When planning for retirement, many retirees believe their expenses will decrease by as much as 20% to 25% as soon as they stop working.  Others believe the amount they spend in retirement won’t change but rather what they spend it on will.  A recent article in US News by Tom Sightings on the Yahoo Finance website indicates that both assumptions may be wrong.  Mr. Sightings’ review of the trends in retirement spending suggest the reduction in expenses is not a sudden drop but more gradual.  In a study by the Employee Benefit Research Institute household expenses decline by 19% during the first ten years of retirement between the ages of 65 to 75 as housing, travel, taxes and transportation costs decline.  Retired employees no longer need to purchase work clothes for the office, commute and child care are usually expenses that cease with retirement.

Furthermore there is a drop in Payroll taxes  – Social Security and Medicare decreases expenses on income by almost 7.65%. In 2013 the US government estimates the average cost to own a car is about 61 cents per mile and according to AAA the average cost to own a car is $9,122 in 2013.  So reducing the mileage because you no longer drive to work saves about 61 cents a mile.  For the working poor commuting consumes between 6 and 9 percent of income whereas for higher earners it is 3 to 5 percent*.  However, a reduction of 3 to 5 percent plus the 7.65% for payroll taxes paid directly by workers equates to 10 to 13% reduction in costs just from these two items.  Furthermore people no longer have to save for retirement so those funds are also freed up.  Per the 2013 US Department of Commerce, Bureau of Economic analysis Americans on average save 4.6% of their income.  So if we assume people do not have to save for retirement during retirement then the cost of saving for retirement decreases by about 4.6% for about a 15 to 18% reduction in spending from these few factors.

Now that does not explain it all.   The study shows that as activities decline so do expenses which explains the total of 34 percent decline in household expenses by age 85, according to a study by the Employee Benefit Research Institute.  The same study showed that the largest expenses in retirement are the following:

1. Housing. This remains the largest expense in a retiree’s budget, just as it probably was before you retired. People over age 50 spend an average of 40 to 45 percent of their household budget on housing and housing-related items such as utilities, home insurance, home furnishings, gardening and yard expenses, EBRI found. Many people retire to low cost of living environments such as Florida which helps to reduce costs of living even further.
2. Health care. This category of expenses tends to increase with age. Even if you have good health insurance you’ll likely face increasing out-of-pocket costs for medical procedures and tests, as well as both prescription and non-prescription drugs. And don’t forget dental expenses, which also tend to go up as we get older. Health care costs typically swell up from 10 percent of income for those in their 50s to 20 percent for people in their 80s. One option to consider is long-term care insurance, which will cost you money in the short term, but may save you from spending down all your assets if you need extensive nursing or assisted-living care. It is estimated that 80% of life time health care expenses are consumed in the last few years of life and much of that is for long term care so purchasing insurance prevents this expense should create a cap for this expense.

One of the best ways to reduce health care costs in retirement is to stay healthy.  We have written in the past about studies showing a $600,000 and more difference between healthy senior medical costs and those who are not healthy.  Furthermore, the quality of life for someone who is healthy is superior.

Health maintenance is a marathon (life time occupation) not a sprint where you can try and be healthy in spurts.  You really cannot stop working at it and expect to be healthy in a few years later.

Also, the exercise and activities that keep a 5 year old, 20 something, 30 something, 40 something, fifty something and sixty something are different.  There are studies from the 1980s where Olympic athletes in their twenties tried to emulate a two year old and the Olympic athletes did not have the energy.  A fifty year old cannot perform like a twenty year old and will cause more damage to their body trying to.  Also recent studies show that healthy weight for an eighty year old is much greater than for someone sixty or younger.  Common sense in this approach is important.

3. Taxes. You’re no longer subject to payroll taxes once you stop working, but you may still have to pay income tax on a portion of your Social Security benefits as well as income you receive from investments and withdrawals from your IRA. In addition, some states tax Social Security and pension incomes so you can reduce taxes by avoiding living in high tax states for retirees. Massachusetts is a high tax state for retirees.
4. Transportation. You will save on commuting costs after you retire, but you still have to get around. Even with the recent lower price of gasoline, it costs almost 61 cents per mile to drive your own personal vehicle when you factor in insurance, maintenance, repairs and depreciation. One way to save is to downsize from two cars to one car. In some neighborhoods with good public transportation it’s even possible to go carless. Many retirement communities offer greater access to public transportation.
5. Travel. Many retirees, especially younger retirees, say that travel is one of their top priorities. A survey by Allstate found that baby boomers’ most desired activity is travel, and on average they plan to spend $7,700 annually, taking four trips a year. This is obviously a discretionary expense, and the one you have the most control over. You can travel as much as you want, or not at all, and you can stay at a five-star hotel, or you can stay over with the kids. It’s all up to you.

The above discussion is provided to assist you with comprehending the costs and savings of retirement.  You have total discretion on how that retirement looks like and making choices today greatly influences the look and feel of your retirement.

* Per: Robert Puentes, a senior fellow at the Metropolitan Policy Program for the Washington, D.C.-based Brookings Institution

Sources:

Put a lid on your 5 biggest retirement expenses

Cost of vehicle ownership

Cost of commuting