As we have said many times in this blog, if you want a reasonable spending budget in retirement (or if you want a better idea of whether you can afford to retire) it is important to estimate your expected non-recurring expenses in retirement separately from your expected recurring expenses. For example, see our post of February, 7, 2019, “If You Aren’t Separately Budgeting for Non-Recurring Expenses, You Probably Don’t Have a Robust Retirement Spending Budget.”
When developing a spending budget, many DIY households and many financial advisors focus on how much real-dollar lifetime spending can be supported by a given level of assets. But that is not how we spend in retirement. Total spending can vary significantly from year to year depending on many factors, some expected and some unexpected.
Assuming constant real dollar spending for your entire period of retirement can either overstate or understate the assets you need to fund your retirement. This can occur because:
- Some non-recurring expenses (such as travel expenses, new cars, pre-Medicare healthcare premiums, home remodeling expenses) can be primarily front-loaded during retirement, or
- Some non-recurring expenses (such as long-term care or bequest motives) can be primarily back-loaded during retirement
If non-recurring expenses are primarily front-loaded, constant real-dollar spending at a given level may be insufficient to cover the front-loaded expenses and may be overly sufficient to cover back-end expenses. If non-recurring expenses are primarily back-loaded, constant real dollar spending may be sufficient to cover front-end expenses but insufficient to cover back-end expenses. In either instance, ignoring non-recurring expenses entirely in your planning will generally understate the assets you may need to fund your retirement.
In his recent blogpost entitled Plan for Unexpected Expenses in Retirement in Three Steps: Addressing the Systematic Underestimation of Accumulation Levels, Mathew Greenwald of Greenwald Research focuses primarily on non-recurring expenses that, in his firm’s experience, tend to get ignored in the retirement planning process. Mr. Greenwald notes:
“Greenwald Research has conducted multiple studies on the unplanned expenses retirees encounter. These are the ones we hear about most often:
- Repair and replacement of major household systems, such as a furnace and roof
- Unexpected medical, pharmaceutical, and dental expenses, including hearing aids and other devices
- Unexpected family needs, especially grown children needing money because of a loss of job, a divorce, or mental illness
- Death of spouse
- Long-term care expense
- Major unexpected (yet controllable) luxury expenses, such as the wedding of a child, or a second home or yacht”
In this post, we encourage you to take steps to make sure that your retirement plan considers the potential cost of expected as well as unexpected non-recurring expenses (including the ones identified as frequently ignored by Mr. Greenwald). And since it has been a while since we talked about developing an estimate for the present value of future long-term care costs (and it can be a significant part of your retirement plan), we will also revisit long-term care planning.
Planning for Non-Recurring Expenses
In his blogpost, Mr. Greenwald outlines a three-step process for planning for unexpected (or unplanned) expenses in (or near) retirement. We have modified Mr. Greenwald’s suggested process slightly, to address general planning for non-recurring expenses with the Actuarial Financial Planner, as follows:
Step 1: Identify expected and unexpected non-recurring expenses
These expenses may include the expenses identified by Mr. Greenwald in his article as frequently unexpected (or unplanned or ignored) and other non-recurring expenses such as:
- new car or cars
- home improvements
- remaining home mortgage payments
- travel/vacation expenses,
- pre-Medicare health costs,
- support of aging parents,
- other unexpected or expected non-recurring expenses
Step 2: Estimate and enter (or rely on AFP to calculate) present values of individual future non-recurring expenses
The AFP has cells for entering either the estimated present values of individual non-recurring expenses, or the user may input annual costs and timing and rely on AFP to calculated the present values. You can also use our Present Value Calculator spreadsheet to do the necessary calculations. The assumptions used for these calculations should be consistent with the assumptions used in the AFP.
Once data has been entered for the expected and unexpected non-recurring expenses, AFP will automatically calculate the impact on your household actuarial balance sheet and your current year spending budget.
Present Value of Future Long-Term Care Expenses
In many ways, future long-term care cost is the elephant in the room that retirees and near retirees don’t like to think about, so we are not terribly surprised that Mr. Greenwald listed this cost as one that is frequently ignored in retirement planning. Even we don’t spend a lot of time thinking about or discussing long-term care costs in our blog. We do, of course, include a cell for entering the estimated present value of this cost in our workbooks, and readers of the overview sections may stumble across our recommendation for determining an estimate for that present value (discussed below) for those without long-term care insurance, but the last time we discussed long-term costs in our blog was in our post of January 9, 2016 and our follow-up post of January 12, 2016. We, like many of our readers, simply assume (hope) that the equity in our homes will be more than sufficient to cover these costs when the time comes. Admittedly, things can get a little more complicated when you are married and one spouse enters assisted living and the other spouse wants to stay at home.
Medicare does not cover long-term care expenses. Medicaid will cover long-term care expenses of the impoverished. Long-term care insurance is available, but not many individuals purchase this insurance and it can be very expensive. Not everyone will need long-term care, but those who do need it, may potentially need it for quite a long time, so it is difficult to plan precisely for long-term care costs.
Based on the brief analysis we did over six years ago (and haven’t revisited since then), we recommended assuming two years of assisted living care followed by one year of nursing home care. We noted that moving into assisted living three years prior to end of life, would likely reduce the cost of recurring expenses, so we recommended inputting 60% of the current cost for three years in your geographical region as an approximation with about the same effect as including the full present value of long-term care cost and adjusting the lifetime planning period used to calculate the annual recurring spending budget by three years. This estimate assumes the household has no long-term care insurance and also assumes that future increases in LTC costs would be about the same as the discount rate used to determine the present value. As noted above, the 60% figure may be a bit low for married couples who may not want to sell the family home when one of the couple enters assisted living care. You should feel free to use more sophisticated approaches (or more conservative estimates) when estimating your long-term care present values (reserves).
The annual Genworth Cost of Care survey provides useful data to help you determine the amount you might enter for long-term care costs in the AFP. This table shows median costs for 2022, by state, for in-home care, assisted living care and nursing home care.
When planning for retirement (in or near), it is important to anticipate what your expenses may be, both recurring and non-recurring. Researchers note that households may not anticipate incurring certain expenses and therefore, they may underfund their retirement goals or they may need to cut back on future discretionary expenses. We encourage you to plan, as best as you can, for all your expenses in retirement. For this purpose, we suggest that you keep track your annual spending and build in a little extra (a rainy-day reserve) for unexpected expenses, because as we all know, S (as in unplanned “Spending”) happens.