If you’ve ever met with a financial planner, you’ve likely been asked, “How much income do you think you’ll need when you retire?” When I was asked this, my immediate thought was, “Hardly any!” In my retirement vision, my children were independent, and my house was paid off, leaving me with minimal financial obligations. However, I soon realized I’d still need some money for enjoyable vacations and gifts for my grandchildren.
While many significant expenses are usually taken care of before retirement, retirees still have various financial obligations. Retirement isn’t just about painting classes or walks on the beach, despite what some advertisements might suggest. A 2016 study from the U.S. General Accounting Office found that retirees generally spend about 77% of what they did while working, with spending decreasing as they age. (See also: 9 Unexpected Expenses for Retirees — And How to Manage Them)
Let’s look at some retirement expenses you might not have considered, and how to address them.
1. Health Care
While other expenses tend to decrease after retirement, health care spending often rises. Currently, retirees aged 65 to 79 spend an average of $5,000 annually on health care, compared to $3,900 for workers aged 50 to 64, according to the same GAO report. Looking ahead, predictions for health care costs in retirement are concerning.
HealthView Services’ 2017 Retirement Health Care Costs Data Report anticipates medical costs will increase by 5.47% each year, meaning a 65-year-old today may spend $10,000 or more annually on health care by age 75, in addition to Medicare coverage.
“Health care will be one of the largest expenses during retirement. However, the savings needed might be modest, especially if you’ve used an income replacement ratio (IRR) of 75-85%,” the report states.
HealthView encourages discussing anticipated medical expenses with your financial planner based on your current health status. It’s also wise to position your retirement portfolio to meet health-related needs. For instance, some experts recommend using a health savings account for retirement medical expenses, but these are only available for individuals with high-deductible health plans. (See also: How an HSA Could Help Your Retirement)
Proactively managing health conditions can significantly reduce lifetime expenses. For example, “A 50-year-old male with type II diabetes can save an average of $5,000 annually in pre-retirement health expenses by moving from poorly managed to well-managed care,” says the report.
2. Taxes
While you might think your income tax burden will lessen or disappear in retirement, remember that withdrawals from 401(k) plans and traditional IRAs are taxable, as are most pensions and some Social Security benefits. If your plan includes rental income, that is also taxable. Additionally, if you’ve paid off your mortgage, you’ve lost a significant tax deduction from mortgage interest payments.
This tax situation often leads many workers to invest in a Roth IRA or Roth 401(k). Unlike regular retirement accounts, which are funded with untaxed income, a Roth involves income that has already been taxed, making withdrawals tax-free. Since future tax rates are uncertain, many advisors suggest diversifying investments across both account types. (See also: Here’s How Your Taxes Will Change When You Retire)
If you plan on making charitable contributions as part of your estate plan, consider discussing with an accountant a strategy for making these donations during your lifetime to maximize tax deductions and potentially reduce your tax obligations.
3. Inflation
While inflation has been low recently, the long-term average annual inflation rate is 3.22%. If you retire with savings and benefits designed to cover 80% of your current income, these funds will cover a smaller portion of your expenses each year unless they grow at a rate exceeding inflation. This is why financial planners advise against keeping your savings idle in cash.
In retirement, while you don’t want to take excessive risks with investments, being too conservative can lead to the erosion of your savings due to inflation. Low-interest rates make it unlikely that certificates of deposit will outpace inflation. For most retirees, having some investment in stocks, bonds, or other assets is essential. It’s crucial to stick with your investment strategy, even through market fluctuations. (See also: 7 Reasons to Invest in Stocks Past Age 50)
4. End of Life
When planning for retirement, you may dream of leisurely golf games or traveling, but it’s important to also prepare for potential end-of-life costs such as assisted living or nursing home fees.
Get an accurate estimate of the costs for assisted living and nursing homes. If you’re still young enough, consider long-term care insurance. Discuss with family members what their plans would be if you need additional care in the future. If long-term care seems likely, consult with an attorney who specializes in Title XIX planning to explore asset preservation options. (See also: Is Long Term Care Insurance Worth It?)
Healthcare expenses typically increase in the final years of life, often costing an additional $7,000 to $8,000 per year during the last two years. Consider prepaying funeral costs to alleviate this burden during retirement and consult an estate planner to ensure your wealth is distributed according to your wishes. (See also: 9 End-of-Life Cost Savings Your Survivors Will Thank You For)
5. Mandatory Withdrawals
Starting at age 70 and a half, you’re required to take minimum distributions from your IRA, 401(k), and other retirement accounts on an IRS-prescribed schedule. While this may seem straightforward, if you don’t need the required distribution, you’re still obligated to withdraw it and pay taxes, or face a 50% tax penalty on the amount you failed to withdraw.
Although you can’t change the IRS schedule for withdrawals or roll the distribution into another tax-deferred account, you can plan around it by adjusting your income and spending, potentially avoiding selling assets or cutting back work hours if you’re still employed. You can also invest your distribution outside of retirement accounts if you don’t need immediate access to the funds.
To manage mandatory distributions better, consider putting some savings into a Roth IRA, which has no required distributions. As you approach retirement, if it seems your IRA distributions will be larger than you can effectively use, discuss with a planner the possibility of converting a traditional account into a Roth.
