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How much will you really spend in retirement?

by Susan Wright | Contributor
June 9th, 2021


Although your current financial professional may have alluded that your expenses in retirement will be lower than during your working years, this is not necessarily the case. Unfortunately, though, this is what many investors believe – and plan ahead for – until they get an unpleasant surprise when it’s too late to go back and alter their savings.

The reality is that there are some future expenses that will likely decrease, or possibly even disappear altogether when you retire. But there are other costs that can go up – particularly those that are health care related, as well as other expenses that are associated with fun activities like travel and entertainment.

In addition, with people living longer lives (on average) now, not only will your income in retirement have to cover your essential and non-essential expenses, but it will have to increase over time and last for what could be two or more decades after you have left the working world.

One of the best ways to ensure that your income won’t run out in retirement is to come up with an estimate of the expenses you will have, as well as the sources of where that cash flow will be coming from. Then, if there is a “gap,” you will have time to plan for it by either reallocating your outgo in retirement and/or adding one or more additional income streams.

Which expenses will change in retirement?

Many people assume that expenses will go down substantially in retirement. But they don’t always do that. In fact, your out-of-pocket costs will oftentimes go up after you have left the world of employment – particularly on items like health care, vacations and entertainment. (Remember, every day is Saturday in retirement!)

As a result, saving and financial planning should not be based on the false belief that living in retirement is cheaper. Rather, you should plan ahead, based on which expenses are likely to go down in retirement, and which may go up.

Because everyone’s retirement goals and lifestyles can differ, though, it is important to come up with an expense and income generation plan that is designed specifically for you (and your spouse, if applicable).

Overall, there are some expenses that will typically go down for most retirees. These can include:

  • Savings
  • FICA taxes
  • Mortgage payments (in many cases)
  • Taxes (especially if you are generating less income in retirement)
  • Transportation (work- or business-related)
  • Dry cleaning and other work-related expenses
  • Insurance premiums (in many cases)

On the other hand, many retirees could see an increase in expenses, such as:

  • Vacation, fun and other “non-essentials”
  • Hobbies
  • Country club dues
  • Health care and medical expenses
  • Gifts for loved ones
  • Support for children and/or other loved ones in need
  • Inflation-related price increases
Expenses that usually decrease in retirement Expenses that usually increase in retirement
Expenses that usually decrease in retirementSavings is no longer necessary in retirement Expenses that usually increase in retirementVacation, entertainment, travel and fun expenses
Expenses that usually decrease in retirementFICA payments go away, as you will no longer incur this payroll tax that builds up your credit for Social Security benefits Expenses that usually increase in retirementCosts related to hobbies (such as golf, country club, bicycle riding, etc.)
Expenses that usually decrease in retirementHome mortgage balance may be paid off Expenses that usually increase in retirementMortgage and other expenes for a second / vacation home
Expenses that usually decrease in retirementTaxes will decrease - provided that income is also lower and tax rates remain the same Expenses that usually increase in retirementHealth care and medical costs
Expenses that usually decrease in retirementTransportation costs may be reduced due to less driving Expenses that usually increase in retirementGifts for family members
Expenses that usually decrease in retirementWork-related costs will usually be eliminated (such as clothes, dry cleaning, lunches out, etc.) Expenses that usually increase in retirementSupport for adult children (if applicable)
Expenses that usually decrease in retirementInsurance premiums could be reduced (especially if you have premium-free Medicare Par A, lower life insurance benefits, and auto insurance that is based on driving fewer miles) Expenses that usually increase in retirementHigher price of items and services you need (such as groceries, gas, etc.) due to inflation

Some of these expenses, such as health care and medical costs, are typically out of your control, while other costs – like those for vacations and entertainment – may be reduced, or possibly even eliminated. So, planning ahead can make a big difference in how you fare financially – even in the event of the unexpected.

For instance, according to a recent survey by Fidelity Investments, the average 65-year-old couple who retired in 2021 can expect to pay approximately $300,000 in out-of-pocket health care costs throughout their remaining years.

For many people, this figure alone can equate to a lifetime of savings – or possibly even more – and it doesn’t even include the cost of a long-term care need, which could easily add several thousand dollars per month (or more) to the tab.

2020 monthly median cost of long-term care in the U.S.

In-home care Community and assisted living Nursing home facility
In-home careHomemaker services: $4,481 Community and assisted livingAdult day health care: $1,603 Nursing home facilitySemi-private room: $7,756
In-home careHome health aide: $4,576 Community and assisted livingAssisted living facility: $4,300 Nursing home facilityPrivate room: $8,821

One way to help with defraying these costs is to purchase long-term care insurance coverage. Likewise, enrolling in original Medicare or a Medicare Advantage plan could keep your out-of-pocket health care expenses lower.

