This month we are tackling some of the most frequent retirement myths I encounter in my practice with new and prospective clients. This week we are going to look at the reality of retirement expenses.
I will have lower expenses in retirement - my income and expenses will both be fixed in retirement.
Many of us assume our spending will decline in retirement but this isn't always the case. I've noticed that the majority of my clients tend to experience increased expenses during the initial years of retirement. They often travel more, dine out frequently, and undertake home repair projects they had postponed due to time constraints. One common rule suggests people plan on needing about 70% to 80% of their pre-retirement income to pay the bills and this can be misleading, as every individual’s situation is unique.1, 2If you are uncertain about retirement income, it's advisable to aim for saving enough to replace your current income.
Now, I am not saying that many retirees do see their expenses go down in retirement, but in my experience, it doesn’t happen in the early years of their retirement. Some of the reasons that your expenses will be a bit lower in retirement are that you won’t be paying for things like commuting, work clothes, business lunches, or withholding for things like your 401(k), Medicare, or Social Security.
While you stop spending on certain things, the issue is that in retirement, other things quickly surface to replace those items you are no longer spending on. Many retirees travel more, and then there are uncovered medical expenses or higher taxes. The problem is that in retirement you have a lot more free time and you find new ways to spend that time. A lot of times those new things you begin doing involve spending more and more money.
Here are a few of the main reasons why your expenses could actually rise in retirement.
What many retirees don’t realize is that your travel expenses will likely rise especially in early retirement. You’re newly retired and excited to start on your next adventure which probably includes seeing places you didn’t have time to travel to while working and raising children. While you are no longer spending money on the cost of having a job, like commuting and the like, travel will more than exceed what you spent on a monthly basis.
Many retirees look forward to receiving Medicare because insurance and medical costs can be daunting. However, what many retirees don’t realize until they are using Medicare is that if you get very sick or need numerous surgeries your expenses will likely go beyond what Medicare covers. The other thing that many retirees don’t realize is that Medicare doesn’t cover many of the expenses employer-sponsored plans do cover like certain dental procedures, eye exams, hearing aids, foot care, and more
Another thing that many retirees don’t realize is that while your income may go down in retirement causing your marginal taxes to decline, the money in your retirement accounts will probably be much larger and could face larger taxes. For example, if you have a traditional IRA funded with pre-tax dollars, come Required Minimum Distribution (RMD) time, you may find that both your income and your income taxes rise.4 For this reason, I often encourage my clients to pursue Roth IRAs or Roth Conversions which are funded with already taxed dollars so you will not be required to pay taxes at the time of withdrawal.5
In addition, retirees don’t often realize that their Social Security benefits may be taxable if their income exceeds certain IRS thresholds. These thresholds are something I review in the very detailed process of retirement planning with clients.
Join me next week when we will talk more about how Social Security affects retirement.
Until next time…
One last thought: We believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share.
1Charles Schwab. "How Much of Your Income Do You Need to Replace in Retirement?"
3 Medicare.gov. "What's Not Covered By Part A & Part B.
4 Internal Revenue Service. "Retirement Topics — Required Minimum Distributions (RMDs)."
5 Internal Revenue Service. "Distributions from Individual Retirement Arrangements (IRAs)," Pages 27-28 and 35.
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