Tofu instead of chicken in retirement? With all due respect to tofu, I hope not.

But that's the case for retirement plan contribution limits (and the provisions of the Tax Cuts and Jobs Act [TCJA] indexed for inflation, such as tax brackets, the standard deduction, and tax credits).

The 2017 Tax Act ushered in the use of a "chained" Consumer Price Index (CPI) as the measure of inflation used by the federal government for indexing. Inflation, and the resulting bumps in brackets and other numbers tied to cost-of-living adjustments (COLAs), are now determined by the Department of Labor's Chained Consumer Price Index for All Urban Consumers (C-CPI-U).

The C-CPI-U incorporates changes in both the quantities and prices of products and services, rather than a fixed basket of good and services, and attempts to reflect the choices people make when prices go up.  For example, if the price of chicken goes up, many (some?) people may buy tofu instead of chicken as a protein substitute if it costs less. Sales of tofu soar, while the sales of chicken slump. The chained CPI essentially ignores the price increase of chicken on the theory that people aren’t buying it.

What Does This All Mean?

Inflation will track more slowly. So instead of 2% in a given year, it may now be 1.8% based on the new index. This will translate to more modest COLA bumps for brackets and other numbers, such as retirement plan contribution limits, tax brackets, the standard deduction, and tax credits. As with all the other changes made by the 2017 Tax Act, this may serve as a reminder to clients that saving for and spending in retirement in a tax-focused way is still not a do-it-yourself project. Planning the silos for savings and the sources of spending will go a long way in helping clients secure the choice of tofu or chicken in retirement.

Other Key Points

• Unlike many of the tax changes for individuals under the 2017 Tax Act, chained CPI indexing does NOT sunset after 2025.
• The calculation of Social Security COLAs is still tied to the CPI-W and was not impacted by this change.
• Regardless of price increases, not all goods and services may be substituted for lower-priced alternatives, particularly healthcare.

Should you have any questions regarding chained CPI indexing, please feel free to contact the Pacific Life Retirement Strategies Group at (800) 722-2333 or send an email to RSG@PacificLife.com.