How much is your retirement income impacted by inflation?

Consider how the cost of everyday items like a gallon of milk, a gallon of gas, and a loaf of bread have increased over time. With that in mind, it is absolutely essential that you factor inflation protection into your retirement income plan. Otherwise, you could lose purchasing power.

1970 1990 2020
New home 1970$23,450 1990$123,000 2020$288,600
New car 1970$3,450 1990$16,950 2020$37,851
Gallon of gas 197036 cents 1990$1.34 2020$2.17
1 lb. hamburger meat 197070 cents 199089 cents 2020$3.95
Loaf of bread 197025 cents 199070 cents 2020$1.40

As an example, using an average inflation rate of just 3.2%, your retirement income would have to double in 20 years in order to just keep pace with the rising cost of the goods and services that you need. So, if your initial monthly income in retirement is $4,000 it would have to increase to $8,000 per month 20 years later in order to keep your purchasing power on track.

Have you planned your retirement income according to the wage replacement ratio?

One strategy for narrowing down how much income you will need in retirement is to use the wage replacement ratio. The wage replacement ratio, or WRR, refers to the annual estimate of how much money you will need during your retirement years, along with the amount that you should be saving in order to reach that objective. This is usually expressed as a percentage of your pre-retirement income that will be needed in retirement.

Because not everyone has the same goals and time frame until retirement, the WRR can differ from one person or couple to another. However, it can be extremely beneficial for helping you to determine whether or not you are far off course.

So, it can still be a good tool for helping you estimate your future income needs after you’ve retired. In this case, the annual income that is associated with the wage replacement ratio is typically increased every year by the rate of inflation.

Having an approximate estimate regarding your income in retirement can help you with determining an appropriate allocation of assets – as well as the type(s) of investments – that may work best for your specific needs and objectives.

For instance, if you are planning to be retired within the next couple of years, investing in growth-oriented – but risky – stocks or mutual funds may not be the best answer. This is because if you suffer a loss due to a market downturn, you may not have enough time to rebuild your portfolio on or before your intended retirement date.

This means that you will likely have to spend less (in turn, reducing non-essential expenses, and possibly even some of your essentials) and/or postpone your retirement date until you have replenished your funds and achieved your ultimate savings goal.

So, how exactly is the wage replacement ratio calculated?

There are actually a few calculations that need to be made. As an example, if your pre-retirement income is $100,000 and you assume that your expenses in retirement will be roughly 80%, then based on the WRR, you will require $80,000 in income during your first year in retirement.

Pre-Retirement Income x .80 = Year One Replacement Income

Pre-Retirement Income x Annual Rate of Inflation (Added Per Year) x .80 = Replacement Income for Each Subsequent Year

Then, for each year after that, the inflation rate is factored in. Therefore, if inflation is 3% for that year, your income for the second year of your retirement should be $82,400 (which equates to a 3% cost-of-living “raise”).

Year 1 of Retirement Income: $80,000

Inflation Rate: 3%

Year 2 of Retirement Income: $82,400

Where will your retirement income be generated from?

In many cases, retirement income is generated from more than just one source. Some of the most common sources of incoming cash flow for retirees include:

  • Employer-sponsored defined benefit pension plan
  • Social Security
  • Personal savings and investments

Employer-sponsored retirement plan

While many employers have done away with traditional pension plans, there are some that still provide these to retirees. The benefits that are paid out from these plans are typically computed using a formula that considers several factors, including:

  • Length of employment
  • Salary history

In the case of defined benefit pensions, both the employer and the employee know how much income will be paid out. However, it is the employer that takes on all of the risk in these plans. So, if the underlying investments perform poorly, the employer will still be responsible for paying the benefits to its retired employees.

Depending on the plan, income may be paid for the life of the retiree – and in many cases, income will continue for a surviving spouse when the worker/retiree passes away. (The dollar amount of the income may either stay the same or be reduced for the surviving spouse).

While some of the federal government pension plans are indexed for inflation, many private-sector workers who retire on fixed pensions do not receive regular “raises.” Therefore, purchasing power can be reduced over time. So, in the event of a retirement that lasts for many years, it will either be necessary to reduce expenses or to increase income that is generated from other sources.

