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The costs of retirement and how to estimate them

Planning for retirement is one of the most important steps you can take to ensure financial security and well-being in the later years of life. However, there are many challenges and uncertainties that can make retirement planning difficult. Let's look at the main challenges and uncertainties, and tips to reduce your expenses and increase your retirement income.

Why do I need to plan for retirement?

Did you know that people nowadays are spending just as many years retired as they were working? Imagine working 30 years, receiving a regular paycheck, and then, you retire, and that paycheck stops. How will you pay for your day-to-day expenses for the next 30 years?
Unfortunately, Social Security is only a small amount and usually starts much later in life. In fact, it can be really hard to live off of Social Security alone. So, if you want to retire early or live comfortably during retirement, you should start planning and saving now.

Challenges and uncertainties

Planning for retirement means you need to think about following things:
  • Longer life expectancy: People are living longer, which means you might need more money to cover your expenses for a longer period of time. As mentioned earlier, it is important to plan on being retired for just as many years as you were working.
  • Rising care costs: As you get older, you might need more medical or long term care, and these costs can add up. You should plan on seeing a doctor more often, and potentially needing more regular medications.
  • Inflation: The cost of living usually goes up over time, so it's important to plan for how inflation might affect your retirement expenses. Your grocery bill today won't be the same when you retire - it will likely cost more money to buy the same items.
  • Market fluctuations: The value of your investments can go up and down, which can impact your retirement savings. If the investment market goes down close to your retirement, you may end up with less money than you had planned.
  • Changes in social policies and programs: Government programs, like Social Security, might change over time, so it's important to stay informed and plan accordingly. Sadly, cuts and restructuring of these programs happen often and that can impact your retirement.

Benefits and consequences of planning (or not planning) for retirement

Planning for retirement has many benefits, such as:
  • Having enough income and savings: If you plan well, you'll have enough money to cover your expenses and to do the things you want to in retirement.
  • Maintaining your standard of living: By planning, you can make sure you have enough money to continue living the way you want to.
On the other hand, if you don't plan for retirement, you might face some consequences, like:
  • Retirement savings gap: You may not have enough money saved to cover your expenses, which could lead to a lower standard of living, or having to go back to work.
  • Financial stress: Not having enough money saved can cause stress and worry during your retirement years.

Estimating retirement expenses in detail

When planning for retirement, it's crucial to think about the various costs you might encounter. These can vary depending on factors such as your lifestyle, the location where you reside, your health status, and your family situation. To better prepare for your retirement, consider the following main categories of expenses:
  • Housing: Housing expenses go beyond just rent or mortgage payments. They also include property taxes, home maintenance costs, utilities, and homeowner's or renter's insurance. If you plan to pay off your mortgage before retiring, your housing expenses may be lower. Keep in mind that maintenance costs may increase as your home ages.
  • Food: Food expenses include groceries, dining out, snacks, and drinks. These costs can vary depending on your eating habits, dietary preferences, and the frequency of dining out. It's essential to account for any changes in your eating habits during retirement, such as cooking more at home or eating out more often.
  • Transportation: Transportation costs encompass car expenses (such as fuel, maintenance, insurance, and registration), public transportation fares, and travel expenses for vacations or visiting family. Consider how your transportation needs may change in retirement – for example, you may drive less if you no longer commute to work, or you may travel more frequently for leisure.
  • Health care: Health care expenses can be a significant part of your retirement budget. They include insurance premiums (for Medicare or supplemental policies), out-of-pocket costs for medical services, prescription medications, and over-the-counter drugs. As you age, your health care needs and expenses may increase, so it's essential to plan for potential changes in your health.
  • Entertainment: Entertainment costs cover hobbies, trips, and other recreational activities. Think about how you'll spend your free time in retirement and factor in any additional expenses for new hobbies or increased travel. Also, consider costs for memberships, subscriptions, and tickets for cultural or sporting events.
  • Insurance and taxes: Don't forget to account for any ongoing insurance policies (such as life or long-term care insurance) and taxes on your retirement income and investments.
To estimate your retirement expenses accurately, you can use methods like the replacement ratio, the budgeting approach, or an online calculator.
  • The replacement ratio is calculated by estimating what percentage of your pre-retirement income you'll need during retirement (usually around 70% to 80%).
  • The budgeting approach involves creating a detailed budget for your retirement expenses, considering all the categories mentioned above.
  • Online calculators can help you estimate your expenses based on factors like your age, income, and savings.

Tips for reducing retirement expenses and increasing income

Here are some tips to help you reduce your retirement expenses and increase your retirement income:
  • Downsize: Consider moving to a smaller home or getting rid of things you don't need to lower your costs.
  • Relocate: Moving to a less expensive area can help you save money on housing, taxes, and other expenses.
  • Work part-time: If you're able and willing, you can work part-time during retirement to earn extra income.
  • Delay retirement: If you wait a few more years before retiring, you can save more money and increase your Social Security benefits.
Remember, it's never too early to start planning for retirement. Ideally, if you are working, you are also saving for retirement at the same time.

Want to join the conversation?

  • male robot johnny style avatar for user Kalfus
    Does the 50/30/20 rule still apply at this stage? Does it mean you split the 20% into all these categories?
    (4 votes)
    Default Khan Academy avatar avatar for user
  • blobby green style avatar for user sv1653
    Great information. Unfortunately, we currently live in a society where people's pre-retirement income isn't nearly enough to retire. What does Sal think about this?
    (5 votes)
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    • purple pi purple style avatar for user Dvortygirl
      This is as much a political question as a financial question. At a financial level, "society" doesn't dictate what you do, and retirement has everything to do with your savings rate and relatively little to do with your income. There are those whose income just is not enough to support themselves for basic food and shelter, and I will be the first to agree that "society" could do better at educating those who can work and supporting those who can't. (One of the reasons I support Khan Academy is that I believe it helps give many more people access to education.)

      Individually, it's going to be up to you, if you can, to increase your income and keep your expenses moderate. If you can do that, you can set aside savings and then invest. There are very high earners who blow through every cent and then some. There are some people who manage to save on even pretty modest incomes.

      Your savings rate determines whether you can retire. If you spend less, you need less to retire.
      (1 vote)
  • blobby green style avatar for user zscholl1
    coast much money neax is uo
    (1 vote)
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  • blobby green style avatar for user Giannalie Almedina
    Does it mean you split the 20% into all these categories?
    (1 vote)
    Default Khan Academy avatar avatar for user
  • blobby green style avatar for user Giannalie Almedina
    how will our retirement plan workout in the future.
    (1 vote)
    Default Khan Academy avatar avatar for user
  • starky seed style avatar for user 149822
    Is it necessary to wait the longest amount of time before you retire to have as much money possible for retirement?
    (1 vote)
    Default Khan Academy avatar avatar for user
    • purple pi purple style avatar for user Dvortygirl
      No, but this is a question worth answering correctly for your circumstances before you make a decision. (Your circumstances may include what other savings or income you have and whether you are in relatiely good health at retirement age.) There are benefits calculators that will help you estimate monthly and lifetime benefits, and there are books you can buy or get from the library to walk you through making the most of your benefits.
      (1 vote)