It’s often said that “no matter how carefully something is planned, things may still go awry”. The saying is adapted from a well-known line in the Poem “To a Mouse” by Robert Burns. Perhaps Mr. Burns was in the process of retirement planning when crafting this poem? Regardless, its cautionary tone can be applied. As we work with clients helping them articulate and achieve financial goals, there are a number of areas that can be underestimated relative to actual spending.
- Helping family: several quarters past, we discussed this topic in “When Helping Hurts” (highlighting the moral hazard and personal risks that can be created by regularly helping able-bodied adult children) – that topic remains one of the most common potholes hit by clients. Those comments aside, you may be willing to slash your own expenses in retirement if times get tough, but what will you do if your children get in a bind? Saying “no” is hard. Also of critical importance, we regularly see a deficiency in the size of personal (non-retirement) account savings. Personal savings is a more tax-efficient source to utilize than retirement accounts when considering financial assistance. But be careful, as utilizing personal money to provide assistance reduces your own flexibility down the road; this should be carefully considered before offering assistance.
- Periodic Big-Ticket Purchases: it is easy to forecast what financial life should look like on a “normal” monthly basis. Yet few of us are disciplined – or perhaps “lucky” enough – to experience lots of “normal months” or years. Life happens! Folks often meticulously estimate day-to-day expenses but forget to factor in the periodic, but mostly predictable expenses like a new car, new furnace, or roof. Failure to build-in a cushion or allowance for these big-ticket purchases can result in actual Annual Spending Rates that run well ahead of projections and create emotional anxiety. It is also these big purchases and “lumpy” cash needs that can blow holes in a financial plan if one did not save post-tax during working years to supplement retirement saving. Lumpy withdraws from retirement accounts can quickly push one into a higher tax bracket and require larger distributions than if taxes were not due on the amount distributed. A better approach is to utilize personal money and/or spread withdraws for larger purchases over a multi-year period.
- Entertainment: many retirees assume that with kids out of the home and a mortgage paid off, their household budget will enjoy a dramatic trimming. Yet when retired, the desire to travel, visit adult children (and perhaps grandchildren), or pursue other hobbies results in a much higher leisure budget than during the working years. From our observations, leisure spending does not begin to meaningfully taper back until closer to age 80 or beyond, depending on health.
- Health care: even when insured by Medicare, folks are often shocked by the cost of health care. The average married couple in their late 60s can expect to spend $13,000+/year in medical related expenses when including deductibles, medicines, and etc. Prescription drugs are one source of surprise. Another revelation facing affluent retirees is that Medicare premiums are higher for couples whose gross income exceeds $170k. Again, if all your retirement savings is held in retirement accounts, your ability to manage taxable income below the threshold may be constrained.
- Long term care: this is perhaps the most costly unexpected expense in retirement. The biggest challenge relates to the nearly impossible ability to know who will require long-term care: 15% of folks will spend more than $250k on long-term care-related expenses during retirement years; while roughly 50% of retirees won’t spend anything at all. Married couples are at greater risk because of the increased probability of a long-term care event relating to joint lives, and also because of the impact such spending can have on the assets available to the surviving (and possibly still very healthy) spouse.
Living a long life – it is no mystery that the longer one lives, the more savings (personal and retirement) they will require. Often folks worry about dying young; but when it comes to retirement planning, the focus often becomes living too long and managing the consumption of savings!
From where we sit, underestimating spending in key areas is a BIG deal because forecasting incorrectly can mean the difference between a comfortable retirement and one that is a struggle. Further, while we take care to offset the potential for over-optimistic assumptions – by utilizing conservative rates of investment growth relative to the inflation of expenses and impact of taxes on distributions from traditional retirement accounts – this writing hopefully further illustrates why savers are very wise to be deliberate about building financial flexibility. Specifically, this means making after-tax, personal (non-retirement) saving an important priority – just as important as contributions to your retirement plan/accounts. The best, most “bulletproof” financial plans are those that feature not only pre-tax retirement monies, but also a meaningful non-retirement investment balance, that when added together translate to a low-sustainable spending rate from the outset of your retirement years.