September, 2008
by Dr. Thomas E. Bell, CMG Member, Michelson Awardee (Retired)
Tom received his Ph.D. in Management from UCLA many years ago, and was a consultant for about 25 years before he retired. He is a recipient of the A.A. Michelson award (in 1975), has served CMG as its Treasurer and its Secretary, and has repeatedly been on the CMG Board of Directors. He retired at the end of 2005.
About the Author
Dr. Thomas E. Bell
How much will you spend each year after retirement? Is the amount some magical percentage of your pre-retirement income, like 70% or 80% ? or 100%? The impact of changing your status from "employee" to "retiree" may be either an increase or a decrease (depending on your age and the on-going contributions to your retirement account). Larger increases and decreases arise from changes in your individual lifestyle over the years, and (if you're many years from retirement) those may require a bit of effort to predict.
Every family has its own lifestyle, and that lifestyle is not likely to change dramatically on the day of retirement; I certainly didn't experience a dramatic change the day I retired. You can start with your current level of expenditures and then compute how various components may change for the critical years just before and after your retirement. If your retirement is reasonably close (say, within the next five years), you may be able to make a good projection by using the worksheet provided by Michael Hinesi (a fellow CMG member) and available by clicking HERE. You can fill out the form, perhaps using some of the suggestions below to make a projection. With this information you may find that your retirement savings are inadequate, so you may want to find a way to extend your full-time employment, to convert to part-time employment, or to engineer reduced expenses in some way.
For people farther from retirement, a projection may be easier by assuming your current income is equal to your expenditures (including savings and taxes) and then projecting the major changes. The material below begins with the simpler, financial issues and then it moves to the harder, lifestyle issues. If the result of your own analysis shows that you won't have enough saved, you'll need to make other plans.
As a first guess, your current annual expenditure rate (including taxes and savings) can be estimated as equal to your income. Just look at your checking account statements, your W2s (for both you and your spouse, if appropriate), and/or your income tax return. Your household's annual income includes all the income reflected on the W2s, but some of it may come from sources other than salary, so you need to look at the bank deposits to see if you have some sources of income that you've forgotten. Such sources may be income from stocks and bonds held outside your retirement accounts, payments made to you outside normal employment (recorded on 1099s), gifts from relatives, and payments from estate trusts.
In addition, you may have supported your current level of expenditure by taking out some loans, either from a commercial lender or by borrowing from your retirement accounts. Any loans taken out over the last year probably count as income too; payments on such loans probably count as expenditures for this analysis.
Of course, your salary will probably change (hopefully upward) before you retire, and inflation may result in further increases just to keep you at the same real value. However, for an initial analysis, just use current values; you can make adjustments later.
The total annual income can be summarized as follows:
If you are repaying a loan to maintain your lifestyle, enter it as a negative loan.
Fortunately, most of the expenditure changes due to ending employment are downward, although loss of medical insurance and other employer-sponsored benefits will probably increase your personal expenditures. The major expenditure decreases are listed below:
Social Security Taxes:
Your Social Security taxes will go to zero when you stop receiving a salary. The total amount of reduced expenditures will be equal to, or less than, 6.2% of your salary. If your salary exceeds the Social Security cap ($102,000 per year in 2008), then you only pay the tax on income up to that level. (If you are self-employed, you also pay the employer's portion, another 6.2%.)
If your spouse retires at the same time as you do, the reduction in Social Security taxes will be the sum of both the taxes.
Medicare Taxes:
Your Medicare tax will also go to zero when you retire, down from 1.4% of your total salary; there is no cap. This rate applies to the income from both spouses, and self-employed people must pay the employer's rate too (another 1.4%).
Contributions to Retirement Accounts:
In general, your contributions to retirement accounts will go to zero when you retire. If you are, for example, contributing 6% of your income to an employer's 401(k), your expenditure rate will decline by that amount when you retire.
Many people contribute to both a tax-deferred account and to their own taxable brokerage account. It's probably a safe assumption that you'll also halt contributions to such accounts when you retire.
Income Taxes Paid to a State Other than your Residence
(e.g., if you work in New York but live in New Jersey): After retirement you'll probably still need to pay income taxes in your state of residence, but you probably will not need to pay in another state. However, your income tax liability in your state of residence may increase if you don't have the deduction from paying in another state.
