When can I afford to Retire? Part 3: Expenses

If you haven’t already questioned what you mean by “retirement” or taken an inventory of your expected retirement income, go back to Part 1 and Part 2, respectively. 

What does it cost to be you?

Most folks don’t stick to a rigorous budget and track every expense (more power to you if you do!) If you’re like me, you’ve got a general sense of where your money is going (savings, mortgage, monthly bills, tuition, travel, major expenses), and as long as you’re not running down your checking account or dipping into your brokerage account for recurring expenses, you’re probably doing a decent job of living within your means. That said, this is a time to try to understand “what it costs to be you” in a little more detail, especially as you approach retirement (and sooner if living within your means and saving enough is something you struggle with or you’re facing a major change like starting a business, taking a sabbatical, or a divorce). Making the transition from building your savings to spending it down can be a jarring one, but arming yourself with knowledge about your actual expenses can give you the confidence to make the transition, which may even be feasible sooner than you think.

Travel and entertainment expenses certainly increase early in retirement, but overall spending actually tends to decline throughout retirement when adjusted for inflation.

A good first approximation is that you will spend about the same amount in the initial years after retirement as you did immediately before. Sure, some expenses go down, like work clothes, saving for retirement, and maybe the gas bill if you had a long commute. But other expenses tend to go up as you finally take those big trips you've been dreaming about, go out to lunch after golf, spoil the grandkids, and pay for a larger share of your health insurance.  It tends to balance out, at first.

The Retirement Spending Smile

The typical assumption is that retirees will try to maintain a consistent standard of living, which means your annual spending will increase at the same rate as inflation. However, research has shown that, for the majority of retirees, annual spending increases at a slower rate than inflation, meaning “real” spending (i.e. inflation-adjusted spending) trends downward over time. Intuitively, this makes sense as the so-called “go-go” years of early retirement (full of travel and activity) transition to the “slow-go” years of middle retirement, and then the “no-go” years of late retirement. Even the uptick in healthcare expenses in the later years is typically more than offset by the overall decline in discretionary spending, such that the increase in overall spending still remains below the rate of general inflation.  

A chart of the changes in real spending over time actually resembles the shape of a smile, where real expenses decline most rapidly from the early years of more active retirement toward a low point in the middle before ticking up toward the later years. This phenomenon is even more pronounced among more affluent retirees, who have a higher rate of discretionary spending to begin with, which then declines over time more dramatically than that of a retiree whose budget is more constrained by fixed expenses from the beginning. 

This research suggests that individuals and advisers may be overestimating the amount of savings you need to retire and that you could feel more confident in taking those dream trips and spending a little more during the more active years of your retirement. 

Retirement doesn’t change your habits much

People who were savers all their lives don't easily shift to being spenders when they retire. The same thrift that enabled them to build up a sizable nest egg in the first place doesn’t just go away. Many retirees actually underspend in their retirement, and they end up passing on a sizable amount of their wealth to the next generation, even when that wasn’t one of their goals. In your head, you may be thinking, “I’ve worked hard my whole life so that now I can afford to really enjoy myself!” You may be on board intellectually with spending down your assets doing all the things you put off doing before, so long as you’ve got enough in reserve to handle contingencies, but old habits are difficult to shake. The shift to spending down your savings is psychologically difficult. This can be exacerbated when you experience a market decline early in your retirement and you see your account balances shrink (even if we planned for this possibility, and you are still on track to have more than enough!). 

The corollary is true also: people who were high earners and high spenders may have trouble shifting to thrift in retirement. These are the folks that may be in for a rude surprise, as they’ve likely not amassed the savings that would have been needed to sustain their level of spending once they’re no longer working. It’s not terribly difficult to understand the necessary changes on paper; it’s putting them into practice that is the problem.  

Other Major Expenses to Consider

Now that you’ve got an idea of what it costs to be you and the overarching trends, let’s consider some of the big-ticket items that we need to have a plan for.

Relocation

Many retirees will relocate at least once. You may want to downsize, move to a more active neighborhood, be closer to children and grandchildren, have better weather, or want to seek out a location with better services and proximity to medical and assisted living facilities. Depending on your current situation and your goals, this could create a significant one-time or ongoing expense, or it may be a windfall if you’re selling your house to move to a less expensive location. 

Medical Expenses

There’s no question that medical expenses increase with age, but the increase you experience may not be as significant as you might think; especially if you’re part of the subset of more affluent retirees who have full Medicare Part B and Part D coverage along with a Medigap supplemental policy. While such coverages are out of reach for many, costing $5-7 thousand per year per individual, they essentially convert the risk of a large future medical expense into a steady premium that will rise with the cost of inflation. Keep in mind that Medicare does not cover long-term care expenses should you require the care of an in-home aid or a nursing home. Medicare only covers hospital, medical, and short-term skilled nursing and rehab services.

Long-Term Care

Non-medical long-term care expenses are not covered by Medicare and are one of the bigger unknowns that you still face. The 2021 median annual cost of an in-home health aid was $61,776, the median assisted living facility costs $54,000, and the median private room in a nursing home facility cost $108,405. These costs are rising faster than the rate of inflation right now. As baby boomers get older and people continue to live longer, the need for more skilled workers grows significantly. Where you live is a major factor in the overall cost of care, and there’s a wide range of facilities at different price points (see link for state specific median costs Cost of Long Term Care by State | Cost of Care Report | Genworth). 

If you’re not planning to rely on family members or the government for indigent care through Medicaid, you’ve got two options to plan for this possible expense: self-insure (i.e. put aside some savings for contingencies) or purchase long-term-care insurance. Unfortunately, many insurers underpriced their LTC policies decades ago, resulting in a nice benefit to those who purchased these policies, but losses for the insurance companies, who were forced to raise rates on future policies. LTC insurance can make sense for a narrow slice of individuals who don’t have the savings needed to self-insure but are able to afford the premiums, which have stabilized in recent years but are still quite high. Typically, it’s worth it for more affluent individuals to self-insure, but even they may find the certainty of coverage to be worth the higher premiums.

Gifting

If you’re fortunate enough to have saved more than you’ll conceivably need, you’re in a position to think about transferring some of your wealth to future generations or charitable pursuits. Developing a strategy for planned gifting is important to avoid potential tax pitfalls and ensure your generosity makes the intended impact and is handled responsibly. Many individuals who did not consider themselves particularly wealthy will find by their mid-retirement years (around age 80), that they have more than they’re likely to ever need.  There can be great joy in seeing the positive impact that your good fortune can have on your family members and your community.