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How Much Does Retirement Cost? Tools & Sources

By Justin Pritchard, CFP®

When you stop working, the big question is whether you have enough resources for everything you want and need. So, it’s helpful to get realistic expectations of roughly how much retirement will cost.

Once you leave the workforce, you’ll likely live on a fixed income from Social Security or a pension, and you’ll supplement that income with any assets you’ve saved. But how much will you need?

Fortunately, you can make some reasonable estimates about costs during your retirement years. You certainly won’t predict expenses down to the dollar, and surprises can happen at any time, but making realistic projections is the best anybody can do in an uncertain world.

Your primary retirement costs consist of the following items, which will dig into below:

  1. Household spending: wants, needs, vacations, etc.
  2. Health care, including long-term care (LTC)
  3. Taxes on retirement income and withdrawals

As you might imagine, the categories above can get quite complicated, and they may change over time. Inflation will most likely cause costs to increase, and other factors will undoubtedly come into play. With that in mind, let’s get started.

General Spending in Retirement

In many cases, your retirement spending patterns are similar to your current costs—or that might be a goal to aim for. Ideally, you may want to continue with your current standard of living and avoid cutbacks. But your costs will almost certainly change when you retire.

If that sounds reasonable, there are several ways to estimate your retirement spending need. Unfortunately, none of them are perfect.

  • Replacement ratio: Pick a percentage of your current income. It might be lower than your gross income because you aren’t paying payroll taxes or saving for retirement. But going too low can be risky.
  • Current spending level: Look at how much you spend toda and assume you’d like to continue with a similar lifestyle.

Two ways to look at your current spending levels include a top-down and a bottom-up approach:

  1. Top-down: Start with your gross income from a pay stub or tax return. Subtract any money you add to savings (such as contributions to a retirement account or savings accounts). The remainder is total spending that went somewhere. You don’t necessarily know where, but you know you spent the funds on something. Some of it went to taxes, and those may change in retirement, so you may need to make some adjustments.
  2. Bottom-up: Review every transaction that represents spending. To find this information, go through bank accounts, credit cards, your check register, and other records. Be sure to account for infrequent items like annual insurance premiums.

Potential Changes

No matter what method you use, it’s important to recognize that costs will likely change when you stop working. For instance, explore some of the following (and more):

  • Will you pay off your mortgage, freeing up cash flow from principal and interest payments?
  • Will you travel more?
  • Will you spend less on work-related costs like commuting or dry cleaning?
  • Will your habits change, causing you to eat out more or less than before?

Some changes will surprise you, but you can anticipate many of them.

Other Sources of Information

You can also gather information about typical costs for retirees in different geographic areas. That might be helpful if you’re thinking of moving after retirement or just want to understand how you stack up to others nearby.

As just one source of information, you might consult the Economic Policy Institute. You can enter your geographic area and the size of your household. Then, you’ll get a breakdown of expected spending in different categories. Of course, your numbers won’t match perfectly, but this may provide valuable insight.

Inflation and Spending Patterns in Retirement

You’ll likely spend differently in retirement, and there’s research to back up that claim. The changes come from several sources, including inflation and lifestyle changes.

For starters, your retirement income needs to keep up with inflation, otherwise you lose purchasing power due to inflation.

As just one critical example, the price for one pound of chocolate chip cookies was $1.70 at the end of 1980. Fast forward 40 years, and that same treat would cost $3.79 at the end of 2020. That’s a relatively benign example, and housing costs might be more intimidating.

But retirees don’t always spend at a flat inflation-adjusted rate. Instead, some research suggests that you might spend at roughly inflation minus 1%. That’s David Blanchett’s conclusion with his retirement spending “smile” study. However, health care costs seem to increase at a rate that’s faster than inflation. As a result, those costs lead to a steep increase in spending later in life as health issues develop.

Another way of thinking about spending changes is the concept of retirement stages:

  • The go-go years: You just retired, you’re going to travel and enjoy life, and you’ll likely spend at a relatively high rate.
  • The slow-go years: You’re slowing down a bit, and you’ve done many of the things you dreamed of before retirement. Now, you’re more content spending time at home or with loved ones, and some activities are difficult. You likely spend less on entertainment and travel.
  • The no-go years: You find it challenging to participate in many activities, and managing your health consumes much of your time. You likely spend a substantial (and increasing) amount on medical care.

The theories above also show up in various surveys. For example, the Consumer Expenditure Survey conducted by the BLS shows decreasing spending over time (see Table 12). Studies from financial firms show similar results.

