement age of around 65 will be similarly if not moreso expensive as the years immediately after 65.

Using earnings-terms for income to age 70 leads to peak income in real terms at age 70 when I should be at the start of that U-shape, and then income will decline relative to earnings thereafter. I'm happy enough with that, as the higher income needs late in life can come from property if required but we should have plenty due to caution built into assumptions.

I think it is more important to put a higher escalation than CPI on the years prior to State Pension age for those retiring very early, otherwise the erosion of income relative to earnings can be severe due to the number of years retired, and also that a greater proportion of those years will be spent in good, active health with the associated expenditure needs.

May also be worth remembering that State Pension is earnings-linked, and that may end up making a significant part of retirement income later in life.

michaels

Thanks for the useful answers.

I guess the older you get, the more you may require services (care, gardeners etc) and thus the more your expenditure may be driven by average wages rather than the overall price level.

Linton

I believe there are three separate issues.
1) Maintaining current expenditure despite inflation. CPI is an adequate measure for this.
2) Maintaining ones current standard of living relative to other people. This is why updating 1970s income with CPI gives apparently low present day incomes. People in the 1970s bought less stuff than now and lived simpler lives. Although this may not bother those of us who have never seen an iPhone or a 50inch tv as an essential it may be more of an issue for younger people.
3) Age related expenditure patterns.

The way I planned retirement and continue to finance it was to focus on maintaining current normal expenditure indexed by cpi assuming a pessimistic value for future planning. Any desired major expenditure beyond that is assessed at the time by its impact on estimated wealth at death at 91.This is currently unnecessarily high as it is more than enough to pay for care for many years. So expensive holidays can be booked without any worries.

hugheskevi

I have detailed and comprehensive expenditure data going back since retirement over 13 years ago. Over that time period total average annual expenditure on essential living expenses eg food, council tax, utilities, insurance, clothing, has matched cpi very closely.

Looking at CPI and average earnings between November 2005 to November 2018 shows CPI up by 33.6% and average weekly earnings up by 35.4%

I do wonder how long it takes before the statistics associated with living through an economic shock become the new normal.