How Much Does It Really Cost to Retire?
It’s a dream shared by most – finally hanging up our work hats and enjoying our retirement years. For many people, however, the dream of retirement can seem like an elusive oasis, a hazy, far-away spot on the horizon. Often, we don’t know how much money we’ll need or have a good plan to reach our retirement goal.
Understanding your retirement costs requires some educated guesses – because we don’t know how long we’ll live – and some careful planning to be sure you haven’t overlooked any potentially large expenses that can spoil your retirement plan.
How long do people live after retirement?
According to USA.gov, people in the US live an average of twenty years after retirement.[1] This statistic provides a useful starting point for planning but should be used as a minimum retirement length. Life expectancy is a moving target that can be influenced by several factors. In general, the trend is that life expectancy is increasing. Recent downturns in average life expectancy can be attributed to an increase in drug overdoses and suicides. Absent these risks, life expectancy continues to increase, largely due to medical advances. Many illnesses and diseases that were fatal in the past or reduced life expectancy can be successfully treated now.
It’s also important to consider what goes into an average. Low numbers are included as well, including the lower ages of those who died early in life. Using averages that include young deaths may not be useful for estimating life expectancy after retirement.
SSA.gov provides a life expectancy calculator that accounts for mortality risks early in life and increases life expectancy once you reach certain age milestones.
https://www.ssa.gov/cgi-bin/longevity.cgi
For example, a male who is 50 years old can expect to live 82.1 years as an average estimate. If that male reaches age 62, estimated life expectancy increases to 84.5 years. At age 67, life expectancy is estimated at 85.7 years and if that male reaches age 70, life expectancy increases to an estimated 86.5 years. For a female who is 50 years old, the pattern is similar with an estimated life expectancy of 88.5 years if that female reaches age 70.
If social security is part of your retirement plan, you’ll want to calculate the difference between when you qualify for full retirement benefits, currently age 67, and the estimated life expectancy based on reaching age 70. For people age 50, this is about 20 to 22 years. The numbers don’t change dramatically for younger people. For example, a male who is 20 years old can expect to live an estimated 88 years if he lives to age 70. This is 1.5 years longer than a male who is age 50 now.
While estimates can be a useful tool for determining how long you’ll live after retirement, it’s wise to pad the numbers when setting a goal. With a bit of luck and a healthy lifestyle, maybe you’ll be one of the people who brings up the averages by living longer than most.
We can work with an estimate of living 25 years after reaching retirement age. Using a lower number puts you at risk of running out of money at a time when it may be difficult or impossible find another income source.
How much income do you need each year?
Many experts use the “80% rule” to estimate retirement income needs. This rule of thumb states that to maintain the same standard of living in retirement, you would need an income equal to 80% of your income before retirement. Some financial planners stretch the 80% rule to include a range between 70% and 80%. There’s some room for flexibility depending on your ongoing financial obligations.
Some of the primary reasons that support a reduced income in retirement revolve around work-related expenses. More specifically, the absence or reduction of work-related expenses contributes to a lower income requirement in retirement. If you were putting a couple hundred miles on the car commuting each week, that expense goes away. You’ll probably drive much less. Other work-related expenses like dry cleaning, eating lunch out, and purchasing suits or dress clothes will also be reduced or might go away altogether.
Your taxes are also likely to go down in retirement. Specifically, FICA taxes which pay for social security and Medicare only apply to wages. Between those two taxes, you’ve recouped about 8% of your income if your retirement income comes from savings as opposed to wages. It’s likely that your income will be taxed differently as well. Income withdrawn from a traditional IRA is taxed as regular income while dividends are taxed at a lower rate. It’s possible that you’ll be in lower tax bracket overall because you’ll be drawing a lower amount of income.
It’s likely that you were saving for retirement during your working years. This monthly “expense” is no longer an expense once you’ve reached retirement. Depending on how much of your income you were saving during your working years, the monthly cash flow difference can be considerable.
The 80% rule also assumes that your mortgage will be paid off by the time you retire, eliminating one of the largest monthly expenses in most households. However, maintenance, home insurance, and property taxes will be ongoing expenses, as well as homeowner association fees if there’s an HOA where you live.
Calculating retirement income needs
If we assume that you’ll live for 25 years following retirement and that you can maintain a similar lifestyle on 75% of your prior income, splitting the difference between the 70% and 80% estimates, we can do the simple math.
25 x (income x 0.75) = annual income requirement
If you were earning $50,000 before retirement, you’ll need $37,500 per year. Over 25 years, that equals $937,500.
The simple math is a bit too simple, however. It assumes that your retirement savings isn’t growing at all while you draw down the balance.
If you allow for conservative growth of 8% and assume that you’ll be in the 22% tax bracket, you’d need less than $500,000 to last throughout your 25-year retirement. Theoretically, the balance is still growing as your investments post gains in most years.
We still haven’t accounted for inflation, though. Over 25 years, you can be certain a gallon of milk and a gallon of gas will go up in price, along with most other things. If you allow for a 3% rate of inflation which adjusts your monthly income needs by 3% each year, you’ll need $640,000 to provide income for your retirement.[2]
The math can get complicated if you have to account for both an average rate of return on investments as well as for annual inflation which will increase your income needs. There are several good online calculators that can help you do the math for your particular income needs.