All of this points to looking at the big picture. Plan for rising costs, but remember subtleties in spending patterns. And health care costs need special attention, as we’ll discuss below.

Health Care Costs

Health care is one of the biggest unknowns in retirement, and it’s crucial to plan for significant expenses. But the amount you pay depends on a variety of factors. For instance, costs depend on your health conditions, location, age, and more.

Before Age 65

When you retire before age 65, you’ll likely need private health insurance. Even if you get retiree health care from an employer, it’s worth shopping around to get the best deal. You can often buy coverage through a Marketplace or Exchange affiliated with your state, and costs can vary widely. That’s because you might qualify for subsidies under the Affordable Care Act (ACA) if your income is low enough.

But you might use other methods to get coverage. For example, if you have a working spouse with health coverage through their job, it may be possible to join their plan. Or, you might continue your job’s coverage via COBRA or your state’s continuation program.

So how much will medical coverage and out-of-pocket costs be in retirement? Amounts are all over the board, but it’s worth doing some research. Start by looking at prices for health insurance in your state, and take note of your maximum risk.

If you’re hoping to qualify for ACA subsidies or tax breaks based on your income, play with this calculator from the Kaiser Family Foundation. You can enter your location, income, and household information to understand how different income levels impact your premiums. Of course, you need to verify those numbers with insurers.

Again, your age, health, and location all matter. You can see some national statistics from CMS here, but remember that these are broad averages. For instance, at age 65, your costs will likely be lower than costs for the “over 65” group. But in your later years, costs will almost certainly rise.

Fidelity also has some useful calculators. For example, if you’re a 60-year-old woman retiring today, total costs could exceed $13,000 per year if you pay full price. But after age 65, the expense is dramatically lower.

Medicare at 65

Most people become eligible for Medicare at age 65, although it’s best to research plans and enroll several months ahead of time. Once you’re covered by Medicare (and possibly a supplemental plan), your out-of-pocket costs may fall.

For example, a typical 65-year-old woman might expect to pay less than half as much each year as that 60-year-old woman. Of course, that’s counterintuitive if we expect health care expenses to rise as you age, but switching to Medicare changes things.

That said, Medicare doesn’t cover everything. In particular, dental, vision, and LTC costs are generally not covered. So, you’ll need to plan for those expenses. It’s wise to speak with an insurance agent specializing in Medicare as you approach this stage. Different plans can cap your risk, and you have limited opportunities to sign up for coverage.

Long-Term Care (LTC)

Potential LTC costs are one of the most challenging pieces of retirement planning. You don’t know if you’ll need LTC, much less how long it will last or what level of care. For example, will somebody come to your home and clean up periodically, or will you require skilled care in a facility?

While you can’t predict the future, you can run what-if scenarios and see how a health event might affect your finances. You can also think about sources of funding for LTC. For example, you might earmark retirement savings for LTC, tap equity in your home, use an LTC insurance policy, or have other resources that can provide cash.

One of the most robust sources for estimates on LTC costs in your area is Genworth’s Cost of Care study.

Taxes in Retirement

Taxes are another cost in your retirement years, and they might come as a surprise. Fortunately, many people pay taxes at relatively low rates in retirement. Still, taxes add some strain to your budget, and it’s critical to anticipate those costs. You might even be able to take steps to manage your taxes.

The taxes you pay depend on your income—and your sources of income. You can learn more about the topic in this 7-minute video, but withdrawals from your savings are a major factor.

Withdrawals From Savings

If you’ve saved money for retirement in 401(k), 403(b), IRA, TSP, and similar accounts, you’ll likely owe some income tax when you take distributions from those accounts. That’s the case when you make pre-tax or deductible contributions to your savings. You (or your employer) got a break while adding funds to the account, so you’ll pay tax when the money comes back out.

Plus, with pre-tax money in your accounts, the IRS may eventually force you to take required minimum distributions (RMDs). Those RMDs can get quite large, possibly bumping you into high tax brackets—which might be avoidable with some planning.

Income Sources

Your retirement income might also be taxable. Pensions are often included in your taxable income, which surprises some people. What’s more, even a portion of your Social Security retirement benefit could be taxable. That happens when your income exceeds certain levels.

Taxes are a nice problem to have, but it’s crucial to know about them ahead of time so you can plan for after-tax spending on all of the costs we’re discussing here.

So, how much will you spend on taxes during retirement? The best way to figure that out is to run some projections. A financial planner or your CPA can help you estimate your future income and tax liability, enabling you to understand how much remains for your wants and needs. Send an email if you’d like professional help with your retirement projections.