There are two prevalent assumptions about the cost of living in retirement. One is that most retirees can live on 70% to 90% of their pre-retirement income. Another is that that percentage will decrease (net of inflation) as we grow older.
Both offer some comfort when we look at the cost of a long retirement. And both are true in some respects, but they come with many caveats, and there are some important considerations to remember.
When it’s mostly true
First, let’s look at the true parts. Many people entering retirement will start out spending less than they did before retirement IF they have paid off their mortgage, have no child-related expenses, have lower health insurance costs due to Medicare, and are no longer contributing to retirement savings.
If they had high-cost work-related expenses (commuting, clothing, supplies, etc.), that would further reduce their expenses.
Some retirees downsize their homes (eliminating or reducing mortgage expenses and possibly taxes, insurance, utilities, and maintenance expenses). Others relocate to a place with lower costs of living. How much a household will save will vary significantly based on specific circumstances.
For some retirees, their charitable giving may go down when they first retire. Perhaps because they are using a tithe (10% of income) and have less income, or because they are concerned about running out of money or having something left for heirs.
Others will decide to ramp up their giving significantly.
I’ve written about giving in retirement, and my general take is that generosity should continue in retirement; it’s a waste of time to split hairs over what income is ‘tithable’ and what isn’t, and to instead give generously in proportion to whatever God has entrusted to you. Plus, you may be able to be more and more generous as you grow older and realize that you have more resources than you are likely to need in your lifetime.
When it’s not
Here’s how it can become untrue: Many retirees enter retirement with a mortgage and other debt, incur unplanned expenses, or just spend more on travel, a new car, or a boat.
According to the Congressional Research Service,
Debt among senior households (i.e., households whose head is 65 years old or older) has increased substantially in the past three decades. From 1992 to 2019, the share of senior households with debt increased from 43.0% to 62.1%, and the median amount of debt among older families with debt rose from $7,294 to $34,000 (in 2019 dollars).
The study also found that in 2019, mortgage debt for a household’s primary residence was the largest type of debt among aged households (in terms of total debt amount), and credit card debt was the most prevalent type of debt.
Another big factor is healthcare expenses. Although retirees may pay less for health insurance premiums once they are on Medicare, total health care spending will likely increase in retirement, if only due to the effects of aging.
Another reason many new retirees have higher expenses is that they spend more on travel and recreation than they did during their working years. And some in their 50s, 60s, and even 70s may be financially assisting their elderly parents who are not in their 70s, 80s, or 90s. They may also be financially helping their adult children.
There’s no reason to assume that the situation had gotten any better due to the pandemic and high inflation.
Do they decline over time?
There is some truth to the claim that our expenses decline as we age. A study by The Center for Retirement Research at Boston College found that retiree households spend about 0.7 to 0.8 percent less yearly in retirement. In English, that means after ten years, the expenses will have declined by 7.5% (not a particularly big number).
And a key factor not mentioned in the study (surprisingly) was inflation. Even if average annual inflation is low (say, 2.0 percent), that’s a 12.2% increase in living costs over ten years. Therefore, although retirees may spend a little less, they are also getting less for their money.
What doesn’t get cheaper?
Health care is the main thing that doesn’t cost less as we age. While spending for lots of other things may go down (before inflation), it’s the one that tends to increase steadily with age.
That said, health care isn’t a big one-time expense for most people (although it can be). The cumulative expenses of Medicare insurance premiums and out-of-pocket costs are incurred over several decades. (Some have suggested the total averages in the $300K to $400K range per person.)
Medicare premiums are relatively stable, whereas out-of-pocket (OOP) expenses are not. My wife and I pay for Medicare Part B, a “Medigap” supplemental insurance plan, a Part D prescription plan, and vision and dental plans. Altogether, our total cost of premiums is about equal to what I was paying before retirement for an employer-sponsored plan (which was not a high-deductible plan).
A study by T. Rowe Price (TRP) found that Medicare premiums with prescription drug coverage account for between 70% and 81% of annual healthcare costs for most retirees, regardless of their type of Medicare coverage.
