Hoboken, NJ—For many seniors retirement can be daunting. Sure, it’s great being able to spend more time out in the garden, to travel more often, or to catch up with friends. But transitioning from going to work every day to not can be quite a change. It’s important for seniors to plan for all the changes that come with retirement, but personal finance expert Eric Tyson says one area that deserves special attention is how their spending must change in order to keep them financially stable throughout their golden years.
“Retirement is financially unlike any other period in their lives because retirees generally are working less or not at all, living off investments and monthly benefit checks, and using more medical services,” says Tyson, coauthor, along with Bob Carlson, of Personal Finance For Seniors For Dummies® (Wiley, May 2010, ISBN: 978-0-470-54876-9, $21.99). “Making the most of their senior years and their money requires them to plan ahead and be prepared for some surprises.”
Tyson’s first piece of advice: don’t freak out. One study from a large accounting firm ominously warned that about 60 percent of middle-class retirees would probably run out of money if they maintained their pre-retirement lifestyles. Technically that may be true, but, as Tyson notes, an important detail the study failed to mention is the vast majority of retirees spend less—in some cases quite a bit less—when they retire in comparison to their pre-retirement spending.
“By the time most people reach their retirement years, they’ve been managing money for several decades,” says Tyson. “That’s a good thing. Between the knowledge acquired over time and the valuable lessons learned in the school of hard knocks, people enter retirement a lot wiser and more money savvy than they were as young adults.”
To help you make the most of your retirement, read on for some advice from Tyson on how you can best manage your spending throughout your retirement.
Use the 4 percent rule. The vast majority of retirees need to live off at least a portion of their investment portfolio’s returns. If you’re in this majority, a logical concern you may have is determining how much of your portfolio and its returns you can use each year, while still having some reasonable expectation that your portfolio will last throughout your retirement. “That’s where the 4 percent rule comes into play,” explains Tyson. “Analyses and studies have found that if you withdraw about 4 percent of your nest egg in the first year of retirement and then bump that amount up by a few percent per year for increases in the cost of living, your portfolio should last at least thirty years.”
Save no more! Most of us spend so much time thinking about scrimping and saving that we can’t stop doing it. But after you retire and stop earning employment income, one of the cash outflows that should go away is saving more money. “Some folks early in retirement continue to effectively save by not using all the money coming in,” says Tyson. “For example, from Social Security, pensions, and so on. They scrimp and save and do without when they don’t need to. If your retirement analysis shows that you don’t need to save anymore, then don’t. Use that income; after all, you’ve earned it!”
Consider supplementing your income with a reverse mortgage. If you own the same home during most of the decades of your adult life, you probably will have some decent equity accumulated in it. You may wish to tap that equity to supplement your retirement income. A reverse mortgage enables you to receive tax-free income through a loan on your home’s equity while still living in the home.
With reverse mortgages the lender pays you, and the accumulated loan balance and interest is paid off when your home is sold or you pass away. Here are the basic standards for eligibility:
- You, the homeowner, must be at least sixty-two years of age.
- You must use the home as your principal residence.
- You must have any outstanding debt against the home paid in full.
“Retirees we speak with who have taken a reverse mortgage generally say it has been a good experience for them,” says Tyson. “They often cite that the extra income allowed them to keep up a home’s maintenance, pay medical and other costs, avoid having to scrimp so much on things like eating out sometimes, and gain peace of mind not having to make house payments. However, reverse mortgages aren’t free of their downsides. The effective interest rate can easily jump into the double-digit realm if you stay only a few years into the loan. So as with any financial decision, do some research to determine if it is right for you.” (For more information on reverse mortgages, visit the AARP Web site at www.aarp.org/revmort.)
Throughout your retirement, consider inflation. When you examine your spending now or next year, remember that you’re examining a snapshot or point in time. “Over the years, most items increase in price,” says Tyson. “Three percent per year is a good average to use when calculating inflation because that is what consumer price inflation in the U.S. has averaged over many years. So plan accordingly by considering not just your current spending but also your spending in the years and decades ahead.”
Prepare for increased healthcare expenses. Most people end up spending more on healthcare during retirement. The average American over the age of sixty-five spends about $7,000 per year, and costs keep rising faster than the overall rate of inflation. In your elderly years, even if you remain in good health, you’ll probably visit the doctor more and undergo more frequent routine and preventative testing. You also may be unpleasantly surprised at the increase in how much you spend on prescription drugs and dental and vision care visits and procedures.
“Don’t be confused about what your former employer will cover in terms of healthcare and what Medicare will cover,” says Tyson. “The reality is that in retirement, you’re on your own for a great deal of your medical expenses and for long-term care. A reasonable estimate of your different health expenditures and how they’ll be paid or insured needs to be part of your retirement plan. Important factors to consider will be Medicare, Medicaid, and long-term care.”
