Retirement essential expenses may expose a flaw in the 80% rule
Morningstar researchers say retirees should test plans for healthcare, housing and widowhood costs that can squeeze income late in life.
By Sal Moretti · Money Reporter
3 min read
The usual retirement essential expenses math may be too tidy for real life. A study by Morningstar researchers Sebastian Gomez-Cardona and Spencer Look says retirement plans should separate must-pay bills from optional spending, because basic costs take up a larger share of income as people age.
Financial advisers often start with a broad target: replacing about 70% to 80% of pre-retirement income. Gomez-Cardona, director of research, investment advice and planning at Morningstar, told MarketWatch that this can be a starting point, but it does not answer which bills are hard to cut.
Trips, restaurant meals and some purchases can be reduced or delayed. Housing, healthcare and basic living costs are harder to avoid, the researchers said.
What are essential expenses in retirement?
Essential expenses are the bills retirees are likely to keep paying regardless of market swings or lifestyle changes. In the Morningstar research, these nondiscretionary costs include categories such as housing, healthcare and other basic living needs.
The point is practical: retirees may be able to trim fun money, but rent, medical bills and everyday necessities can keep coming. Gomez-Cardona said people need to plan for both income and expenses, with the most certain expenses forming the base of the plan.
How should guaranteed income cover retirement costs?
Gomez-Cardona told MarketWatch that essential expenses should be matched, where possible, with safer assets or dependable income. That could include Social Security, a pension, an annuity or another reliable source of cash.
The MarketWatch example uses a worker who earned $100,000 before retirement and expects to spend $80,000 a year after leaving work. Based on the Morningstar research, about $45,000 in dependable income would be needed in the first retirement year to cover essential costs, while the remaining $35,000 could come from investments or other assets for discretionary spending.
Using safer income for the must-pay bills may leave 401(k) balances, savings and other investments available for later surprises, according to the research. One example cited by MarketWatch: a retiree with $1 million who withdraws 4% a year could use that money toward discretionary spending.
Why healthcare and housing can strain later years
Healthcare and housing stand out because averages can hide trouble. Gomez-Cardona said average healthcare spending can look stable because many retirees have modest bills, while a smaller group faces much larger costs.
Housing can also change late in retirement. The researchers found rent costs tend to rise after age 80 or 85, possibly when retirees sell homes, move into rentals, or enter assisted-living or long-term-care facilities.
The study found total spending usually falls as retirees age. Even so, essential costs take a bigger bite from income over time.
For average-income households, essential expenses equal about 40% of pretax income before retirement and about 60% during retirement, according to the study. At age 65, the figure is about 45% of income, rising to 51% at 70, 58% at 75, 64% at 80 and nearly 73% at 90.
Higher-income and higher-wealth households follow the same direction, though less sharply. Their essential expenses rise from about 29% of income at age 65 to roughly 54% by age 90, the researchers found.
Gomez-Cardona also said couples should test their plans for widowhood. If one spouse dies, household income may fall while housing and other core bills may not shrink much.
The 70% to 80% rule still has a place. The Morningstar research suggests retirees should add a tougher question: how much of that spending has to be paid, and how much of it is covered by income they can count on?
This story draws on original reporting from MarketWatch.