Retirement Planning Spotlight: Shock Expenses’ Bite

With a new year soon dawning, we have reached what for many people is annual budgeting season—a not-so-joyous time of poring over expected expenses and income. The former’s usual suspects: Housing. Food. Medical care and leisure activities. But unplanned one-off expenses often loom large, too—especially in retirement. In our view, incorporating these into your retirement planning may be a sensible precaution. To help you do so, we compiled a few lesser-known costs we think investors ought to consider.

First up: Home upkeep and appliance replacements. It is easy to forget about your furnace, washing machine or stove—until they break down. Repairing or replacing them can cost a pretty penny. Larger home maintenance projects—like a new coat of paint or replacing an aging roof—are even costlier. And don’t forget possibly the vilest scourge of all: termites. Removal costs a bundle. So do the repairs after they eat your house.

Healthcare costs are a given in retirement, but surprises are still common. Traditional Medicare (Parts A and B) covers most healthcare needs for those 65 and older, but not everything. Hearing aids, routine eye exams and most dental care—including cleanings, fillings and dentures—aren’t covered. Neither are prescription drugs—you would need supplemental coverage (likely in the form of Medicare Part D) for that. Perhaps the biggest exclusion, though, is long-term care. While in certain conditions Medicare covers short stays in skilled nursing facilities, this doesn’t include assistance with daily non-medical needs. This falls into “custodial care”—and whether administered in your home or a nursing home, Medicare likely won’t pick up the tab. These bills can rack up fast. A 2019 study found the median annual cost of a private room in a nursing home was above $100,000, and that of full-time household help was north of $50,000.^[i] These are estimates, but anything in this ballpark could take a big bite out of your savings. Supplemental coverage can patch these gaps, too, but the premiums are often steep—another easily overlooked cost.

Although Required Minimum Distributions (RMDs) are an income source, hidden expenses can still lurk. Starting next year, retirees must begin taking RMDs from tax-deferred retirement savings accounts (such as traditional 401(k)s and IRAs) the year they turn 72. Depending on the RMD’s size and your income from other sources (like Social Security), it may raise your taxable income. Since Medicare Part B costs are linked to income, these could rise, too. If you will take an RMD next year, compare Medicare Part B’s 2020 income/premium increase cutoffs with your expected income to see what you might owe.

One more threat to retirees’ finances: Scams, which crooks frequently design to ensnare the elderly in particular. A government estimate put the amount of money older Americans lose to fraudsters at $2.9 billion last year.^[ii] The true figure is likely higher, as embarrassment, failure to notice the scheme or fear of losing the power to manage their finances often keeps victims from reporting scams. Not that you should budget for this! But awareness helps, in our view.

Unfortunately, unplanned costs like those above appear common. While good data on the subject are scarce, an October Wall Street Journal article highlighted one informative study published in 2017 by the Society of Actuaries. It noted 72% of surveyed retirees had incurred at least one substantial, unexpected expense in retirement.^[iii] Nearly one-fifth had experienced 4 or more, and over a third of those who suffered one lost at least 25% of their assets.^[iv] Thankfully, most in this group were able to adapt. However, it often required big sacrifices—like scaling back their lifestyle, borrowing or materially drawing down savings. Here are some tips to lower the likelihood unforeseen expenses take a similar toll on your retirement.

First, educate yourself on possible unplanned costs—which you are doing right now, congrats!—and consider how you might prepare for or cope with them. Merely knowing they might crop up ought to reduce the shock factor. Second, maintain an emergency fund of cash or cash-like securities. The conventional recommendation of three to six months’ worth of living expenses is a great start, but incorporating the possibility of shock expenses suggests a somewhat bigger buffer may be wise.

To steer clear of scammers’ clutches, learn their calling cards. Fraud takes many forms, but they have a lot in common. Hence, a few simple precautions can thwart most schemes—like not picking up calls from numbers you don’t recognize and contacting government agencies directly if a stranger purporting to be from one of them says you are in trouble. Some carriers will now alert you if a call is spam or potentially fraudulent. You can also block calls from unknown numbers on many smartphones. For more tips, see our commentaries here and here.

Lastly, make sure your asset allocation—your portfolio’s mix of stocks, bonds, cash and other securities—matches your growth needs. In our view, stocks’ superior long-term returns likely make them a better choice for investors seeking to grow their nest egg and ensure unpredictable expenses don’t jeopardize their financial goals.