Union Fees and Professional Costs
(e.g., unreimbursed membership fees, registration fees, travel): These are probably relatively minor to CMG members (unless you continue attending CMG Conferences).
Commuting Costs
(gasoline, auto repairs, increased insurance, highway tolls, train fares): Commuting costs may be rather substantial for commuters who drive over large distances. In the metropolitan area where I live (Los Angeles), many people drive 50 to 100 miles each way to work - and do it in large SUVs. Just the cost of gasoline may be $25 to $50 per day. If your costs are $20 per day, and you commute 220 days per year, you'll be spending $4,400 per year. If you have an income of $100,000, that's 4.4% of your income. After you retire, you won't need to commute to work anymore.
The table below shows some example values of reduced expenditures due to retirement. You can insert your own values to see what level of decrease you might experience due to these issues.
One of the largest single values in the above table is the example of 6% for "Contribution to Retirement Funds". This value does NOT include contributions made by your employer (e.g., matching funds), but it does include the contributions to both taxable accounts and tax-deferred accounts. If the analysis stops at this point, you might assume that your after-retirement expenditure level will be about 82% of your pre-retirement expenditure level (assuming that you're only saving 6% for retirement). Looking at some retirement literature, you may have detected the implication that you just need to compute 70% to 80% (e.g., 82%) of your current expenditures and you can ignore the rest of this article, but life just isn't that easy.
The age of retirement is extremely important when estimating the post-retirement expenditure level. One of the largest reasons for this is medical insurance; Medicare is generally not available until an individual is 65 years old. If your age of retirement is 65 or greater, you only need to add the costs of Medicare, supplements, and uncovered charges to your annual expenditure level. That amount will generally be far less than if you need to pay for an individual (non-Medicare) health insurance policy.
While you're still employed, you probably have medical insurance provided by your employer, but you may still have uncovered expenses and co-pays. Usually these costs are annoying, but not great enough to cause major difficulty - maybe $1,000 or $2,000 per year.
After you're no longer employed, your individual cost for medical insurance before you qualify for Medicare will be dependent on your medical history, your age, your group (if you get medical insurance through a group), your supplier, your state of residence, your gender, and probably lots of other things. In addition, your cost of Medicare will be dependent on whether you take Part B, whether you take Part D, whether you have supplemental insurance, your supplier(s), and which alternatives you select for Part D and supplemental insurance. You may be able to estimate your expenditures by using the data I presented in the May issue of MeasureIT.
If you retire before age 65, you may need to pay the $10,000 per spouse per year that my wife and I paid for her policy before she reached 65. (Her policy had a $5,000 deductible, and our price is from over a year ago. So the price would probably be higher today.) We currently pay about $3,400 per spouse per year for Medicare and associated medical insurance policies.
After retirement you won't incur your previous costs of uncovered care and co-pays, and you won't need to pay the Medicare taxes. However, you do need to pay about $3,400 (if over 65) or about $10,000 (if not over 65) per spouse. If your current costs are $2,000 for both spouses combined, your medical expenses will increase by about $4,800 (2 x $3,400 - $2,000). If both spouses are over 65 the increase will likely be $18,000 (2 x $10,000 -$2,000). If your household pre-retirement income was $100,000 per year, you'll likely have an increase in medical costs of about 4.8%, or 18%, depending on the ages of you and your spouse.
For couples with this income level planning to retire before they are 65, it seems that medical insurance costs may wipe out the reduction in expenditures (if the assumptions above describe your situation). Retiring before 65 is really expensiveii! Either you have no reduction at this point (if you and your spouse are under 65), or you have a 13.2% (18.0% - 4.8% = 13.2%) reduction (if you're both over 65). But remember: These percentages assume you're just saving 6% of your gross income every year.
So much for that nice 70% to 80% factor.
If you're like me, you still have a responsibility for helping kids (e.g., children or grandchildren) get through college. You may have an equivalent situation that can cost many thousands of dollars per year.
If you're like a number of other people, you still have responsibility for elderly parents. (I don't because both of my parents, and my wife's mother, died between 1993 and 2004). If you need to support parents in convalescent hospitals or in other facilities, you may encounter expenditures of several thousand dollars per month.
Support of relatives may only start a few years subsequent to your retirement, and/or they may end shortly after your retirement. Instead of making an estimate of the average expenditure level per year, specific estimates of year-by-year requirements need to be made because of the large amounts involved. A sample chart provided a couple of sections later may be helpful in this regard.
