Don’t Retire Blind! The Ultimate Guide to Estimating Your US Cost of Living!

In planning for your retirement, it’s crucial to have a good handle on the potential cost of living. Without a clear understanding of these expenses, there’s a risk of either outlasting your savings or compromising your lifestyle. Calculating your retirement cost of living can be a bit tougher than you thought, so you may want to consider seeking guidance from an investment advisor portfolio manager. They can assist you in figuring out what elements to include in your retirement budget, helping to ensure a more effective and secure financial plan for the future.

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Retirement Spending Risks

There are numerous risks that have the potential to increase your expenses and jeopardize your financial stability in retirement. Here are seven common risks that you need to be vigilant about:

Healthcare Costs: One of the foremost risks during retirement is the potential surge in healthcare expenses. Unanticipated health issues or ongoing medical conditions can result in higher medical bills, increased prescription costs, and long-term care expenditures.

Inflation: The gradual increase in the cost of goods and services, known as inflation, poses a risk to the purchasing power of your retirement savings. Even at a moderate rate, inflation can make it more expensive to maintain the same lifestyle. Failing to keep retirement income in line with inflation may pose challenges in covering essential expenses.

Longevity Risk: Living longer than expected can strain retirement finances. Underestimating life expectancy may lead to the depletion of savings or income sources before the end of life, resulting in financial challenges in later years.

Market Volatility: Investments in retirement accounts are susceptible to market fluctuations. A significant downturn in financial markets can diminish the value of retirement portfolios, impacting income from investments like stocks, bonds, and mutual funds. Retirees relying on these investments may face challenges if the market performs poorly.

Sequence of Returns Risk: The order in which investment returns occur during retirement can significantly impact a retiree’s portfolio. Poor market returns early in retirement can deplete savings more rapidly as funds are withdrawn for living expenses, leaving fewer assets to benefit from potential market rebounds later.

Unplanned Expenses: Unexpected costs, such as major home repairs, family emergencies, or unforeseen events, can substantially increase retirement spending. Maintaining a contingency fund or emergency savings can help alleviate the impact of these expenses.

Changes in Lifestyle or Needs: Personal shifts in circumstances or desires, such as adopting new hobbies, increased travel, supporting family members, or relocating, can unexpectedly raise spending during retirement.

Taxation Changes: Alterations in tax laws or regulations can potentially affect retirement income and withdrawals, impacting the amount available for spending during retirement. Staying informed about taxation changes is crucial for effective financial planning.

Effectively managing these risks requires meticulous planning and a comprehensive strategy. Key elements include diversifying income sources, ensuring adequate insurance coverage, routinely reviewing and adjusting retirement plans, and maintaining a flexible approach to adapt to changing circumstances. A proactive and adaptable approach is essential to navigate the complexities of retirement and mitigate potential financial challenges.

What to Include in Your Budget for Retirement

Constructing a budget stands as a vital pillar in the financial planning process for retirement. It’s crucial to take into account various types of expenses to formulate a comprehensive financial plan. Here is a list of common expenses to scrutinize when crafting your retirement budget:

Basic Living Expenses: This category encompasses housing costs (mortgage/rent, property taxes, maintenance); utilities (electricity, water, gas, trash, internet, phone); groceries and household supplies; transportation (car payments, insurance, fuel, maintenance); and insurance premiums (healthcare, life, long-term care).

Healthcare Expenses: Typically, this includes health insurance premiums, deductibles, and copays; prescription drugs and over-the-counter medications; dental care and vision expenses; and medical equipment or aids.

Entertainment and Leisure: This covers travel expenses (vacations, trips); hobbies, entertainment, and dining out; as well as club memberships, subscriptions, and cultural events.

Miscellaneous Expenses: This category includes clothing and personal care items; gifts and charitable donations; and pet care expenses.

Debt Payments: This involves credit card payments, car loans, or other outstanding debts.

Taxes: This encompasses income taxes on retirement account withdrawals and property taxes.

Long-Term Planning: This includes savings for unforeseen expenses (emergency fund); long-term care insurance or planning for potential care needs; and estate planning and legal expenses.

Home-Related Expenses: These can include home renovations or repairs, as well as homeowners association fees.

Transportation Costs: Encompassing vehicle maintenance, repairs, and replacements; as well as public transportation costs.

Technology and Communication: Ranging from the upkeep of computers, phones, and other tech devices; to internet and phone service bills.

Family Support: This involves supporting your children or other family members, financing your grandchildren’s education, and other related expenses.

Personal Care: This can range from gym memberships or fitness classes to health and wellness expenses.

What is Your Replacement Ratio?

Determining the retirement income replacement ratio is a valuable tool for individuals to gauge the percentage of their pre-retirement income required to sustain a comparable standard of living in retirement. Here are eight common steps to help you calculate your ratio:

1. Determine your Current Income: Identify your current annual pre-tax income, including salaries, wages, bonuses, and other income sources. Exclude deductions like taxes and contributions to retirement plans.
2. Estimate your Retirement Expenses: Calculate your expected annual retirement expenses, encompassing housing, healthcare, leisure, travel, and other essentials. Adjust for changes in spending patterns.
3. Calculate your Retirement Income: Determine your expected annual retirement income sources, such as Social Security benefits, pension payments, income from retirement accounts (401(k)s and IRAs), and annuities.
4. Adjust for Taxes: Don’t forget about the impact of taxes on retirement income. Adjust your income figures to account for potential taxes on certain retirement income sources.
5. Calculate your Replacement Ratio: To find your income replacement ratio, divide your anticipated annual retirement income by your last full year’s income. Multiply the result by 100 to get the percentage. For example, if your last year’s income was $100,000 and you expect $70,000 in annual retirement income, your replacement ratio is 70%.
6. Interpret your Ratio: While a replacement ratio of 70% to 80% is a common percentage in retirement planning, individual circumstances can vary. Higher ratios may be necessary if you think you may have increased healthcare costs, travel, or other expenses.
7. Consider your Individual Factors: Recognize the uniqueness of your situation. Factors such as debts, savings, lifestyle choices, desired retirement age, and anticipated changes in expenses can significantly influence your replacement ratio.
8. Review and Adjust Regularly: Periodically reassess your retirement income and expenses as you approach retirement and throughout your retirement years. Adjustments may be necessary due to changing circumstances, market conditions, or unexpected expenses.

At the End Of The Day…

It is crucial to comprehend and plan for retirement costs to sustain your lifestyle and prevent the risk of outliving your savings. Consider all potential expenses, ranging from healthcare and housing to daily living costs, the impact of inflation, and concepts like the income replacement ratio. Although financial planning for retirement may seem daunting, remember that you are not alone in this process.

Keep in mind that actual expenses in retirement can differ significantly based on individual factors such as lifestyle choices, geographical location, health conditions, and family situations. Regularly reviewing and adjusting your retirement budget is crucial as circumstances change to ensure financial stability throughout your retirement years.

Engaging an investment advisor portfolio manager is key to preparing for your long-term financial planning. They play a crucial role in assisting you in creating a customized retirement plan and effectively managing your finances to achieve your goals. Their expertise and guidance can provide valuable insights to optimize your financial strategy for the future.

Have Questions? Contact us!

We’ve assisted our clients through every stage of life. Even when you’re not aware that something might impact your financial future, it likely will to some extent. Engaging in a conversation with your investment advisor about any financial changes is an excellent approach to keeping your financial goals in focus.

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Joe A. Macek, FMA, CIM, DMS, FCSI

Investment Advisor, Portfolio Manager

iA Private Wealth | iA Private Wealth USA

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