There's a reason we're told to save independently for retirement and not rely on Social Security alone. Typical retirees need 70% to 80% of their former income to pay their living costs once they stop working. And since Social Security will only replace about 40% of the average worker's pre-retirement income, it's up to us, as individuals, to fill that gap.
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But while the 70% to 80% range has long been a popular benchmark for replacement income, for many of us, it may not be enough. Data from the Employee Benefit Research Institute (EBRI) found that about 46% of households spent more money, not less, during their first two years of retirement. Not only that, but 28% of households spent more than 120% of what they did annually prior to retirement.
And it's not just a short-term trend. By the sixth post-retirement year, 33% of households were still spending more than they did at the tail end of their working years, with 23% continuing to spend 120% more. Furthermore, the EBRI study found these patterns to be consistent across all income levels -- meaning, it's not just the wealthy who tend to spend more once they stop working.
While a fair amount of this extra spending no doubt relates to entertainment and leisure (after all, retirees have far more free time on their hands and need to occupy it), certain expenses in retirement are far less negotiable. And if we don't save enough to cover those costs, a lot of us will be headed for trouble.
What will your retirement expenses look like?
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First, let's get one thing straight: Just because some people wind up spending more money in retirement doesn't mean things always work out that way. The aforementioned EBRI data even confirms that over 50% of retirees wound up spending less than they did during their working years. Since you no longer have to contribute to a 401(k) once retired, or pay to commute to work on a daily basis, it's fair to assume that you'll save a fair chunk of money in those areas alone. But there are other costs that might climb in retirement, and it's best to prepare and save for them ahead of time.
Take healthcare, for example. According to data from the Bureau of Labor Statistics, in 2014, seniors aged 65 to 74 spent an average of $5,956 per household on healthcare in retirement. That's nearly $500 a month. And if you think that's bad, get a load of this: HealthView Services, a provider of healthcare cost-projection software, claims that the average healthy 65-year-old couple who retired last year will spend a total of $377,000 on medical expenses in retirement. And don't gloss over the word "healthy" in there. If your health isn't great going into retirement, or if you develop a condition early on, your costs might climb even higher. Furthermore, these projections don't account for long-term care expenses, like nursing homes or assisted living facilities, which can be a major burden for seniors who haven't saved enough.
There's also housing to consider. Many people assume their housing costs will go down in retirement because they'll have paid off their mortgages by then, but more and more seniors are entering retirement with mortgage debt hanging over their heads. The Consumer Financial Protection Bureau found that the percentage of homeowners 65 and older with mortgages climbed from 22% back in 2001 to 30% in 2011. And among homeowners 75 and older, the rate more than doubled from 8.4% to 21.2%.
Even if you do manage to pay off your mortgage in time for retirement, you'll still have peripheral housing costs to contend with. History tells us that property taxes have a strong tendency to rise over time, even during periods when home values fall. Not only that, but the average homeowner spends 1% to 4% of his or her home's value on annual maintenance. If your home is older, there's a good chance you'll hit the top end of that range -- which, for a $300,000 home, means spending up to $1,000 per month on typical upkeep and repairs.
While you may be able to stretch your retirement budget by limiting leisure spending, you can't discount the possibility that you'll spend more on healthcare, and almost as much on housing, if not more, as a senior. But if you plan accordingly, you'll be in a strong position to cover those costs as they arise.
Start saving now
Whether retirement is a few years down the road or several decades away, the best way to protect yourself from the costs you'll inevitably incur is to save as much as you can, as soon as you can. Socking away $300 a month for retirement starting at age 40 will give you an ending balance of $197,000 in 25 years' time, assuming your investments generate a relatively conservative average annual 6% return. Increase that monthly savings amount to $500, and you'll have $329,000 to help pay your retirement expenses.
Even if you don't have much time before retirement, you can still do your part to save some extra cash. Workers aged 50 and older can contribute up to $24,000 a year to a 401(k) and $6,500 to an IRA. Max out that 401(k) for the next three years, and you'll have another $72,000 off the bat, not including potential investment growth.
No matter what steps you take to ramp your savings, don't get too comfortable with the idea of spending less once you stop working. It may very well be that despite your best efforts to live a frugal lifestyle, your retirement expenses end up costing far more than anticipated. If you don't save for that possibility now, you run a very real risk of coming up short.
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