When planning for retirement, you must consider all the costs you'll be facing. Between healthcare costs, monthly bills, housing, travel and transportation, and other expenses, retirees often face a daunting financial future. But what is the biggest expense for retirees? And what difference does it make? As you'll learn later down this post, one-third of an average American retiree household's costs go to a single expense category. Knowing that category will help you plan accordingly while you're getting ready for retirement. As it turns out, you can minimize those expenses to significantly impact your budget during retirement, but to do so, you need to start acting sooner rather than later.
In this post, you'll learn where most of your monthly income goes, how those expenses are structured, and what you can do before and after retirement to manage them.
How do our expenses change as we age?
Most of our monthly income goes towards essentials like housing, food, and transportation. These are called "fixed costs" because they're roughly the same every month and don't change much from year to year. But as we age, our fixed costs tend to increase, and other variable costs become more important.
For example, a typical 25-year-old spends about 27% of their monthly income on housing, while a typical 65-year-old spends 33%. As we get older, we also tend to spend more on healthcare.
Other expense categories also tend to change as we age, particularly after retiring. In the case of transportation, we may spend less on commuting but more on travel. And as we age, we may also find that we're spending more time and money entertaining ourselves at home.
What is the biggest expense during retirement?
Many may think that medical bills and trips to the drugstore end up eating the most significant part of our budget after we retire, but that may only be true for the older population. Most retirees who are 65 to 70 years old are still in relatively good health conditions, and while they require more frequent medical check-ups, their medical bills are not as high as you may think. As a matter of fact, medical bills aren't even in the second position in terms of an average retiree's expenses.
The biggest expense for most retirees is still housing. This expense category includes:
- Mortgage payments
- Utilities
- Homeowners association fees
- Insurance
- Property taxes
- Maintenance or repairs
- Paying rent
How much do retirees pay in housing?
Until 2020, retirees aged 65 and above spent an average of $16,880 per year on housing alone, adding a total of $1,406.67 to their monthly expenses. The following year, 2021, saw a slight increase in housing costs for retirees. The national average for all retirees reached $17,454 per year, representing a 3.4% increase from one year to the next.
The first ten years of retirement are usually linked to higher housing costs. The younger retirees, those aged 65 to 74, spent an average of $18,027 per annum in 2020, while, for the rest of the retirees, those costs were only a little over $15K.
A recent study from Harvard University shed light on why that is. The study showed that almost half of retirees aged 65 to 79 are still paying a mortgage, while that number drops to roughly a quarter for retirees 80 and up. Therefore, we can safely assume that a good portion of an average American retiree's housing expenses goes toward paying their mortgage, which is quite surprising.
Numbers vary from one retiree to another.
The above numbers are national averages and, as such, do not reflect the actual scenario in every city in every state. Of course, retirees will always spend more or less than the averages we've just discussed, based on where they live and the size of their homes.
For example, in some cities, like San Francisco, New York City, and Boston, living costs are significantly higher than in other parts of the country. This isn't just related to real estate costs but also property taxes, which vary wildly from place to place. This is also true for smaller towns in desirable areas where retirees tend to flock to enjoy their golden years, like Sedona, Arizona, and Hilton Head, South Carolina.
This opens many good opportunities to lower your housing expenses once you reach retirement or even sooner.
How to lower your housing costs as a retiree
Understanding how a retiree's housing costs are structured sheds light on what you can do to manage those expenses better when you retire. It also helps you better prepare for a laid-back set of golden years with more money in your pocket for leisure and entertainment (or, perhaps, investing?). Let's discuss some of the most impactful ways to lower retirement housing costs.
Pay off your mortgage before you retire
Numbers show that retirees today are less averse to taking a mortgage on their home than they were 20 years ago. This partly explains why so many Americans enter retirement still owing large sums of money to a bank, significantly lowering their monthly income.
If you want to enjoy a stress-free retirement without worrying about foreclosure or making ends meet, the best thing you can do is pay off your home loan before you retire. Of course, this isn't possible for everyone, but if you have the opportunity to do so thanks to a windfall or a good investment, you should certainly take it.
Downsize to a smaller house or apartment
Whether you have finished paying your mortgage or not, you can use whatever equity you have on your home to downsize to a smaller and less expensive house or apartment. This will help you save on maintenance, property taxes, and other related costs. It may even clear enough money to finish paying off your mortgage or make a significant contribution to your nest egg, doubly contributing to more retirement income, which is a top priority when you stop receiving your monthly paycheck.
