It's important to have an understanding of what your expenses are going to be in retirement. Having a spending plan or an income plan to meet your expenses and provide the lifestyle that you would like to have in retirement helps to give you the confidence to spend. Often the people that were the best savers in their working years have the most challenging time switching gears and becoming a spender. An income plan can help give one the confidence to spend.
Many folks have the desire to spend more money in the early part of their retirement to perhaps go on big vacations or on other entertainment. Then over time their living expenses in today's dollars might decrease. If this is you then having a plan to meet this desire is so important.
Health care costs have historically outpaced the overall inflation rate. It's important to account for different expenses such as health care separately.
It's important to have a plan that addresses the unique vision of what you want your retirement to look like. This helps to give the confidence to spend money and enjoy the lifestyle one wants in retirement.
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Full Transcript:
We're going to take a look at a sample case study, but we're just going to focus in on the expenses in retirement. Now, there's different approaches you can take and different things that you'll want to consider and we'll discuss some of those. But the most important thing is that you have to have a spending plan or an income plan that you feel confident in because that's what I find is the thing that gives people the confidence to go ahead and spend in retirement. And the reason I think that's so important is because oftentimes the people that have been the best savers over the years are also the people that now when they start to transition into retirement and the paycheck has stopped, have the hardest time now becoming a spender. So let's dive in here and look at our Fred and Wilma sample. So for these folks, he's 62.
She's 61, and we're going to assume that they're going to retire next month when they're both going to be 63 and 62. And their goal is to have $7,000 per month after taxes. This is for both all their living expenses, so their needs and their wants, I call it. And the other category that we have here are the retirement healthcare costs. Really this is all their healthcare costs. So we'll get into that here in just a second. One key point I want to make here is that with these folks, their mortgage was, they didn't have a mortgage, their home was already paid for. So if they did have a mortgage, we would account for that separately because if you have, let's say a 30 year mortgage, that's going to be a fixed rate. So that cost is not going to increase over time. And then it's at a certain point, that loan will be paid for, assuming of course you don't refinance or something.
So that would be accounted separately. But as far as the assumptions here, we are assuming that the overall inflation rate is 2.5%, but with healthcare, we're assuming that costs will increase by 5% per year. So about twice the rate of overall inflation, which is historically healthcare has gone up much faster than the overall inflation rate. And if we look at their healthcare expenses here, if they were to retire and before they go on Medicare, we're looking at about $6,145 for each of them. Now, you might be looking at that thinking, well, is that high enough? That seems a little bit low. So there's different options here, and we're not going to go through everything as it relates to healthcare prior to retirement. But one of the options that's available are ACA plans where even if you've been a high income earner like Fred was in this case, even if you've been a high income earner, now once you retire, depending upon where your income is coming from, you may very well qualify for a subsidy.
So that was the situation here that we were looking at. Again, we're looking at $6,145 each until they go on Medicare. Then once they go on Medicare at 65, they're going to have to pay for part B and part D, and that's based upon your AGI, right? The adjusted gross income. And so if your income is over certain limits, you're going to have to pay the IRMAA surcharges. So you're going to pay higher than others, for instance. So there's a chart there based upon what your income is, but we'll look at what their costs are projected to be. They don't have any surcharges in their case. And then on top of this, we're also going to assume $3,500 per year in out-of-pocket costs. So with Medicare, again, we're not going to get into detail here, but there's two basic ways you could take your Medicare, you can go the supplement route or you can go the Medicare Advantage route.
So as an example, let's say that you went with a supplement, the most comprehensive supplement, somebody new to Medicare now today can get is the Plan G. And the costs vary across the country. But in Orange County, California as an example, it's about $150 per month, more or less. Just depends on the company you go with. Each company, it is exactly the same as far as the plan, the plans are standardized, but just figure $150 a month in these folks' case, which is about $1,800 a year. And then there's also a deductible. So I think it's about $240 right now. It's something like that. So even if they were to go through, use their deductible, there're still not going to be spending more than, let's call it $3,100, or I'm sorry, $2,100 for the year. The $1,800 for the premium plus that deductible. So it's $2,100, but I'm assuming here their total out-of-pocket costs are $3,500.
And I did this to be more conservative because maybe there would be some additional costs perhaps for based on prescription drugs as an example. The other thing too with Medicare is that it's underfunded. And so maybe they're going to have to raise costs. So I figure let's go ahead and bake in a little bit of extra expenses here just in case the costs end up being higher down the road. So that's the healthcare part. Now, as far as their living expenses, again, we're assuming $7,000 per month. This is for their needs and wants a little bit later. I'll show you one way that we can approach this, where we break this out separately between their needs budget and their wants budget. But their plan here was, again, we're assuming the overall inflation rate is 2.5%. Their plan is to have this increase by 1.7%, okay? So their living expenses aren't going to go up at the same rate as the projected inflation in this case, and that's by design.
So what I find happens with a lot of people is that people tend to want to spend more money early in their retirement years, and then over time they start to spend less. So maybe early in your retirement years, first five, 10 years or something like this, you want to go on more trips, vacations, do more entertainment in general. And then as you get older, you decide that you want to do less of those types of things. And so that was kind of the idea here. Well, it was the idea here, but it was just to reduce those living expenses gradually. Now again, their expenses are going to go up or yeah, the expenses are going to go up 1.7%. So let's take a look over here. You can see how that looks.