You probably have a mortgage on your home, and hopefully you have positive equity in it (your home's value over your mortgage). Unless you're like me, by the time you retire your children will have grown up and moved out of your home. If that's true, you have some options that you can pursue, but each of them has financial implications.
The classical assumption is that you'll downsize - sell your home and buy a smaller one, probably in a retirement location like Florida. Of course, that may not be feasible at the moment due to the crash in residential real estate pricesiii, but that problem should go away within a few years - hopefully before you retire. If you plan to pursue this approach, you'll probably dramatically reduce the need to pay your mortgage (because you'll buy a new residence much less expensive than your equity), and experience a drop in expenditures.
Another alternative is to remain in your current residence. Under this alternative, your expenditure level will decrease if you have selected the maturity date of your mortgage to equal your date of retirement. (My wife and I chose a 15-year mortgage the last time we refinanced, and it matured the month I reached 65). If its maturity is significantly earlier than, or significantly later than, your retirement date, then you won't have any expenditure change at the time of retirement.
If you're not certain where you'd like to live, you may sell your home (when the real estate market recovers) and begin renting. With this alternative, your liquid assets will increase (assuming you had positive equity), but your change in expenditures may be positive or negative depending on the price of renting vs the payments on your mortgage. However, this alternative eliminates the risk of maintenance costs, eliminates unexpected property tax increases, and helps you discover whether your new location really meets your preferences.
What will you do with your time after you retire? Some people seem to think that's a big, difficult question, because they think they'll have too much time on their hands. I certainly haven't found that I have too much time; I have too little. And that's the experience of approximately 100% of my retired friends.
Most people have a whole list of things they want to do "as soon as I retire"; we call these their "passions". Maybe your passion is travel, maybe it's visiting your kids and taking grandchildren out to see things, maybe it's doing photography, maybe its renovating your house, maybe it's doing charitable work. Whatever it is, it will probably cost something, and your expenditure level for your passion will go up.
Your various lifestyle changes will occur at different times, so you need to schedule them out to see what kind of expenditures you may experience, especially when you retire. As an example of this kind of schedule, a family named "Measuresmith" will be used. Important events in the lives of its members are as follows:
1940 Parents born, need some support from son/son-in-law starting in 2010, die in 2030
1960 Mr. and Mrs. Measuresmith born (toward end of baby boom)
1980 Mr. and Mrs. Measuresmith meet at college and are married
1982 Sara Measuresmith born
1983 Mr. and Mrs. Measuresmith start saving for retirement
1990 John Measuresmith born
2001 Sara enters college (age 19), graduates in 2005
2001 Mr. & Mrs. Measuresmith take out 20 year mortgage on their home (maturing in 2021)
2009 John will enter college (age 19) and graduate in 2013
2013 John will enter graduate school and receive Ph.D. in 2017
2021 Home mortgage paid off
2023 Mr. Measuresmith retires
2025 Mr. and Mrs. Measuresmith both reach age 65 and go on Medicare
Note that Mr. & Mrs. Measuresmith have saved for retirement since they were 23, and they diligently saved since; during their last year they contributed 9% of their total income. (This is unlike Dr. Bell who didn't start saving for retirement until age 40). In addition, they arranged for the mortgage on their family home to mature in 2021 when they will be 61. Mrs. Measuresmith remained at home to raise the children and to maintain the family home.
The chart below uses percentages; this (sort of) compensates for inflation, but it mixes fixed payments (e.g., mortgage payments) with inflation-dependent payments (e.g., college costs). However, it does provide an initial estimate of the various expenditures so that some planning can be done.
The projection of expenditures for the Measuresmiths shows that expenditures actually increase a bit (by 1.8 percent) at the year of his retirement; at that time expenditures are down by about 16.5% from the 2008 level. When they can take advantage of Medicare at age 65, their expenditures will probably drop to about 75% of their 2008 level of expenditures (before they started their second child through college).
Two major effects are important in the reduction of the Measuresmiths' expenditures. First, their payments for children's college terminated before they retired. Second, they paid off their mortgage before they retired. These two effects amounted to a total of almost 40% of their expenditures (18.0% + 21.2% = 39.2%); many CMGers probably don't have their lives so well organized. They may find that a smaller reduction in expenditures occurs because they still have a mortgage to pay.
