Every penny counts for retirees. Funds tend to be limited without an incoming paycheck and unanticipated expenses can force retirees to make lifestyle sacrifices. Healthcare, taxes, and inflation should be integral to any retirement strategy, as they comprise some of the largest expenses. Unfortunately, these areas are often overlooked in retirement.
Tax Impact on Retirement Income
A popular misconception is that taxes decline when an individual stops working. While they can and income may be lower, taxes still tend to have a significant impact on retirement savings. Tax brackets can also change in retirement. Since an individual may be drawing from multiple income sources, it can move them into a higher tax bracket, especially after retirement minimum distributions (RMDs) take effect at 73. Here are some retirement income streams that are subject to taxation.
- Traditional IRAs and 401(k)s: These tax-deferred retirement accounts are taxed as regular income. An individual’s tax bracket determines how hard the savings are hit. Participants should know that after taxes, they may not have as much as they think.
- Social Security benefits: Shocking as it may seem, the Internal Revenue Service (IRS) taxes Social Security benefits above a certain threshold, up to 85% of benefits could be taxable.
- Pensions: Generally, most pensions are subject to federal income tax. However, not all pensions are taxed at the state level, depending on your residence.
An efficient tax-planning strategy should be part of an overall retirement plan. Tax planning considers potential tax liabilities in current and future years. It seeks tax-saving opportunities and employs strategies to reduce taxes while maximizing financial well-being in the long term. For example, Roth IRA present an opportunity for tax deferred growth and tax-free withdrawals in retirement if certain criteria are met. A financial advisor can help savers identify strategies that maximize tax efficiency.
The Eroding Power of Inflation
Inflation silently attacks wealth by compounding and reducing purchasing power over time. This means the money individuals save today will buy less in the future, which can make living on a fixed income especially difficult. For example, if a retiree needs $50,000 per year today to cover expenses, the same lifestyle could cost almost double in the next 25 years. The Social Security Administration (SSA) applies an annual cost-of-living adjustment (COLA) to SSA benefits. However, SSA benefits can be insufficient to live comfortably in retirement. Since personal savings and investments typically supplement Social Security benefits, they should also consider inflation.
Healthcare costs increase faster than the general inflation rate of the Consumer Price Index. Medical advancements, labor-intensive services, supplies, prescription drugs, and an aging population requiring care drive those escalations. They result in higher operational costs, which can impact insurance rates and result in higher patient fees. Because healthcare is a more significant factor and cost for older adults, retirees can experience inflation more intensely than some other demographics. For these reasons, a portfolio that grows to at least keep pace with inflation is vital. A financial advisor can help savers implement a retirement plan armed against inflation.
More about Healthcare
Healthcare is usually the highest retirement expense, and it is often underestimated. Fidelity’s 2024 Retiree Healthcare Cost Estimate reported that a 65-year-old retiring today requires an average of $165,000 to cover medical expenses in retirement. That’s $330,000 for a married couple, excluding long-term care costs. Healthcare is essential and should be the root of a solid retirement plan. While many people assume they will have medical needs in retirement, they don’t understand that coverage can be more complicated under Medicare. Basic Medicare plans do not cover all costs. Most people will need supplementary coverage through other Medicare programs or outside insurance, and there will be out-of-pocket costs. Here’s a brief overview of Medicare programs and what they cover.
- Medicare Part A (Hospital Insurance): Part A covers hospital bills, hospice, home health, and access to a skilled nursing institution. It also includes hospital admission (minus copays and deductibles) and skilled nursing home care for a maximum of 100 days after a qualifying hospital stay.
- Medicare Part B (Medical Insurance): Part B includes outpatient preventative care, checkups, X-rays, medical supplies, and laboratory and ambulance services. Participants pay an income-adjusted monthly premium, deductibles, and coinsurance.
- Medicare Part C (Medicare Advantage — MA): Part C offers alternative insurance for individuals enrolled in Medicare Parts A and B through Medicare-approved private health insurance companies. It may include coverage for prescription drugs, vision, hearing, dental, and health and wellness programs. This plan, along with Medicare Part B, has a premium.
- Medicare Part D (Prescription Drug Coverage): Part D is a voluntary prescription drug plan for anyone enrolled in Parts A and B. It covers most prescription drugs and vaccines, but there are still gaps.
Long-Term Care Insurance
Long-term care is separate from other healthcare costs. According to the U.S. Department of Health and Human Services, seven out of ten Americans will need long-term care in their lifetime. The cost of long-term care can be overwhelming and unattainable if the resources are not there to cover it. A Genworth Financial survey from 2023 reported that the annual national median cost of a private room in a nursing home is $116,800 and $75,500 for a home health aide.
Long-term care insurance, health savings accounts, and other strategies can protect wealth and ensure that retirees get care when needed. A financial advisor can help estimate costs, evaluate options, and create a personalized plan for care using tax-advantaged solutions and structuring investments for long-term care needs.
You don’t have a stable retirement plan if you have not accounted for taxes, inflation, and healthcare. By working with a financial advisor to identify and manage vulnerabilities in your retirement planning, you can feel confident in your ability to cover essential expenses while maintaining your lifestyle. Contact us at SHP Financial today for a complimentary review of your finances.
If you need help planning for your retirement expenses, at (866) 746-2401 or ask@shpne.com.
