Advisors can get some hard data on how expenses change over a person’s lifetime, help plan their clients’ retirement income and ease their fears, based on a new research paper.
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The amount of non-discretionary, or necessary, expenses, drop in retirement but grow as a portion of income, from about 40% to about 60%, for someone with average income, according to a research paper by Morningstar Investment Management. That data suggests some tweaks advisors may want to make to their retirement income and spending recommendations.
Advisors should use relatively stable income sources for essential expenses as well as making sure clients have savings in case of unforeseen costs related to health and housing expenses late in life, the Morningstar researchers recommended. As part of preparing for retirement, it is critical to test financial plans against higher levels of expenses even at times when incomes are increasing, they wrote.
Then, during retirement, an increasingly large share of income is dedicated to necessary, unavoidable expenses like long-term care and rising medical costs when retirees tend to have less flexibility to cut their spending.
“The more granular you can get, or the more realistic of estimates you can get, I think lead to a lot better outcomes for planning,” Spencer Look, associate director of retirement studies for Morningstar Investment Management, said in an interview. “I think this really helps with people who don’t … know where to start, because this is grounded on real data for thousands of real people all across the country.”
Advisors should guide would-be retirees to plan not only for the average costs of necessities but also for unexpected expenses.
“A plan built only on average essential expenses may understate the assets or income needed to sustain spending under unfavorable but possible outcomes,” the researchers wrote.
Unforeseen health care costs
Health expenses are a risk in retirement. A person with average income and wealth pays about $1,000 on an annual basis at age 25, growing to $3,600 at retirement, according to the Morningstar research. In the first decade of retirement, health expenses spike to $5,000 and then stabilize.
A health care shock is “a really tricky planning problem, because planning on just the average cost is going to oftentimes be way too much … but in some cases, will be way too little,” Look said.
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Some clients might need to live in an assisted living or skilled nursing facility, and that can be difficult to anticipate years or decades in advance. Long-term care insurance, which can help cover those costs, varies by state and level of care and can be a significant expense. Even so, it could potentially be worthwhile as long-term care costs are eating a growing portion of retirees’ incomes.
“Many years of care is where it gets probably prohibitively large and expensive to really plan for or budget for because you just have to save so much to cover that,” Look said.
Worrying about money
While expenses change over the course of a person’s life, as Look’s research examined, income also changes, likely dropping significantly during retirement.
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“The expenses might go down, but your income could go down even more during your retirement years, and one of the things that I’ve experienced in my career … is that regardless of how well off an individual is, many individuals, as we age, become less and less confident that they have enough money,” Mark Parthemer, chief wealth strategist at Glenmede, a boutique wealth management firm founded in Philadelphia, said in an interview. “What we don’t want to do is have clients … have to borrow money from their kids.”
Meanwhile, retirement is often considered a long-awaited time to enjoy time with family, hobbies, travel or other activities.
“Anxiety is not giving the peace of mind that planners want to provide our clients,” Parthemer said.
Budgeting expenses and planning ahead with an advisor can help ease these anxieties.
“I’ve had clients with, you know, $100 million who are worried that they can’t buy new clothes or new shoes because they’re going to run out of money. That fear is real,” Parthemer said. “I think, as advisors, our goal is to try to logic the clients away from how they feel.”
