If you’re financially comfortable and tend to be more of a saver than a spender, there’s a good chance you have a sizeable nest egg–but is it enough to handle unexpected costs in retirement? Focusing on a “retirement number” rather than planning for the expenses and economic factors that can affect your savings is a mistake that’s unfortunately all too common. Having an accurate understanding of how to estimate retirement expenses while accounting for life’s unpredictability is much more important than just stockpiling savings. With that in mind, let’s look at a few of the most overlooked retirement expenses and what you can do now to create a resilient retirement strategy.
Healthcare Expenses Not Covered by Medicare
Many retirees assume they can check medical expenses off the budget, but unfortunately, Medicare doesn’t cover everything. If you retire before age 65, you won’t be eligible for Medicare and will have to find another option for insurance and healthcare costs. On top of that, healthcare costs are on the rise; a 2024 study found that the average 65-year-old needed $165,000 in after-tax savings to cover medical expenses–an increase of 5% from the year prior. Without accounting for these expenses, a medical emergency could wipe out your retirement savings.
Long-term care (LTC) insurance is crucial protection against long-term care expenses in retirement. Without it, you could be left paying for expenses like an extended stay at a nursing facility or in-home care out of pocket. On average, a private room in a nursing home will set you back $116,000 per year, but would be entirely covered by LTC insurance.
Another thing to consider is how your Medicare premiums could be affected by the Income-Related Monthly Adjustment Amount (IRMAA). The higher your retirement income, the more likely you are to face higher premiums for Medicare Part B (coverage for doctor’s visits and outpatient care) and Part D (coverage for prescriptions). If you have access to a Health Savings Account (HSA), contributing aggressively before retiring can help reduce your Modified Adjusted Gross Income (MAGI), lowering your taxable retirement income. This can help affluent retirees reduce or avoid IRMAA while providing tax-free savings for medical expenses. You can even use HSA savings to pay for Medicare premiums.
Keeping Up With Inflation
Even if inflation were to stay at a relatively conservative rate of 3%, the cost of living could double in about 24 years. Considering the unpredictability of inflation, like the 9.1% peak we saw in June 2022, positioning your savings to grow at least at the same rate is crucial, or you risk outliving your nest egg.
While it’s true that your saving strategy should lean towards low-risk options like bonds and annuities, the closer you get to retirement, eliminating risk completely means the value of your savings will be eroded by inflation. Diversifying your holdings and exploring alternative asset classes may be a good way to stay within your risk tolerance without hindering growth potential.
Managing Lifestyle Creep
Even the most financially conservative people are susceptible to lifestyle creep: the tendency to increase spending as income increases. Once you’re retired, you finally have the freedom to enjoy hobbies, travel, and luxuries that you may have put off during your working years. While it’s understandable to feel the freedom to spend your savings in retirement, it’s equally important to keep a sharp eye on your financial habits once you’re on a fixed income. While a budget may seem restrictive, it can actually increase your satisfaction by helping to alleviate the fear of running out of money and reduce the mental load surrounding financial decisions, leaving more time and energy to be present and enjoy your retirement years.
Anticipating Taxes in Retirement
Many high earners are surprised to discover that their taxes are just as high, or possibly even higher, once they’re retired. For many, tax-deferred retirement savings vehicles like 401(k)s and traditional IRAs are a good way to reduce taxable income during peak earning years, when you’re in a higher tax bracket. However, that means those withdrawals will be taxed once you’re in retirement. When Required Minimum Withdrawals (RMDs) kick in, you won’t have any control over how much you’re required to withdraw at once, which makes it difficult to space out taxable income in retirement. And if you were a big saver during your working years and have substantial retirement savings, those taxable withdrawals will also be substantial. The result is increased taxable income, which can also lead to higher taxes on Social Security income, in some cases up to 85%.
One option is to do a Roth conversion. While this will trigger a tax event since you’ll owe on whatever you convert at the time of conversion, Roth IRAs don’t have RMDs, and withdrawals are tax-free. This allows you to create a more flexible and tax-advantaged retirement income strategy. If you’ll be in a lower tax bracket immediately after you retire but before RMDs kick in, you can even do a Roth conversion during that window to limit the overall tax burden.
Working with your financial advisor and tax planner to create a tax-advantaged withdrawal strategy can also help you reduce your tax liability. Depending on your savings and situation, it may be beneficial to withdraw from taxable accounts in the early years of retirement, and then focus on tax-deferred accounts second.
Saving Strategically for Retirement
Planning for your future doesn’t have to be complicated, but it does need to go beyond a dollar amount. Being proactive is your best weapon against hidden retirement costs and unpredictable factors like inflation and medical events.
At CAP Northwest, we strive to present you with all of the facts so you can make informed decisions and confidently chart your future. No matter what your ideal retirement looks like, we’re here to help you anticipate the unexpected and create a plan that’s flexible and resilient enough to help you retire confidently. If you’re not sure whether or not your savings will be sufficient, start the conversation here.
