Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Retirees and those about to enter retirement like to have a pretty good handle on what their cost of living is going to be. I'm here today with Christine Benz, she is our director of personal finance, on some areas that a lot of retirees tend to overlook.
Christine, thanks for joining me.
Christine Benz: Jeremy, it's great to be here.
Glaser: The first piece that you are warning retirees not to overlook is healthcare. Everyone knows they are going to have a lot of healthcare expenses, but you think that often it's underestimated?
Benz: Probably so. Every year Fidelity Benefits Consulting puts out an estimate of what a 65-year-old couple will spend during their lifetimes on healthcare expenses, out-of-pocket healthcare expenses. This would include supplemental insurance policies, prescription drugs, any other out-of-pocket outlays. $275,000 was the most recent figure. You think about retirees embarking on retirement, maybe looking at 25 years in retirement. That's more than $10,000 a year.
As you are thinking about your in-retirement budget, make sure that you are accounting for those healthcare costs. Make sure you are accounting for stuff that isn't covered by Medicare and isn't covered by most supplemental policies. Dental is a huge category. In fact, we talk to our Morningstar.com users about their biggest spending surprises in retirement. Dental was right at the top of the list. And people do oftentimes have large dental bills later in life. Unfortunately, that converges with a time when they don't have dental insurance anymore. Dental coverage or dental outlays, vision expenses aren't typically covered, hearing aids aren't typically covered. Think about all of those things that may not be covered by Medicare or by your supplemental policy. Make sure you are thinking about padding your budget a little bit to account for those costs.
Glaser: Of course, these costs aren't completely new. You are paying for medical care before you hit retirement. You are not going from zero to $10,000 …
Benz: That's such a valuable point. Maria Bruno, our friend at Vanguard, who focuses on retirement planning, always makes that point. I think the thing is, is that for many of us who are having our healthcare expenses deducted from our paycheck, we tend to be a little bit insensitive to what we are paying. But yes, you are absolutely right. These aren't brand new costs for most households. Most of us have been at least paying part of our healthcare expenses along the way.
Glaser: A healthcare cost that could be new is long-term care, something that we know is not covered by Medicare.
Benz: That's right. That $275,000 figure that Fidelity Benefits Consulting provided as an estimate does not encompass long-term care costs. There are so many tricky aspects to long-term care planning. One of the biggest tricky aspects is that about half of us will need some type of a long-term care plan, some type of long-term care coverage during our lifetime; about half will not. It's hard to know what to do from the start. The other issue, of course, is the cost associated with the insurance coverage for long-term care. People who have thought they were doing the right thing and purchased the policies have had to deal with sky-high premium increases over the past decade. That's a tricky problem with no easy answers. Unfortunately, the cohort that is best-positioned to self-fund the long-term care expenses is probably also best-positioned to be able to handle the premium increases. People who are most at risk of having big long-term care costs erode their plans don't have any easy answers.
Glaser: Let's talk about the taxes or the cost of taxes. You know you are going to pay them, but some retirees are surprised at how many they are paying.
Benz: I think so. One of the beautiful parts of having some sort of tax-deferred retirement account is that money is growing on a tax-deferred basis, but then when you pull the money out in retirement, that money, for the most part, will be taxable at your ordinary income tax rate. Say, you have $1 million portfolio and you are in the 25% tax bracket, that takes your portfolio balance down to $750,000. Keep in mind the tax effects. Strategize if you can with a tax advisor about how you can pull from different pools of money in an effort to keep your tax bracket as low as it possibly can be. Also think about the fact that Social Security in most cases, in many cases, is taxable to some extent as well.
Another, I think, thing that gets under-recognized in terms of retiree planning is, many homeowners are shouldering higher and higher property taxes. That's not a situation that is going to get any better anytime soon in most large urban centers. When I think about retirees who I know well, it's the biggest ticket item in their household actually, their outlays for property taxes. This is also an issue for renters indirectly because as property taxes go up, renters shoulder their share of these costs as well. That's another category to have in mind.
Glaser: When people enter retirement, they often think of the costs that are going away--commuting, buying clothes for work. But there's other discretionary expenses that could go up considerably.
Benz: That's right. Retirees need to take stock of what their retirements will look like. For some retirees, especially in the perhaps early years of retirement when retirees are feeling good, they maybe have some pent-up demand to do, say, expensive travel or elaborate travel, the discretionary expenses can start to tick up. Taking stock of what you want your retirement to look like. Other retirees might say, you know what, what I really want to do is take advantage of this time. Maybe I like riding my bike to the library most of all or cooking at home or doing some of the things that I haven't been able to do because I have been too busy working. Really just taking a step back and thinking about the direction of your discretionary expenses, I think that's a really helpful step as you formulate a vision for your retirement spending.
Glaser: Finally, inflation needs to be on retirees' radars?
Benz: Right. Factoring in the rate of inflation for various categories where you are spending money is a really valuable part of the exercise. If you are working and you are receiving periodic cost of living adjustments, you are probably not that sensitive to inflation because your paycheck is offsetting some of those higher outlays. But if you are retired, certainly the portion of your portfolio that you are pulling from to fund your living expenses, that's not inflation-adjusted. That's one of the reasons why we talk about the importance of building in that inflationary bulwark in portfolios to think about categories like Treasury Inflation-Protected Securities, certainly, stocks as a component of retiree portfolios, things that help offset higher costs as you are spending from your portfolio, that's a really valuable exercise.
Glaser: Christine, thanks for sharing your thoughts today.
Benz: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.