Why Retirees Need To Account For Inflation.

For New York City teachers who manage to reach retirement age, (only about 33% will reach full retirement age).  They can look forward to a generous pension and a TDA.  The average NYC teacher retiree has a pension of $45,000 and a TDA balance of $325,000.  Add that to Social Security and a teacher who reaches full retirement age can look forward to nearly $100,000 dollars of guaranteed income. Moreover, with an inclusive health plan and welfare benefits, the teacher retiree is in very good shape as he or she retires.  Finally, the pension and Social Security are indexed to inflation.  Why should teachers worry?

Teachers need to worry as they proceed in retirement.  First, the pension is only partially indexed for inflation by increasing at a third of the CPI which is usually lower than the actual inflation rate.  Furthermore, the pension adjustment is capped at 3%, regardless how high the CPI goes.  Furthermore, the first pension adjustment occurs five years after retirement or if you retire at the age of 60 or less the first pension adjustment cannot occur until the age of 65 years of age.  Finally, Social Security is usually only 25-30% of the total retirement income at the most.

As for the TDA, there is no inflation adjustment and since 60% of the teachers keep their money in the fixed income option (7% interest rate), there is no inflation protection.  Therefore, the teacher retirement income will steadily erode the retiree's pension income.  How much will the pension erode?  The table below shows a worst case scenario since its complicated, due to the partial indexing of the pension and the reduced indexing of the Social Security income

Retiree Salary = $100,000, Inflation 3.4% annually

Years in Retirement..........Factor.........Actual Income

0......................................1.00...............$100,000

5......................................0.85................$85,000

10....................................0.72.................$72,000 

15....................................0.61.................$61,000

20....................................0.51.................$51,000

25....................................0.43.................$43,000

30....................................0.37.................$37,000

Of course,  its probably not as bad as the table shows because at present inflation is lower and there is some partial inflation protection in our pension but all the same the retiree's income will erode significantly over time.

What can a teacher do as they approach retirement?  Make sure they have at least 20% of their income in equities, preferably in low-cost index funds that historically appreciate above the inflation rate.  Otherwise, expect to reduce your standard of living as inflation slowly but surely erodes your effective retiree income.