Retirement Spending: A Reality Check for Your Retirement Dreams

Maybe it happens after you’ve had a hard day at work. We all have times when we slip into our daydreams. And lately, maybe yours are about retirement: dreams about a life of freedom - with no bosses and ample time to travel, to play, to volunteer, to learn…

It’s fun to dream about retiring. But our retirement dream has a price tag, and one of the most important things we can do as we work is to understand what this price tag will be.

The cost of our retirement, especially when the actual date is far into the future, is not easy to approximate and essentially is a mix of calculation and speculation. Nevertheless, an estimate of what we will spend is critical to our retirement planning calculations; the more thought out, the better the plan.

Of course, for many retirees, the size of their retirement income, not the dimensions of their retirement dreams, dictates their retirement lifestyle. Too late, they discover that taking action earlier on could have helped them develop sensible plans to realize their dreams.

Taking shortcuts. In the past, retirement planners figured that most of us spend less after we retire than we do while we’re working. They suggested using a simple planning shortcut, the spending replacement ratio—70 percent of what we spend while working—instead of bothering with thoughtful retirement expense forecasting. Today, the spending replacement ratio calls for 75 percent to 85 percent of pre-retirement income as a minimum.

Is it safe to assume that your expenses will be less when you retire? Is using a simple spending ratio a safe foundation for planning? What will your own retirement dreams cost, anyway?

At first glance, you might assume that expenses will decrease when you retire. After all, there’s no more commuting costs or need for expensive work clothes, or taxes for Medicare and Social Security. Maybe now you’ll save on household tasks - yard or home maintenance - that you were paying others to do.

However, research shows that a significant number of retirees spend at least what they did before retirement. Many spend more.

Reality check. Rather than relying on a rule of thumb for retirement planning, you should complete a carefully considered retirement spending plan, which compares today’s major expenses with costs expected during retirement, to measure the cost of your dreams. That way you can take actions today that will put your retirement dreams within your reach.

Retirement Expense Checklist

Taking a realistic look at your retirement plan and your expenses is a good starting point as you save toward your retirement dreams. Here is a checklist for you to use as a guide:

• Develop a retirement savings plan.
  • Manage spending. By developing a retirement savings plan and managing your expenses now, you will be able to save.
  • Travel and leisure. Many retirees place travel at the top of their list of objectives - count this dream into your retirement savings plan.
  • Gift giving. Giving monetary gifts to a family member or favorite charity is a consideration for many retirees.
• Examine how today’s decisions can impact future expenses.
  • Mortgage payment. As one of the largest monthly expense for a family, your mortgage payment can make a difference in how much you can save for the future.
  • Manage debt. By managing debt today, you save more toward your retirement goals.
  • Health care. The cost of health care in retirement could generate expenses for you - both planned and unexpected.
• Expect some costs to decrease in retirement.
  • Taxes. Social Security and Medicare payroll taxes typically decline in retirement, when earned income is usually lower or nonexistent.
  • Retirement contributions. In retirement, contributions may no longer be made to the retirement account.
  • Insurance. Life insurance might not be needed after retirement, possibly eliminating payments for this expense.
• Anticipate changes in the cost of basic living expenses.
  • Daily living expenses. The costs during retirement for basic living expenses will likely fluctuate.
• Plan for the inevitable.
  • Survivor costs. Consider the financial needs of surviving loved ones as you develop your retirement plan.

Develop a retirement savings plan:

• Manage spending. By managing your daily living expenses and eliminating debt, you’ll have more money to spend as you want in retirement. Whatever money is not needed for required expenses should be set aside for your retirement dream.
• Travel and leisure costs. When asked what they dream about doing when they retire, many people reply, “I want to travel.” Although there are budget-sensitive ways to travel, the costs for extensive travel is a new expense in retirement.
  Recent retirees do more traveling than those who have been retired for a few years because they are usually more fit, both physically and financially. If not done within a realistic budget, travel expenses can consume retirement funds.
• Gift giving. Many retirees who have been financially successful may wish to contribute to a grandchild’s education, or to make gifts to adult children or a favored charity. Sharing their gifts with family or a charity can be a tremendously satisfying capstone of their life’s dreams.

Examine how today’s decisions can impact future expenses:

• Mortgage payment. A mortgage payment is often a family’s single largest monthly expense, especially during younger years. Retirement spending rules of thumb assume that the mortgage will be paid by retirement age, but that is not always the case. According to the U.S. Census Bureau, in 2004 nearly a third of families age 65 still had a mortgage balance at age 65. There can be good reasons for high income, high net worth families to carry mortgage debt. However, for the average retiree, mortgage tax advantages are usually minor or nonexistent.
• Manage debt payments. Poor debt management can devastate retirement dreams. Many retirees must make debt payments out of limited retirement income. The New York Times, citing the Federal Reserve, reported that “as a group, people over 65 have the distinction of having not only the fastest-growing home debt, but also the fastest-growing share of personal bankruptcy filings.” The study reports that those age 65 to 69 had the greatest average percentage increase in credit card debt of any age.
• Health care costs. In retirement, the days of getting a generous employer contribution to our health care costs are over. For a couple who retires before Medicare eligibility at age 65, monthly health insurance premiums can easily exceed $1,000. Even after age 65, a Medicare supplement often exceeds $500 a month for a couple. Check with your benefits office at work to understand what the cost of health insurance will be under COBRA before age 65, and check with www.medicare.gov for an estimate of cost after age 65.

Expect some costs to decrease:

• Taxes. With no earned income, payroll taxes for Social Security and Medicare disappear. The FICA tax is 6.2 percent on gross compensation (to $97,500 in 2007) plus 1.45 percent Medicare tax, with no earnings limit. For example, someone earning $50,000 pays $3,825 this year, but will pay nothing in retirement if there is no earned income.
• Retirement contributions. One major expense that normally disappears entirely is retirement plan contributions. For those who are saving aggressively—as they should just before retirement—this change can be significant. Still, some retirees may need to save from their retirement income if they do not have significant cash for unexpected and occasional retirement.
• Insurance. Life insurance might not be needed after retirement, or at least not as large a policy as during the working years. Survivor pension benefits and retirement savings should combine to take care of dependents. (Other insurance, particularly health and perhaps long-term care, may cost a good deal more, however.)

Anticipate changes in daily living expense:

• Everyday expenses. Many assume that there will be lower costs during retirement for basic living expenses such as utilities, food, clothing, and commuting. However, retirement generally changes utility costs little and may even increase heating and air conditioning if more time is spent in the home. Food costs can fluctuate depending on whether or not meals are prepared at home. The clothing budget may increase for a time as the work wardrobe is replaced by casual clothes. And, commuting cost savings may be more than offset by leisure travel or the costs of going to volunteer work. Retirees may find that bargain shopping can reduce these costs.

Plan for the inevitable

• Survivor costs.For couples, however emotionally difficult, financial planning for survivorship is a necessary part of retirement planning. Understanding how the death of one partner will have an impact on both expenses and income, can lead to better decisions that will reduce money worries for a surviving loved one.
  

Dreaming is the first step to creating a realistic retirement plan. An important part of a retirement plan is to predict as realistically as possible what these dreams will cost.