Once you retire, several costs go away. Most people stop paying Social Security and Medicare taxes once they stop drawing paychecks, and instead, they'll be likely to receive benefits from those programs. The costs of going to work fall off your budget, too, as do any taxes owed to cities or states you work in but don't live in. On top of that, many states offer tax breaks on retirement income, which also keeps that cost burden down.
Add in factors like a paid-off mortgage and children who are independent by the time you're retirement-ready, and a cursory look might make you think you'll face substantially lower costs in retirement. But while your costs might drop because of all those factors, chances are, other costs will take their place. Some of those costs might very well be things you're looking forward to spending money on, but others may be a result of the unfortunate consequences of aging.
The new costs you'll see in retirement
Once you retire, you'll still have 24 hours in a day, and seven days in a week. The key change you'll face is that the structure of those days and weeks will be different. Instead of spending a significant chunk of those hours and days at work, you'll have to find other ways to fill that time.
Particularly as a younger retiree, you may find yourself spending that time in ways that also spends your money. Travel? That costs money. Spoiling your grandkids? The love and attention you give them are free, but everything else costs money. Local entertainment? While you might get some senior discounts, it's still money out of your pocket.
As you get later into your retirement, unfortunately, many of your costs risk becoming both less pleasant and less voluntary in nature. Healthcare costs are a particular concern for retirees. People generally spend more on healthcare as they age. On top of that, healthcare inflation is generally higher than the overall inflation rate. That combination means the costs you see for your healthcare will likely rise substantially during your retirement.
In addition to healthcare costs, many people need help with daily living activities and chores around the house as they age -- activities that they used to be able to handle on their own. According to MetLife's 2012 survey of long-term care costs, typical costs for homemaker services ran at $20 per hour, while adult day care services ran around $70 per day.
Be prepared to cover those costs
Those new costs you face may very well offset what you're saving by no longer working. That's one reason Social Security estimates you'll need to replace around 70% of your pre-retirement income to retire comfortably. Some retirement experts like Fidelity think an even higher number -- around 85% -- is more likely a reasonable target.
On average, Social Security covers around 40% of a typical retiree's pre-retirement income. Even that level of replacement income may be aggressive in the future depending on how lawmakers address the long-term funding gap facing Social Security. Regardless of what level it actually provides, however, there's a clear gap between what Social Security can help with, and what you'll actually need. If you have a pension, that might help as well, but there are fewer of those around than there used to be.
In any event, you'll need money saved up to cover the gap between what you'll otherwise get in retirement and what you'll need to cover your costs. How much you'll need depends on your specific circumstances, of course, but a decent rule of thumb is that you'll want to have 300 times the typical monthly costs you need your savings to cover.
That level gets you covered by a guideline known in retirement planning circles as the 4% rule. The 4% rule indicates that you have a very good chance of not outliving your money if you do all of the following:
- Maintain a properly allocated and diversified retirement portfolio.
- Spend 4% of that portfolio's value in your first year of your retirement.
- Increase your withdrawals in line with inflation each year.
You can get there
Your retirement is probably the largest financial goal of your life. If you haven't yet reached the point where it's comfortably covered, don't worry -- you're certainly not alone. As long as you're still drawing a paycheck, you can do something to help get yourself closer to funding that goal. Still -- the sooner you start to work toward it, the easier it is for you to reach that goal. There's no sooner time than today, so get started now to have your best shot to cover the costs you'll face in your retirement.
Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.