Of course, this isn't the ideal solution for everyone. Some people are simply too attached to their homes or community and will find it next to impossible to find a cheaper place nearby. Other retirees simply don't want to be bothered with the hassle of moving, no matter where that may be. If that is your case, don't worry, there are still other ways to manage housing costs in retirement.
Rent out a part of your house or your entire home
An indirect way to lower housing costs without moving is renting out your extra space. Of course, this is more of an additional source of income to offset housing expenses rather than a way to lower those expenses, but there are ways to make it so that you do reduce your costs and make extra income on the side.
You can do this by renting with a triple net lease or NNN, as they're referred to in the real estate business. A triple net lease is one in which the tenant agrees to pay all the expenses related to the property, including taxes, insurance, and maintenance. In other words, as a retiree renting out your home with a triple net lease, you wouldn't have to worry about any of those things, as they would be entirely covered by your tenant's rent payments, effectively taking those costs off your shoulders.
This type of rental agreement is most commonly used with commercial properties, but it can also be adapted to residential ones. The main advantage of using a triple net lease for your retirement home is that you can be sure about the income you'll receive every month, as all related expenses are factored in the rent price. This gives you a degree of stability and predictability that can be very valuable when living on a fixed income in retirement.
A reverse mortgage could be an option
If you're 62 or older, own your home outright, and live in it as your primary residence, you could qualify for a reverse mortgage. A reverse mortgage is a loan that allows you to tap into your home's equity and convert it into cash, which you can then use to supplement your retirement income.
It's called a reverse mortgage because, instead of making payments to the lender, the lender makes payments to you in the form of monthly income. The loan doesn't have to be repaid until the last surviving borrower dies or moves out of the house, at which point the home is sold, and the loan plus interest is paid off from the proceeds.
Other expenses to look out for during retirement
Housing may be at the top of the list regarding retirement expenses. However, it amounts to 35% of a retiree's total monthly budget, meaning there's still 65% of costs we can manage to ensure we'll have enough left over to enjoy ourselves, travel, and even splurge a bit.
Transportation costs during retirement
As mentioned earlier, once you retire, you don't have to worry about the daily commute to work anymore, which can save you a lot of money. But that doesn't mean transportation costs during retirement will be negligible. In fact, as of 2021, they're still the second biggest expense in a retiree's budget, despite the pandemic locking everyone inside for months that caused an 8.5% drop in transportation spending in 2020.
But why do retirees still spend so much on transportation, even though they don't commute to work anymore? The reason is that 4 out of 5 retirees live in suburban neighborhoods or rural areas, so they often have to drive long distances to get to the places they need or want to go. This makes retirees spend an average of $568 a month or $6,819 per year on things like gas, bus rides, car insurance, maintenance, and more. While this is lower than what the average household spends (which is $9,761 per year), it's a considerable sum that offers an opportunity to cut down living costs during retirement.
Healthcare costs are third in line
Trailing closely behind transportation are healthcare costs, which add up to $6,749 per year or $562 per month during retirement. This figure should be taken with a grain of salt, though, since it's just an average, and it doesn't reflect the fact that these costs tend to increase as we age and may become quite substantial in our later years.
Healthcare costs can be divided into two broad categories: insurance and out-of-pocket expenses. The first category, insurance, includes premiums for Medicare (Parts A, B, and D) and any supplemental insurance policies you may have. The second category, out-of-pocket expenses, refers to the deductibles, co-pays, and other costs you must pay even with insurance.
This is where things can become very expensive, as Medicare doesn't cover everything, and supplemental policies often come with high deductibles. This is why it's essential to plan for healthcare costs during retirement and ensure you have enough to cover them.
If you want to control your healthcare expenses, the best way to do so is to live a healthy lifestyle and take preventive measures to avoid getting sick in the first place. This includes eating a healthy diet, exercising regularly, and getting enough sleep. Additionally, you should get vaccinated against the flu and other diseases and stay up to date with your regular screenings and check-ups.
Taxes are always something to look out for
An unexpected tax hit in retirement can impact your finances even more than during your working years. That's why you should always keep an eye on your taxes and include them in your retirement budget. This includes income taxes, property taxes, capital gains taxes, and any other tax payments you're obligated to make.
The bottom line
Retirement is a time of life when many expenses go down, but there are still some that we need to be mindful of, especially considering that you don't have a paycheck to look forward to. Housing, transportation, and healthcare costs can add up quickly if we're not careful, so it's essential to plan and make sure we have enough savings to cover them or take steps to minimize them while we still have a chance. Living a healthy lifestyle is one way to keep healthcare costs down while being mindful of how much we drive and where we live can help reduce transportation costs. By being aware of the biggest expenses during retirement and taking steps to control them, we can ensure a comfortable and enjoyable retirement.
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