People often underestimate how much they will need to maintain their desired lifestyle in retirement. Most assume their expenses will go down when they’re no longer working, and the kids are out of college. While certain work-related costs, such as commuting, parking, clothing or uniforms, and even that daily latte may cease, other costs for travel, entertainment and healthcare can quickly replace, or outpace, expenses incurred during your working years. That’s why it’s so important to estimate your retirement expenses well before you pull the plug on work.
Determining how much you may need in retirement takes a little work, but it’s much easier if you have a good handle on your current expenses. If you’re not sure what you’re spending now, create a budget. Expenses generally fall into three broad categories:
- Essential expenses
- Discretionary expenses
- One-time expenses
Begin by determining what your necessities are. Ask yourself: “If I lost my job tomorrow, what expenses must I maintain to manage my household?” Essential expenses are non-negotiable, such as food and clothing; your rent, mortgage and utilities; healthcare expenses; transportation costs; and taxes.
Next, list your discretionary expenses. These includes money spent on entertainment, dining out, gifts, leisure travel, gym memberships, and more. Discretionary expenses may also include tuition that you’re paying on behalf of a child or grandchild.
One-time expenses are a little different because they’re not ongoing. Some of these may be immediate, like replacing a refrigerator that’s stopped working, or planned, such as a full kitchen renovation, new roof, or wedding expenses.
After documenting your current expenses, you’ll need to determine which of these expenses may go up, down or stay the same in retirement. For example, do you plan to pay off your current mortgage prior to retirement and remain in your home? Or do you plan to downsize or move out-of-state? Will your kids be out of college and supporting themselves? Will you need two cars, or just one? All of these decisions have an impact on how much income you will need in retirement.
Living expenses can also vary greatly by state and geographic region. To get an idea of how much the “average” retiree may need to live comfortably in different states, a recent study looked at five factors, including an individual’s spending on groceries, healthcare, housing, utilities and transportation. The annual retirement income needed to cover these living expenses was calculated, with an additional 20% buffer to account for the “comfortable” aspect of retirement. Results ranged from about $54,000 a year in Kansas and Oklahoma, to roughly $62,000 annually in South Carolina and Florida, and nearly $100,000 a year for New York and California. Keep in mind, these are based on the “average” retiree’s needs. You’re not average. Your income needs may be significantly higher or lower based on your personal spending habits, lifestyle goals, and healthcare needs.
When estimating your future spending, it’s important to understand which of your expenses may rise in retirement and why. Below are four things that retirees can expect to spend more money on in retirement.
A 65-year-old couple retiring this year can expect to spend $295,000 on health care expenses throughout retirement, according to Fidelity Investment’s annual Retiree Health Care Cost Estimate. Factors driving the increase in costs include longer life spans, health care inflation that continues to outpace the rate of general inflation, and high healthcare premiums for early retirees. Even with Medicare, there could be significant out-of-pocket expenses and conditions or treatments that are not covered. And keep in mind, Medicare does not cover long-term care expenses, which can easily surpass $100,000 annually for nursing home care.
For most retirees, housing will continue to be one of the largest monthly expenses in retirement. Based on Bureau of Labor Statistics, seniors pay $3,800 a month, on average, compared to $1,322 a month for all age groups. However, if you live in a more expensive part of the country (as noted above) that could easily double or triple.
Typically, retirees spend considerably more on travel in the early years of retirement. And why not? You’re free to see the world and finally have the time to do it. However, this is a tricky one given our current environment with global travel restrictions and fewer older Americans willing to travel. Prior to the pandemic, a AAA survey found that Americans age 60 and over planned to spend just over $6,600 for a total of 4-5 leisure trips in 2019. This year is a different story, given the pandemic. The availability of an effective vaccine will impact how quickly retirees resume travel, as well as the type of travel and destinations they choose. On the one hand, safety precautions to help travelers feel safer, such as more space per passenger on airlines and cruise ships, improved ventilation, and other measures could drive up travel costs. On the other hand, discounts could also be available for a time to lure travels back.
Since 2008, food prices have risen 32%, yet the Consumer Price Index (CPI), which measures changes in the cost of goods and services, has only increased by half, at just over 16%. Like healthcare, food prices are outpacing the rate of inflation. And since you have to eat in retirement, that can…um…take a bite out of your income. Costs associated with dining out are also going up. Business Insider reports that the costs associated with running a restaurant were already rising prior to the pandemic. As owners incorporate new safety measures and face a 38% increase in wholesale food costs as a result of the pandemic, consumers can expect eating out (or carrying out) to become even more expensive.
Understanding how much you will need and what you will spend your money on in retirement is a fundamental aspect of retirement income planning. Sticking to a budget and spending plan not only helps to keep you on track, but it also reveals areas you can cut back on if you need to stretch out your retirement savings. To learn more about planning for a successful retirement, download our complimentary guide: 8 Blunders to Avoid in Retirement.