As the study also pointed out, these payments are relatively predictable; they can be budgeted monthly. But on the other hand, OOP expenses can vary significantly from one person to another and are, therefore, more unpredictable.
Budgeting for OOP expenses is more challenging. TRP and others recommend maintaining a ‘health care fund’ as a savings account that can be tapped for such costs, much like other ‘sinking funds in your budget. It would therefore need to be replenished periodically.
The big wild card
Although some healthcare expenses are relatively unpredictable, long-term care is the real wild card among retirement expenses.
It’s estimated that around 60% of Americans will require some form of long-term care during their lifetime, which Medicare does not cover. This statistic, often utilized by long-term care insurance providers to promote their policies, encompasses a wide range of costs, from several thousand dollars that can be easily covered out of pocket to potentially “catastrophic” expenses that can’t.
As I’ve discussed in articles on Long Term Care Insurance, many retirees can expect no long-term care costs, some will have minimal costs, and an even smaller number will have above-average expenses.
In other words, most retirees may incur some LTC costs but will manage them without insurance, even if they have to take more drastic measures like tapping their home equity. Still, that leaves a significant percentage (perhaps 20 to 30%) of retirees expecting high, possibly catastrophic long-term care costs.
So, you may not have long-term care needs or only need care for a short time and experience manageable costs. Still, the possibility remains that you or your spouse might have catastrophic long-term care needs that could negatively impact your financial plans later in retirement.
LTC insurance is available but costly, especially if you try to get it after retirement. Wealthy people can self-insure (meaning they’ll be able to cover LTC expenses with savings). Those with scarce resources won’t be able to afford it. That leaves a large group in the middle with a decision to make about purchasing LTC insurance.
The longevity factor
Another crucial unknown factor affecting retirement expenses is our life expectancy. A shorter retirement will entail lower costs, potentially significantly so, compared to a longer retirement that extends into our late nineties. While studies show that some expenses tend to decrease as we age might provide some solace, longevity truly determines whether the cost of retirement will increase or decrease.
Given the possibilities of very long life and catastrophic LTC costs, expenses in retirement can be wildly unpredictable. Part of that risk depends on how you choose to finance it. Those who choose to forgo (or cannot afford) LTC insurance and choose to fund retirement with a stock and bond portfolio will have little control over those risks. Those with little or no savings may have to go the Medicaid route. The range of potential outcomes is quite extensive.
Households that insure against LTC and longevity risk by purchasing LTC insurance and life annuities will have less money to spend elsewhere but will avoid the worst-case outcomes and have more predictable expenses. It can be hard to tell if that’s right for you, so talks with a fee-for-service financial planner or advisor to get some recommendations.
Will they or won’t they?
So, will your total expenses decline as you age?
If you follow the biblical wisdom of contentment and moderation in all things, most retirees may at least be able to keep their spending constant at most income levels. The key for those with limited savings is to live frugally, be generous with whatever they have, and have a heart to serve others while trusting God for your ultimate provision.
If you stay healthy, there’s a better chance they’ll go down. But unfortunately, if you have high healthcare costs and uninsured long-term care costs, expenses can increase dramatically.
But if God has blessed you with a surplus, look for opportunities to “lay up treasure in heaven.” You can use some for yourself but don’t miss the opportunities for gospel-motivated generosity around you, even when times get hard.
Some research shows that retirees rarely run out of money, even when their risk-based investment portfolios are doing poorly. That’s because most retirees adjust their spending if they have any flexibility based on portfolio performance. In other words, when times are bad, the budget tends to be trimmed—and it may surprise you how much just a few minor adjustments in spending can improve your overall cash flow situation.
In other words, viewing your budget (and spending) as a variable rather than fixed, although there are fixed cost components (like the insurance premiums we discussed above), is best. Although certain expenses may naturally go down as we age, there may be times when we have to focus on spending less in certain areas. This will require discipline, intentionality, and sacrifice, but “[we] can do all things through Christ who strengthens [us]” (Phil. 4:13, ESV).