There's no sure way to know exactly what our expenses will be in retirement. As we've seen lately, things like the Affordable Care Act, changes in legislation, and economic conditions can have huge repercussions on our expenses that are beyond our direct ability to control. However, this doesn't mean that I'm content to give up trying to predict what our retirement expenses will be, since at least making my best educated guess can help us better prepare financially.
Adding and deleting expenses
While our lives probably won't change drastically in retirement, our expenses could change significantly. Costs for things like contributions to a retirement account could suddenly become payments from retirement account distributions. Health care costs for insurance might suddenly be reduced due to Medicare eligibility, and tax payments to Social Security could become benefit payments from this trust fund.
Therefore, one of the first things I did to figure out our future retirement expenses was to go through our budget line by line and decide whether certain expenses would remain or go away in our retirement, and if they did remain, in what amount.
Things like gas costs would be cut since my wife wouldn't be commuting to work. Income taxes would go down since income would be reduced and Social Security would be an important part of our remaining income. But things like travel and entertainment costs would likely increase with more time on our hands.
Reviewing prior personal inflation
The next step in determining retirement expense estimates involved getting an idea of what these remaining expenses would be in the future. This can be more difficult since things like food, medical, utility, home, and similar living expenses can be affected by a variety of personal and economic factors. However, one of the best ways that I've found to get a general idea of where costs will be in 30 years is to look back at previous years' expenses to determine a personal rate of inflation.
For those who don't track expenses, this could be a good example of why it's time to start. I've been tracking our expenses for over a decade now. This had allowed me to look back at things like the price of gasoline, how much we spend on food monthly, what our utilities cost, and similar expense data over time. Using this information has helped me determine our overall cost of living - all expenses - increases by about 3.5 percent each year on average, which is critical information to help us estimate what costs will look like 20, 30 or even 40 years from now.
Estimating future values, plus some
Once we have the personal rate of inflation for our family, it's relatively easy - and somewhat scary - to project future expenses. I can take our present expense total, increase it by 3.5 percent each year to account for our personal inflation rate, factor in a particular time value, and see what our expenses would look like.
For example, let's say expenses that we would carry with us into retirement are currently $30,000 a year. At a 3.5 percent rate of inflation over 30 years, using a simple online future value calculator, we can see that this figure would grow to $84,203.81 a year.
Pretty frightening, isn't it?
And while after the kids leave the house and we have fewer expenses relating to their care, our personal inflation rate could drop, there is also the increased possibility of higher health costs. So in my opinion, I'd rather be safe than sorry and aim higher in these estimates to guard against the unknown.
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The author is not a licensed financial professional. This article is for informational purposes only and does not constitute advice of any kind. Calculations have not been verified by a professional. Any action taken by the reader due to the information provided in this article is solely at the reader's discretion.
- Personal Finance - Career & Education
- Retirement Benefits