Accounting for Hidden Retirement Costs

In this series, we’re going to dive into the details you should consider when projecting income throughout your retirement years. While nothing is guaranteed, an early and comprehensive look at your income needs, coupled with a realistic look at the true costs you’ll see in retirement, can help assure a relaxing, enjoyable, and well-deserved retirement period.

In the series, we’ll look at three core aspects of a quality retirement income plan strategy:

1. Hidden costs you’ll encounter during retirement.
2. A lifelong approach to capital allocation we call the Three Bucket Strategy that you can start using today.
3. Identifying and mitigating income gaps during retirement.

Accounting for Hidden Retirement Costs

When weighing retirement costs, most focus on how they plan to spend discretionary income to maximize their golden years. Often, retirement expense planning centers around what vacations you’ll take, how you’ll renovate (or buy) your dream home, and how much cash you’ll allocate to your favorite hobbies that you never had time for during your working life.

But focusing on the fun parts of retirement spending can be a huge misstep in retirement income planning. While managing these discretionary expenses is important, and preferable to thinking about healthcare costs and taxes while you’re healthy and still in a 9-to-5 grind, overlooking major hidden expenses can mean those discretionary funds dry up faster than expected post-retirement.

Longer Life = Less Money?

Did you ever think that a long, fulfilling life is the biggest problem you’re facing today as you develop a retirement plan? It’s true – many of the current systems in place, like Social Security, account for much lower life expectancies than todays. In fact, the average life expectancy in 1935 (when FDR signed the Social Security Act) was 60 years for men and 64 for women. For those that broke the 65-year-old barrier, the minimum eligibility age, actuaries projected 12 – 14 years of Social Security income.

Today is different, as life expectancy has jumped nearly 15 years. Those hitting 70 will likely live until their mid-to-late-80s, putting substantial pressure on the system. According to 2023’s Social Security Trustees report, improved longevity looms large on Social Security and Medicare’s future:

In 2021, costs began exceeding income (more money paid to beneficiaries than taken in from workers). The Trustees expect that trend to be valid indefinitely under the current system.

The current pot of money, and its projected balance, will be exhausted by 2034, leaving all current and future beneficiaries in the lurch. Notably, last year’s report indicated 2035 as the point of no return – meaning the trend towards Social Security insolvency is accelerating. 

Inflation Nation

Most are all too familiar with inflation and its immediate economic impact. Many fail to consider, especially those on the younger end of the pre-retirement spectrum, that inflation over time can wreak havoc on income planning.

While you’re working, assuming a quality company and continual contributions to investment accounts, inflation isn’t a huge deal. Your salary likely keeps pace with inflation; if it doesn’t, you probably have the flexibility to explore other options. And, in the long run, stock market returns blow inflation away.

When you’re faced with a fixed income in retirement, though, and withdrawing from investment accounts faster than your capital grows, inflation is a serious issue. Tomorrow’s money isn’t worth the same as todays, and planning expenses using today’s purchasing power can devastate retirement. For example, if inflation averages 3% annually (a standard estimate), prices will double over 25 years. If you’re planning to retire at 65 and live another quarter-decade to 90, your healthcare, clothing, food, gasoline, and basic living costs double – did you account for that when you circled the “I can retire with this much in my investment account” figure? And, since prudent retirement investing usually demands cycling into reliable and steady fixed-income securities, your capital growth rate may not match inflation’s effects on your nest egg.

Unexpected Costs in Retirement

After decades of hard work, many plan their retirement income around basic needs and well-deserved niceties. It’s simple to calculate, for example, a baseline annual living expense total and tack on a few Hawaiian vacations or home renovations when you’re 30 and in good health.

But two key categories aren’t usually addressed: healthcare and tax expense.

Healthcare Costs in Retirement

But many overlook the sheer size and scope of late-life healthcare costs, and even fewer consider long-term care. A 2022 study found lifetime per-capita healthcare costs may be as high as $700,000, and a landmark 2004 research project indicated that “one-third of lifetime expenditures is incurred during middle age, and nearly half during the senior years. For survivors to age 85, more than one-third of their lifetime expenditures will accrue in their remaining years.”

Despite advances in medical technology, there’s little reason to expect the trend to reverse when we consider increased longevity and the bevy of ill health outcomes associated with advanced age.

Long-term care costs demand even more of your retirement income, considering they exceed the baseline expected healthcare expenditures. These costs range from relatively limited, like a few hours of in-home care weekly, to very pricy if you need private nursing home residency. While specific costs vary by location, consider this output from AARP’s long-term health care calculator for zip code 77380, a region whose household median annual income is slightly less than the national average:

For retirees needing moderate assistance, including a few home help weekly hours and a few days at adult day care, you’re looking at an annual $31,500 expense – in 2023 dollars before accounting for increased national overall costs and inflation. If you need greater assistance, including assisted living or private nursing home care, you’re left with an annual bill as high as $70,000:

While government programs, private insurance, and family assistance can offset these costs, the fact remains that they’re a massive demand on your post-retirement income and should be a core part of your planning efforts today – but they’re often not fully considered.

Tax Effects on Retirement Income

Finally, taxes often jump up to bite unsuspecting retirees in their golden years. Everybody’s tax situation is different, and variables include retirement account types, residency location, and additional retirement income streams like rental property or part-time jobs.

Often, retirees spend carefully according to their budget but get surprised with a whopping tax bill in April. In these cases, even the most diligent income planning is knocked askew. That can have devastating follow-on effects as each year’s additional tax expense dips into your reserves, forcing the sale of taxable assets and incurring another tax burden the next year – you get the point.

Tax nuances are a bit beyond the scope of this piece, but it’s best to work with a tax advisor during retirement income planning sessions to account for these nasty little surprises that often arise.

Conclusion

These are just a handful of considerations you should carefully weigh before you dive fully into planning your golden year vacations, whether it’s an annual Hawaii trip or transitioning to an RV life and traveling cross-country. While these expenses should form a major part of your plan, to be sure, a comprehensive retirement planning session should also account for managing hidden costs like healthcare and taxation.

We already demonstrated that Americans are living far longer today than when many social safety nets were enacted – make sure you’re able to maximize those additional years by working with your wealth manager to include these hidden costs.