Start saying no to the taxman. One fringe benefit of ceasing work and getting over the financial impact of losing that income is the associated and often dramatic reduction in income taxes—both federal and state—as well as FICA (Social Security and Medicare) taxes and possibly local taxes. However, even though you’re retired, some of your taxes may actually increase or stay the same. Keep close tabs on the following taxes:
Taxes on Social Security benefits: Pay close attention to the triggering of taxes on Social Security benefits if your income exceeds particular thresholds. If you’re working part-time in your retirement, you may want to consider contributing to a retirement account to reduce your taxable income.
Property taxes: Many communities offer some seniors the ability to postpone property tax payments and offer reduced tax rates for low-income seniors. To qualify, you typically have to present a copy of your completed IRS Form 1040 each year. Options offered usually include abatement (reduction), deferment, or freeze.
Reduce the amount you spend on housing. Many retirees are able to enjoy and benefit from the fact that they no longer have mortgage payments in retirement. There are many ways to manage and even reduce your housing expenses during retirement. You simply have to consider your options and choose which might work best for your circumstances. “Some retirees have attachments to their homes and don’t want to move, while others don’t mind downsizing or moving to a lower-cost area,” says Tyson. “Some would never consider taking on a tenant or opting for shared housing, while some, especially those who have been widowed, might find the social aspects of those situations appealing. Each person’s situation and preferences are unique, so we advise that you explore your options and select the choice that feels right for your situation money-wise and comfort-wise.”
Reduce utilities costs. A great way to manage your spending changes during retirement is to reduce the amount you spend on utilities. Changing the energy and communication sources you’re using in your home or car isn’t a simple matter of course for everyone. However, that doesn’t mean you’re powerless to reduce your utility bills. “One option is to reduce your garbage bill by recycling more and creating a compost pile for biodegradable trash,” says Tyson. “Slim your water bill by installing water flow regulators in shower heads and faucets. If you buy bottled water or have it delivered, consider instead installing a water purification system. Another option might be to bundle your television and Internet with your phone bill. Bundling can lead to the best deals and pricing.”
Carefully plan your food budget. During retirement you want to manage how much you spend on food. You may want to start preparing more meals at home and reduce how often you eat out. “There are all kinds of ways to reduce the amount you spend on food,” says Tyson. “You can start buying grocery-store-brand products, whose quality and ingredients are often the same as higher-cost name brands at a much lower price. Or if you do eat out, consider going for a lunch when prices are cheaper, get the early bird special, or order take-out—all cheaper options than normal restaurant dining. Food is such an easy cost to manage that you don’t want over-spending in this realm to cause you financial discomfort during retirement. You don’t have to give up going out for a great dinner once every month or so, but you should carefully consider whether your pre-retirement food budget is ideal for your post-retirement living.”
Consider getting rid of your wheels. Another benefit of leaving the workforce and retiring is the elimination of work-related transportation expenses. You no longer have a commute and the associated expenses, including gasoline, maintenance, tolls, public transit fees, parking charges, and so on. Your car should last longer, too, because you likely won’t drive as much. You can further reduce your expenses related to transportation by possibly reducing the number of cars you own. “Because you no longer have the burden of daily commutes, you may even be able to make do without a car at all and rely on public transportation,” says Tyson. “When you need a car for a weekend or other excursion, you can just rent one. Some areas also have rent-by-the-hour car rental services for local driving. Getting rid of your car also reduces your auto insurance expenses.”
Manage your personal care expenses wisely. Spending on clothes, shoes, jewelry, dry cleaning, and other amenities also take a tumble when folks retire from jobs, especially those who worked in more formal office settings. You also will likely spend less on haircuts and salon treatments. “It’s important to remember, though, that you shouldn’t skimp on taking care of your health and being physically active,” says Tyson. “Consider joining a health club or gym that’s user-friendly for folks of your age and interests. Of course, you don’t need a gym membership to be active. Walking, hiking, and other outdoor activities are low-cost and generally healthy. Just be careful about falls, which become increasingly common as we age. By staying active and healthy, you can help reduce your overall healthcare spending.”
Don’t be afraid to indulge responsibly. Being able to travel, relax, and have some fun is what retirement is all about. You’ve worked for decades and now is your chance to kick back a little. Don’t feel guilty about spending a bit more on travel and entertainment, especially during your early retirement years. As long as it is within your budget, you are good to go. “Most folks don’t travel much later in retirement due to reduced mobility and increased health issues,” says Tyson. “Keep that in mind in the earlier years of retirement and be sure to take advantage of your mobility and money while you’re able. During your retirement years, you can save money on entertainment and travel expenses in a couple of easy ways: travel during off-peak times or benefit from reduced senior prices.”
“Retirement spending will take some getting used to,” says Tyson. “You’ll be spending more in some areas while easily decreasing what you spend in others. But as with most aspects of retirement, with a little planning and the wherewithal to stick to your budget, you will be able to manage your expenses efficiently while enjoying the best parts of the retirement life.”
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