By: Tahir Jaffri, Financial Advisor
As retirement time horizons continue to increase and people are living longer, the rising cost of lifestyle expenses can dramatically impact a retiree’s likelihood of financial success. As a retiree’s cost of living increases, so does their need to increase income in retirement. Factoring in the increasing costs of living represents a retirement risk that plays a large role in calculating a retirement savings need.
What does it mean for retirees?
The U.S. Bureau of Labor Statistics Consumer Price Index (CPI) regularly averages the costs of goods and services used by American households to help determine how much consumer prices are increasing. This increase is commonly referred to as inflation. The chart below illustrates the increase in costs over a 20-year period.
Housing, health care, food, transportation, and charitable contributions account for 89% of spending in households over age 75. As retirees age, their spending on housing and health care typically increases while the spending on food and transportation usually decreases.
While 2022 was an unusual year with the June CPI reading peaking at 9%, the highest inflation figure since the 1970s, inflation over the past 50 years has averaged 4%. And more recently, the inflation rate from 2013 through 2023 has averaged 2.7%.
Consider this hypothetical case of a 65-year-old planning to fund $50,000 of annual expenses over a 14-year retirement through age 79. Without assuming any inflation, the total amount of retirement expenses through age 79 would be $700,000. If 3% inflation is factored into this scenario, the total expenses through age 79 would be $854,000.
An important part of preparing for retirement is protecting against a variety of potential risks. With a 3% inflation rate, the cost-of-living doubles in 24 years. Inflation and increasing living costs could become challenging as someone lives 25 to 30 years or more in retirement.
Staying healthy, managing health care costs, preparing for potential long-term care needs, and having enough money in retirement are 4 of the top 5 concerns facing today’s retirees. Health care risk is facing unexpected and increasing medical expenses, such as insurance premiums, copays, and dental care.
What are the potential risks?
According to Fidelity, the average 65-year-old retired couple may spend $315,000 to cover their health care expenses over their lifetimes. That figure does not include a potential stay in a long-term care facility.
Long-term care (LTC) is not only expensive, but the costs are also inflating at a rate faster than the rest of the economy. AARP indicates the national median cost for a private nursing home room is $9,034 per month. Many LTC recipients are making the choice to receive long-term care services at home based on the understanding that home health care is not as expensive. While this may be true, average home health aide costs are $5,148 per month.
While consumers may not entirely understand how LTC insurance works, they express a clear need for it. In a 2022 study, 60% of respondents said they need LTC insurance. This number jumped from 55% in 2019, which suggests that the COVID-19 pandemic may have raised the perceived need for LTC coverage.
Individuals who are age 65 today have close to a 70% chance of requiring some form of long-term care in their remaining years, leaving retirees to determine how to cover potential LTC costs. About 75% of middle-income seniors would need to use their home equity to pay for assisted living; even then, 39% would still fall short.
The need for these services is projected to grow significantly for the foreseeable future due to the growing number of Alzheimer’s disease cases. It’s estimated that 6+ million Americans ages 65 and older are currently living with Alzheimer’s and that this number is projected to grow to 13.8 million by 2060. As the number of these cases continues to grow, so will the need for LTC support services.
Protecting retirees from the unknown but potentially expensive cost of health care and long-term care will become more important in the future as people continue to live longer. Planning for this financial impact can help provide today’s retirees with more of the peace of mind they desire.