Life doesn’t stop throwing you curveballs once you retire, and unfortunately, a lot of the ones that catch seniors off guard hit them right in their wallets. While some expenses truly are unpredictable, you can save yourself a lot of headaches by planning for these three retirement “surprises.”
1. Medical expenses
There’s no way to know exactly how much you’ll spend on medical care in retirement, but if you get the healthcare you need, it’s safe to assume it’ll cost you a lot. You’ll have Medicare premiums, copays, and deductibles, and you may have to pay extra for prescription drug coverage, hearing aids, or long-term care. According to a study by Fidelity, the average healthcare costs for a 65-year-old couple retiring in 2021 will run to $300,000.
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One of the best things you can do to prepare for that is to purchase sufficiently robust health insurance. That’s not cheap, but it can turn an unpredictable expense into a more predictable one, making it easier to budget for.
Most retirees have Medicare, but that doesn’t cover everything. You’ll need a prescription drug plan if you don’t want to pay for your medications out of pocket. You may also want to look into a Medicare Advantage plan or a Medicare supplement plan to help you cover some of the things original Medicare doesn’t, like hearing aids and dental care.
No matter what you do, you’ll still have some out-of-pocket healthcare costs in retirement. You can save for these in a health savings account (HSA) if your current health insurance has a deductible of $1,400 or more for an individual or $2,800 or more for a family. Individuals may set aside up to $3,600 per year in 2021 while families can save $7,200.
Money you put into an HSA reduces your taxable income for the year, and if you eventually spend it on medical expenses, you won’t pay taxes on it at all. You can also withdraw the funds for non-medical uses, though if you do, you’ll have to pay taxes on the money, plus a 20% penalty if you’re under 65.
2. Taxes
It might seem obvious that you’ll need to plan for taxes in retirement, but many people forget to do so. This can cause them to drain their retirement savings at a faster pace than they expected.
It’s unlikely you’ll be able to avoid taxes entirely in retirement. But you can reduce the amount you pay by using a smart withdrawal strategy.
You’ll owe taxes on any money you withdraw from tax-deferred retirement accounts, like most 401(k)s and Traditional IRAs. But you won’t owe taxes on Roth retirement account withdrawals. That’s because you pay taxes on Roth contributions in the year that you make them.
You can use your estimates of your annual expenses in retirement and the current tax brackets to get a sense of how much you might owe. To reduce your taxes in retirement, you could draw upon tax-deferred savings until your income nears the point where you’d be switching to your highest marginal tax bracket. Then, switch to tapping your Roth accounts, if you have them. That will prevent you from having to pay a higher tax rate on those funds.
Or you could try a proportional withdrawal strategy. If you have, for example, 60% of your retirement investments in tax-deferred accounts and 40% in Roth accounts, then each year, you’d withdraw 60% of the money you need from your tax-deferred accounts and 40% from your Roth accounts. This can also help you keep your overall tax bill lower in retirement.
3. Required minimum distributions
Once you turn 72, each year, you will have to withdraw at least a certain percentage of the assets you hold in most of your retirement accounts — your required minimum distributions (RMDs). The one exception to this rule is if you’re still working and don’t own more than 5% of the company that you work for. In that case, you may delay taking RMDs from retirement accounts associated with that job — but only until the year you retire.
All retirement accounts except Roth IRAs have RMDs. Interestingly, Roth 401(k)s, though they are taxed in the same way as Roth IRAs, do have RMDs. But you can get around that requirement by rolling your Roth 401(k) funds over into a Roth IRA before you turn 72.
For most people, RMDs won’t be much of a problem. You’ll probably need to withdraw more from your retirement accounts than you would be compelled to in any given year anyway. But those who hope to keep their savings in their retirement accounts for as long as possible may have to withdraw more than they’d initially planned.
You don’t want to skip RMDs — doing so will cost you a 50% penalty on the amount you should have withdrawn. That’s certain to be more than the taxes you would have paid if you did what you’re supposed to do.
Familiarize yourself with how RMDs work and, if you’re approaching the age where you’ll have to begin taking them, estimate how much you’ll have to withdraw. If it’s going to increase your tax bill, make sure you budget for this extra expense.
You won’t be able to avoid these expenses in retirement, but planning for them well in advance can prevent a lot of unpleasantness. If you haven’t yet, go back through your retirement plan right now and adjust it accordingly. That may mean you need to increase your retirement contributions. But years from now, when the bills start rolling in, you’ll be glad you did.