What a dreary projection! A short article contributed by Joe Delano, "Concerns about Retirement and Some Strategies to Help", summarizes the situation and suggests some strategies to deal with it. When you actually sit down to see how much you'll probably spend in retirement, it may not look like you have an easy road to retirement.
There may not be a nice 20% or 30% reduction that you can look forward to without taking some pretty definite actions. My personal experience has been that no significant change in expenditures occurred when I retired. (I had actually paid off my mortgage a number of months early because I happened to have the cash to finish it off). I have warned my wife that if we must significantly reduce our expenditures, we will probably need to move to a different state. This move would accomplish two things: 1) we would have a major break from our current style of living, and 2) we would avoid the very high cost of living in California. However, it would also impact our passion (helping foster children to whom we have personal commitments.) I hope we don't find such a move necessary.
If you need to accomplish a significant reduction in expenditures, but you would like to maintain something like your current standard of living, you might start by looking at data on the general cost of living, state by state. A nice map giving general indices along with a table giving more detailed data is available at the following URL: http://www.missourieconomy.org/indicators/cost_of_living/index.stm (from the Missouri Economic Research and Information Center). The difference between the cost of living in Californiaiv (with an index of 139.4 and ranked number 50 out of 51 - including the District of Columbia) and Texas (with an index of 89.5 and ranked number 4) is dramatic - a factor of 1.56 using their indices. At a first estimate using the relative indices, living in California with expenditures of $100,000 would only cost $64,200 to Texas. A friend of mine retired in Texas for this reason.
An analysis of where to live while reducing your cost of living should consider taxation very carefully. As pointed out in an article by Kiplingerv, some states (e.g., California) are particularly hard on retirees. For each state that you might consider, Kiplinger provides a summary of the various types of taxes that are applied; you can look up your potential retirement states at the following URL: http://www.retirementliving.com/RLtaxes.html by clicking first on a range of states and then on the individual state of interest.
Of course, you'll be required to pay the various Federal income taxes without respect to which state you select. However, if you can live in a state (as well as county and city) that reduces your cost of living, then you won't need to extract so much from your retirement accounts because withdrawals count as taxable income unless you are withdrawing from a Roth accountvi. Reduced withdrawals will probably reduce your Federal income taxes.
If you are really concerned about your cost of living, you may want to consider non-US locations (e.g., Costa Rica, Mexico, Australia, New Zealand, France). For these alternatives, you need to do extensive research into taxes, political stability, property ownership laws, money transfers, banking, and (probably most critically) cultural issues. Many people have found that a total change in cultural environment, especially with a lower cost of living, is really natural for them. However, many others have found that trying to live in a very different way is completely unnatural to them.
You'll need to trade off the amenities of each location against its cost of living and its taxes. The earlier you consider your retirement location, the easier your transition will likely be if you decide that a reduction in expenditures will be required. If you start early, you can go on vacation to the potential location and, perhaps, live there for a month or so on an extended vacation. Without trying out the potential location, you may need to reverse course and return to your previous location - at tremendous expense.
If you really, really don't want to change location (like my wife), then you need to look carefully at your expenditures and see where you can reduce them (unless you have far more savings than we do). That means doing a zero-based budget, perhaps using the form provided by Michael Hines. Then you need to fit your lifestyle into your budget.
A survey from 2007 by the Fidelity Research Institutevii found that 39% of retirees had their expenditure levels increase after retirement; 12% experienced "significantly higher" levels and 27% experienced "somewhat higher" levels. These are shown in red on the cart to the right. 28% of those surveyed had post-retirement expenditure levels about the same as pre-retirement levels. That is, 67% did not experience a reduction, and the largest portion found that expenditures increased.
The survey also reported that 48% of retirees "have made a major lifestyle change to better afford retirement, including getting a part-time job, downsizing their home, moving to a different part of the country, or reducing health care expenses (medical visits and prescriptions)."
Quite likely, your best bets to experience reduced expenditures are 1) delaying retirement until you're 65 and can take advantage of Medicare, and 2) paying off your home mortgage when you retire. People are probably fooling themselves if they simply adopt the easy assumption that their expenditures will just sort of magically decrease by 20% to 30% when they retire. You'll probably need to make some serious choices if you must engineer that kind of decline without those two conditions to help.
If you'd like to reach Joe Delano or me, please put [CMG] at the beginning of your Subject Line. Our e-mail addresses are: