3/29/2011 4:15 PM ET|
The hidden costs of retirement
Your plan looks good on paper, but did you think of everything? Be ready for these expenses, which are often unpredictable but always possible.
Cars, home appliances and the rising cost of college tuition are among the savings-depleting expenses that many people in retirement, or approaching retirement, may not be adequately preparing for.
Many people do not "do a very good job of estimating what they will spend in retirement," says Steve Johnson, a financial consultant in the Boston area for Charles Schwab.
Retirees or those about to retire may think they've covered the costs of future health care -- but have they budgeted for 30 years of exponential increases in prices? And what about in 11 other spending categories?
"People often vary on the extremes," he says. "We'll have clients who saved their entire life and have a very large nest egg but are always fearful about spending that. Then, conversely, you have those who really want to maintain the lifestyle they had in their 40s and 50s but don't have enough money. A lot of people don't have a target of how much they are really going to need in retirement, and they really don't have a plan."
Health care and long-term care are among many people's anticipated needs, but they are often underestimated given their exponentially rising costs.
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Housing, property taxes and maintenance
Housing is a major expected expense that may be under-assessed. Property taxes, and how they will increase over the years, need to be part of the equation. An aging house, coupled with the fury of Mother Nature, can mean unexpectedly large maintenance and repair bills.
"This has been a brutal winter. There have been a lot of storms, and people are now forced to add to their housing expenses in terms of costs for damage that has occurred because of the ice and the snow," Johnson says.
Utility costs are another rising expense that may not get enough consideration, as illustrated by the current, unforeseen spike in oil prices.
"If people do their budgeting, they might go look at how much they spend on utilities, food and various expenses," says actuary Steve Vernon, the author of "Recession-Proof Your Retirement Years: Simple Retirement Planning Strategies That Work Through Thick or Thin." "They forget they are going to be retired for 20 to 25 years or more. They are probably going to need one or two more cars during that time; they might need to replace the roof, or the washing machine might go out. All these unexpected but big things can happen. Look back over the past 20 years. How many cars did you buy? How many washing machines did you need to replace?"
Travel costs also add up, especially for retirees who base their plans on how often they used to get away while working. With more free time, there may be more desire to head to the airport and visit scattered family and friends.
The costs of family
Family matters also can drive up future costs, especially for grandparents who want to help out with a grandchild's college expenses. Many older people, years removed from worrying about tuition bills, may not appreciate fully how expensive education has become.
"It is not just college. We are seeing more and more parents choose private schools as well and looking for help from the grandparents," Johnson says.
Broader economic forces may be impossible to predict in detail, but they still need to be considered as part of a retirement strategy.
For example, inflation, current and projected, has a major impact on retirees living on a fixed income, Vernon says. A recent study by the Society of Actuaries found that, compared with other planning activities, only 72% of pre-retirees and 55% of retirees are calculating the effects of inflation on their retirement planning.
Only 5% of pre-retirees have a planning horizon to or beyond their life expectancy, and few individuals look 20 years or more into the future when making important financial decisions, the study says. Compounding inflation and savings concerns, 39% of pre-retirees and 36% of retirees withdraw money from their savings as needed with no set plan.
"Right now, people think inflation is down," Vernon says. "But look back 20 or 30 years -- did we have periods of high inflation? Well, yeah, and if you are going to be retired [for that long] you will have periods of high inflation and periods of a recession again. All you have to do is look back 30 years and count how many meltdowns we've had."
Even lacking a crystal ball, there are ways you can adjust your retirement strategy to make you better prepared for the curveballs that life and the marketplace throw at you.
Johnson says reducing debt, particularly a mortgage, is an important starting point.
"People in our industry sometimes say it is better to invest than pay down your mortgage, but we've seen the probability levels of enjoying a successful retirement go up really dramatically for those who have little debt compared to those who are paying down mortgages and have other forms of debt," he says.
Having some cash on the side for unexpected expenses "adds up across the board and allows people to have much better peace of mind," Johnson says. "We suggest that people have at least a year in cash for their living expenses and then, for those in retirement, having an additional one to three years liquid in instruments such as Treasurys or CDs. Even though they are not paying anything at this point, it is important that people have that on the side.
Vernon says many people project expenses only five years or so into the future, when they need to be thinking in terms of up to three decades.
"When they are working, a lot of people live paycheck to paycheck," he says. "As long as the monthly paychecks meet (your) mortgage and other bills, you are OK and you don't have to think out too far. But once that working paycheck goes away, then what? Then you need to start having a (longer) time horizon. It is just foreign thinking to a lot of people, but nevertheless that's what they need to do."
He suggests consulting with a financial adviser or at least using one of many retirement calculators available online to help get a grip on expenses and ultimate cash needs.
As a rule of thumb, he suggests looking back at your income and expenses over the years and then estimating how much income you will need annually above and beyond Social Security. Multiplying this number by 20, 25 or 33 offers some basic scenarios as to what your total nest egg needs to be -- the lowest number being generally applicable to those retiring later, the highest relating to those concerned about passing on assets to their heirs or to charity.
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