Today, many defined benefit pension plans have been “replaced” by defined contribution plans, with the most popular being the 401(k). While there are some tax-related benefits that may be garnered from these plans, though, it is up to the individual employee to convert what has been saved into a stream of income in retirement.

Social Security

If you and/or your spouse are eligible for Social Security retirement income, these benefits could replace a significant portion of your pre-retirement wages. In fact, according to the Social Security Administration, for an average wage-earner, Social Security will typically replace about 40% of earnings. (For higher wage earners, this replacement percentage is less.)

Social Security retirement income benefits are paid out for the remainder of your lifetime. If you are married, your spouse may qualify for these benefits, too – even if he or she did not work outside of the home.

Typically, if a worker/retiree files for Social Security benefits at full retirement age (FRA), an eligible spouse will be entitled to a benefit in the amount of half of the worker’s amount. So, for instance, if a Social Security recipient is entitled to $2,500 per month, his or her spouse could claim $1,250 per month in benefits.

Year of birth Minimum retirement age for full benefits
Year of birth1937 or before Minimum retirement age for full benefits65
Year of birth1938 Minimum retirement age for full benefits65 + 2 months
Year of birth1939 Minimum retirement age for full benefits65 + 4 months
Year of birth1940 Minimum retirement age for full benefits65 + 6 months
Year of birth1941 Minimum retirement age for full benefits65 + 8 months
Year of birth1942 Minimum retirement age for full benefits65 + 10 months
Year of birth1943 to 1954 Minimum retirement age for full benefits66
Year of birth1955 Minimum retirement age for full benefits66 + 2 months
Year of birth1956 Minimum retirement age for full benefits66 + 4 months
Year of birth1957 Minimum retirement age for full benefits66 + 6 months
Year of birth1958 Minimum retirement age for full benefits66 + 8 months
Year of birth1959 Minimum retirement age for full benefits66 + 10 months
Year of birth1960 or later Minimum retirement age for full benefits67

If Social Security is claimed before full retirement age, the dollar amount of the benefit will be permanently reduced. (These benefits can be filed for as early as age 62). However, if benefits are not claimed until after FRA, the amount will be increased. For every year that you wait between your full retirement age and age 70, you can earn a “raise” of 8%. This is referred to as a delayed retirement credit.

In addition, Social Security retirement income benefits will also typically increase each year to help recipients keep their purchasing power on pace with inflation. While these cost-of-living adjustments (COLAs) are not guaranteed, benefits have gone up in most years.

Social Security cost-of-living adjustments (COLAs)

Year COLA %
Year2021 COLA %1.3
Year2020 COLA %1.3
Year2019 COLA %1.6
Year2018 COLA %2.8
Year2017 COLA %2.0
Year2016 COLA %0.3
Year2015 COLA %0.0
Year2014 COLA %1.7
Year2013 COLA %1.5
Year2012 COLA %1.7
Year2011 COLA %3.6
Year2010 COLA %0.0
Year2009 COLA %0.0
Year2008 COLA %5.8
Year2007 COLA %2.3
Year2006 COLA %3.3
Year2005 COLA %4.1
Year2004 COLA %2.7
Year2003 COLA %2.1
Year2002 COLA %1.4
Year2001 COLA %2.6
Year2000 COLA %3.5

Personal savings and investments

Retirement income may also be generated from personal savings and/or investments. There are many different financial vehicles that can generate an income stream. These may include bonds, CDs, and dividend-paying stocks. Another option is an annuity.

Annuities are designed for paying out a regular stream of income, either for a pre-set period of time, like 10 or 20 years, or even for the remainder of your lifetime – regardless of how long that may be.

In many cases, funds that have been saved in an employer-sponsored retirement plan – such as a 401(k) – and/or IRA (Individual Retirement Account) will be “rolled” into an annuity so that they, plus interest, can be paid out in the form of a retirement income stream.

While the ongoing, lifetime income from an annuity can be enticing, though, annuities can be somewhat complicated. Plus, all annuities are not exactly the same. So, it is important to understand what it is you are committing to. Working with a retirement income specialist can help.

Is your retirement income plan ready if expenses go up in the future?

It is essential to understand how expenses can change during retirement so that you can formulate the proper spending plan and long-term outlook. Having a definitive retirement income plan in place can help you with getting your essential expenses paid, along with various non-essentials that can help you with enjoying your time in retirement.

Talking with an Alliance America financial professional can help you with determining how much income you will need in the future, as well as ensuring that the amount of your retirement “paycheck” will increase over time to help your purchasing power keep pace.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial planners and retirement income certified professionals can assist you in maximizing your retirement resources and help you to achieve your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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