Plan now to manage these expenses later
Retirement planning, in many ways, is all about the rows and columns. How much money is coming in, how much is going out, and for how long. But far too often, some retirees and many pre-retirees don’t have a handle on what their expenses will be after age 65.
A new report from the Social Security Administration should, however, go a long way toward helping those who haven’t built a spreadsheet get a sense of where their money will go in retirement, and how much they might need set aside for various types of expenses.
So what does insights can be gleaned from the SSA Chartbook?
Housing is a budget buster
Most noteworthy is that housing is the largest component of the average retiree household’s expenditures. In fact, housing represents 35% of expenses followed by transportation (14%); out-of-pocket health care (13.2%); food (12.3%); entertainment (5.1%); and apparel (2.6%). Other expenses, such as alcohol, personal care, reading, education, tobacco, miscellaneous items, cash contributions to persons or organizations outside the household, personal insurance, pension contributions, and Social Security payroll taxes, accounted for 17%. And Social Security payroll taxes and pension contributions were small components of total expenses (3% and 1%, respectively).
To be sure, expenses—including that for housing—differ depending one’s income, sources of income, and age. For instance, those age 65 and older and who have earned income spend less on average on housing (33.6%) than the average retiree household; while those in the lowest income quartile (those with income of $16,207 or less) spend more on average (42.6%) than the average retiree household. And housing represented 34.9% (or $10,784) of expenditures for those age 65 to 74 and 35.9% (or $7,832) for those age 70 or older.
But no matter how you slice the data, the inescapable truth about retirement is that housing is year-in and year-out budget buster. It represents, if you want to use walking-around numbers, a good third of your expenses in retirement. What should you make of that?
Well, if you have designs on aging in place, some experts recommend that you minimize housing costs as much as possible. “It is so essential for retirees to minimize housing costs during retirement,” said Ron Rhoades, an assistant professor at Alfred State College, SUNY as well as the curriculum coordinator for the financial planning program at the very same school.
“Since many retirees desire to stay close to their family members, rather than move to more distant and often cheaper retirement housing destinations, a strategy every working American should have in place is to own a home, outright and with no mortgage or other debt, by the time they start retirement,” Rhoades said.
By doing so, he said, your home can also serve as a source of funds in retirement, through a reverse mortgage, should the need arise.
Don’t underestimate rising costs
If you do age in place, don’t overlook the rising cost of property taxes and maintaining your home. “With all the focus in the cost of health care, we may lose the awareness that housing is the biggest item in retirees—probably everyone’s—budget,” said Michael Lonier of Lonier Financial Advisory. It’s three times higher than out-of-pocket health care, three times higher than food, two and one-half times transportation, and two times ‘other.’”
According to Lonier, maintaining your home during your later years is just as important as maintaining your body. “It’s best to look after your roof and your basement as well as your heart and diet,” he said.
What’s more, he warned that rising property taxes, like rising health insurance, are the villains of inflation that can undermine retirement plans.
Don’t age in place
Others, meanwhile, advise against aging in place. “One way to plan for a secure and sustainable retirement income is to lower housing costs for the entire retirement period,” said a Kenn Tacchino, a professor at Widener University and the editor of the Journal of Financial Service Professionals.
According to Tacchino, housing costs may be unnecessarily high for the majority of consumers who choose to age in place. “This lifestyle choice may cause them to jeopardize financial security,” he said. The house that was suitable for raising a family may not be financially suitable for retirement living.”
He noted, for instance, that high taxes, extra home heating and cooling costs, and costly home maintenance can be mitigated by downsizing to a home that is more senior-friendly. “This constitutes a win-win for the retiree,” he said. “It frees up needed cash and it creates a safe and manageable environment.”
What’s more, he said, retirees can have their cake and eat it too; they can choose to remain near family, keeping the same church, doctors, and community. “Seniors need the courage to move to a living arrangement that suits their retirement budget,” Tacchino said. “Retirees who are house rich and cash poor must remember that counting on the home as an investment may be problematic because of the lack of liquidity and the lack of diversification, not to mention fluctuating housing prices.”
According to Tacchino, downsizing can, among other things, turn the equity in your home into cash that can be invested and/or used fund your retirement expenses. “Any retiree who can downsize and eliminate mortgage costs has already guaranteed a rate of return equal to the interest rate they used to pay to the mortgage company,” he said.