Social security and other income
In the last example, we assumed the only income you would have is your retirement savings. The calculation ignores social security and any other types of income you might have, like investment real estate, pensions, annuities, or even part-time work. Any of these will reduce the amount of money you’ll need from savings because you won’t have to draw down your savings as quickly.
Social security often isn’t enough to live on comfortably, but it can take a bite out of your total income needs. In the earlier example, to retire after making an income of $50,000, you would need $3,125 per month ($37,500 per year). A 50-year old male making $50,000 per year would qualify for $940 per month at age 62. This is the lowest amount social security would pay assuming you’d worked consistently. If you wait until age 67, the monthly benefit is larger and continues to grow larger up to age 70 if you wait to take your benefit.
If you had $940 coming in from social security, your monthly draw down from your investment accounts can be reduced. The $640,000 of retirement investment savings from the last example will now last 30 years instead of 25. Alternatively, you can pay for 25 years of retirement with only $450,000 in retirement savings if you are earning $940 per month from social security.
Social security benefits increase if you wait before drawing your benefit, reaching the highest monthly payout at age 70. The $940 per month you would get at age 62 can increase dramatically if you wait until age 70 before drawing your benefit. At age 62, you would get about 70% of the benefit. Depending on when you were born, you may qualify for full benefits (100%) at age 66 or age 67. By waiting until you reach age 70 to take your benefit, you can increase your benefit to 124% to 132%, again depending on when you were born. By waiting, your income requirements from other sources, like your retirement savings, is greatly reduced.
You may also have income from other sources, like royalties, pensions, rental income, or even wages for part-time or freelance work. Every penny counts and will reduce the amount you need to draw down from your retirement savings, helping your savings to last longer and perhaps allowing you to enjoy some travel or recreation.
Other retirement expense considerations
There are a several expense categories that can significantly affect how much it will cost to retire.
- Housing costs: If your mortgage is paid off, you’ll be in a much better position. Retiring with 20 years left on the mortgage can be a heavy weight to carry. If you have enough equity in your home, it may make sense to sell the big house and downsize to a smaller home that you can pay off in full with the sale proceeds.
- Medicare: Depending on how many quarters you’ve worked and paid Medicare taxes, Medicare Part A can cost hundreds per month, or it can cost nothing. Medicare Part B currently has a monthly cost of $135.50 (or higher, depending on your income). Expect to pay deductibles for Part A and Part B as well. Medicare Part C and Part D also have monthly costs. The medical coverage that many people think is free can cost hundreds of dollars per month in some cases.
- Property taxes: If your mortgage is paid off, property taxes remain a consideration. In New Jersey, for example, the median property tax rate is nearly $7,000 per year. By contrast, South Carolina, West Virginia, Alabama, Mississippi, and Louisiana have median property taxes of under $700 per year. Choosing a state with lower property taxes can help you stretch your retirement savings.
- Long term care: Over half of the people turning 65 now will have a long-term care need in their lifetimes.[3] The statistics don’t discriminate by income, with all income groups having a similar need and long-term care needs often lasting about two years in duration. Long-term care can range from extended medical care to assistance with personal tasks such as bathing or eating. Costs can range from $20 per hour for homemaker services to over $200 per day for nursing home stays. Medicare won’t cover most long-term care expenses. When planning for your retirement needs, consider this expense in your cost estimates or investigate long-term care insurance options.
- Travel and leisure: Retirement is often a time when we take those trips we’ve always wanted to take or start a new hobby that’s always piqued our curiosity. Expect to spend more on travel and leisure activities.
Ways to reduce retirement expenses
The biggest change in retirement is often your source of income. Instead of decades of growing wages, this time in your life often has limited income. The challenge is to make it last and to save enough for life’s surprises, many of which cost money.
- Consider downsizing. The big house was great for a growing family. In retirement, a bigger home can be more expensive to maintain and often comes with higher property taxes. Be aware that selling a property costs about 7% of the selling price and buying a new property can cost 2% to 5% of the purchase price. However, in many cases, the move can still make sense – especially if you realize a significant savings on property taxes.
- Take advantage of senior discounts. You’ll find discounts for nearly everything from food and travel to clothing and auto services. In many cases, discounts are available beginning as young as age 50 or 55, so you can begin saving money with senior discounts even before you retire.
- Pay attention to your frequency of spending. We all like a treat now and then. When you’re working, there’s always more money coming in the next week or next month that will help cover your indulgences. When you’re retired, however, financial resources are finite. If you used to get a pizza every Friday night and go to the movies every Saturday, consider moving to a less frequent schedule to reduce your dining and entertainment budget. Living beneath your means is important regardless of age but becomes especially important during your retirement years.
- Avoid debt. It’s common to carry some debt during our working years. During retirement, however, you won’t want to spend part of your life savings paying interest on credit cards, auto loans, and other types of debt. Plan and save for purchases out of your monthly income streams and look for ways to reduce purchase costs, like buying pre-owned cars when your car needs to be replaced or even buying pre-owned household items, like computers or phones.
How much it will cost to retire depends largely on what type of lifestyle you want to maintain. In many cases, it’s possible to still enjoy the nicer things in life but doing so less frequently will help your savings to last. Experts still recommend planning to replace 70% to 80% of your pre-retirement income with other income streams, including social security, pensions, retirement savings, investments, or other income sources. However, with some discipline both before retirement and during retirement, you’ll be able to put yourself into a stronger position to make your retirement savings last and you may be able to get by just fine on much less than you earned during your working years.