So notice right here, they want, again, 7,000 a month, which is 84,000 a year if you can see that. And over time, in today's dollars, in today's dollars, their retirement expenses are going to drop. Okay? Alright. Now if we switch this to future dollars, again, it's still going up at 1.7%. So you are seeing it rise, it's just not going to rise at the overall inflation rate. Now if you're wondering what this cliff is right here, we're assuming that Fred lives to 90 and we're assuming that Wilma lives to be 95 in this example. Okay? So that's one approach that we could take. Now if I come back over here, I want you to see a little bit more detail on that. Here's their healthcare. And so this is just for Fred. So you can see the pre-Medicare costs and then you'll see the breakdown for them. There's no Irma surcharges. So for part B and for part D, and then the all other, again, we're assuming the 5% cola here for these folks. So the same thing for him and her as far as cost expectations. Here's the living expense, again, they're going to go up, but they're not going to go up at the same rate as overall inflation. And again, if I come back to here,
Now notice this too. Again, 84,000 of the living expenses healthcare starts at 12,290. And then over time, healthcare costs end up becoming a higher portion of their overall spending. Alright? That's the assumption here. Now, if I come back to here, and let's take a look at what their probability of success was. So by going with this strategy for spending, they were at a 94% probability of success. Now again, there's different ways that we can approach this. Another way that we could do this instead of reducing their living expenses gradually every year, another thing that we could do in today's dollars. So another thing we could do is that we could keep the living expenses the same in today's dollars up until, let's say he's 75. And then we would reduce expenses down by 10% and then do that again at age 85 and reduce it again at 10%.
So if we did that, that's this option rate down here, you'll see that that would put them at a 91% probability of success. So that could be another approach that we could take to do this. Alright, now let me show you something else. So let's say for instance, I was going to keep those living expenses at increasing by two and a half percent to match the overall inflation rate. That's going to reduce their probability of success down dramatically down to 71%. But again, in their plan, just like a lot of the people that I talk to, most people want to spend more money in their early part of retirement. Now, specifically for these folks, their living expenses were really only about $6,000. Let's change this to six. And their desire really for the other thousand dollars a month approximately, was just to have that money available for the early part of their retirement to go on vacations and different trips, entertainment and stuff like that.
So if we reduce the overall living expenses down to really what their needs are, and then we just account for the other thousand dollars a month or $12,000 a year here for what I've called the fun stuff that they want to do, the vacation and all that. And let's say they're just going to do that for the first 10 years of retirement. So if we did that and plus press refresh, you're going to see that that brings 'em right back to a 94% probability of success. Now the other thing that came up here was Fred was happy that he could retire. And he was also thinking though, I mean the job he was working in, he was burned out. It was a pretty stressful job. So his thinking was he would still want to work. He was only 62, turning 63 here soon. But he figured I could get something and he would want to get something part-time.
Now, he wasn't sure what he would do for sure, and everyone's going to have a different situation here. You might have the ability to have contract work maybe with your company or just find a job in a different field. I have many people that I've talked to such as one guy who was a engineer, and then he decided when he retired, he just wanted to work at Home Depot and just part-time, just because he is a handy type of guy and it would get him out of the house here and there. So for instance, if let's just say he went back to work and made $2,000 a month, so let's just say $24,000 for the year, we could take a look then and see what the impact would be on the plan. And you'll notice this brings 'em right back up here to what, 98% probability of success.
So they might say, well, what if we spend $18,000 a year right upfront on that fun stuff for the first 10 years if he's going ahead and continue to work? Well, they could do that and they could probably also increase the monthly expenses here and still maintain this high probability of success. The key point here as I'm just going through this is that there's so many different ways to approach this, and it's just a matter of doing what's right for you because everyone has a unique vision. Some people that I've talked to, if they have Netflix, which is what, like $12 a month or something like that, they have Netflix on the tv. I mean, they're pretty happy in retirement. They don't need or want a lot. Other people want to go on a trip to Europe every year. So it just completely varies. But once you have that game plan, and in other words, an income plan or a spending plan that you feel confident, that'll give you that confidence, I believe, so that you can go ahead and spend it and enjoy.
Because one of the things that I see happens unfortunately far too often is that again, the people that have been the best savers are the people that have the hardest time spending. And now they retire. Like let's say these folks, it's 62 and 61 and now 10 years goes by and they haven't spent as much and now they're in their seventies and they keep accumulating more money that they'll probably never end up spending. So those are important things to consider. Now, I know what oftentimes happens here too, is that if you have children, you may have desires to leave certain amounts of money to them or not, or just have them receive whatever is remaining. So again, everybody's different, but that were the case and you wanted your kids to receive a certain amount of money, you might be able to separate that out so that hey, this is the money that they're going to receive and I can spend through the rest. Bottom line, so many different ways to approach this, but having a plan is the most important. So hope this was helpful. If you have questions, let me know. And if you like the video, make sure that you like it and that you subscribe and we'll see you soon. Take care.