Don’t forget about health-care costs
Health-care costs, which—according to Rhoades—are largely contained at the moment thanks to Medicare, are another expense about which to worry. According to the SSA Chartbook, out-of-pocket health-care expenditures ranged from ranged from 5% of total expenditures for retiree households aged 55–64 to 14% for those aged 75 or older. And on average, in 2010, retirees spent $3,091 per year on health insurance premiums, $792 on medical services, $805 on prescription and over-the-counter drugs, and $158 on medical supplies.
In the main, however, Rhoades noted that the Medicare system now removes “most of the largest financial risk present” and that just 13% of seniors’ expenditures, on average, are for out-of-pocket health-care costs. “The saving grace for many retirees is the U.S. Medicare system, which was substantially enhanced with the addition of prescription drug benefits,” he said.
But health-care expenses as a percent of a retiree’s budget could change for the worse in the near future for at least two reasons. One, future changes to the Medicare system might increase the percent retirees spend on health care. And two, shocks and long-term care costs tend to dramatically change how much one spends on health care.
“Future efforts to restrain spending in this huge government program, including proposals to move to a voucher system, would likely greatly increase the financial burden upon seniors as to health-care costs,” he said. “It is doubtful that most seniors can afford any material increase in health-care costs.”
What’s more, he said those seniors with some discretionary funds—for entertainment, travel, or small gifts to family members—would likely see those discretionary funds used instead for health-care costs, should some of the current proposals floating around in Congress be enacted. “Now is the time for seniors to voice their concern to their elected representatives in Congress,” Rhoades said.
Others also expressed concern that health-care costs are problematic given potential changes to Medicare. “Whether Medicare and other insurance programs will continue covering some very expensive drugs will be an issue,” said Sherman Hanna, a professor at The Ohio State University and chair of that school’s undergraduate financial planning program. Hanna doesn’t expect real ‘death panel’ decisions soon, but he said the current policy direction would be to move us more toward the British National Health Service model with higher-income households having the choice to maintain life and/or quality of life by spending tens of thousands of dollars per year on prescriptions if Medicare cuts back because of efforts to control costs.
Beware long-term care costs
Rhoades also noted that Medicare doesn’t provide much in the way of support for the expenses of long-term care. “In that circumstance, many seniors who become impoverished turn to the states’ Medicaid system.” He said. “Many more are cared for by younger family members, often placing a huge burden on caregivers, and removing skilled workers from the workforce.”
His advice for those age 45 or older who have significant assets to protect against the ravages of long-term care, where facility costs often exceed $100,000 a year and much more in some states, is to consider long-term care insurance.
Rhoades also noted that roughly 40 states have “partnership programs,” in which qualifying long-term care insurance policies can protect a person’s assets, even if the length of stay in a nursing home or other long-term care facility exceeds two or three years.
Save early, save a lot
Overall, Rhoades said the SSA’s Chartbook paints a bleak picture of retirement. “Most senior Americans are ill-prepared for retirement and are, as a result, living on very limited incomes,” he said. “On a per capita basis, 73% of retirees spend less than $25,000 a year. Does this show frugality? Only in a mandated way, as most retirees have inadequate retirement savings to supplement their receipt of Social Security benefits.”
The SSA Chartbook also reveals, he said, that only 13% of senior Americans are spending $35,000 a year or more in retirement—a level which permits a greater opportunity to pursue long-awaited lifetime goals. Yet most of the income for those in this 13% upper level is derived from continued work, not from accumulated retirement savings.
His advice: “Workers today should be saving, starting in their early 20s, at least 11% of their gross incomes,” he said. “If they wait just 10 years to start saving, the individual’s rate of saving needs to approach 18%. And such saving should occur via vehicles which provide tax benefits, such as IRA accounts or which provide matching employer contributions, such as many 401(k) plans. And retirement savings need to be invested wisely, as well—in low-cost, diversified investments.”
And since most Americans are ill-equipped to undertake the strict personal expenditures budgeting process, discern the best method to save for retirement and other needs, and invest correctly, Rhoades recommends that consumers seek out trusted, fiduciary and fee-only advisers.
Two sources he recommended are the National Association of Personal Financial Advisors, and the Garrett Planning Network.
Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and a Featured Contributor here on the CIF blog.