7 Most Overlooked Budget Items in Retirement

Dean Barber: Thank you so much for joining us here on America’s Wealth Management Show. I’m your host Dean Barber, along with Bud Kasper. Hey Bud.

Bud Kasper: Hey Dean. We got something ready for the people, don’t we?

Dean Barber: All right. There have been many times in my 33 years, and you’re 37?

Bud Kasper: 38 in October.

Dean Barber: Goodness. Okay. Well, yeah. So-

Bud Kasper: When do we stop counting?

Dean Barber: Think about the times when you’ve had somebody come into you after they’ve been retired, and maybe they’ve been retired for five years, seven years, ten years. And they’re like, “Man, I’m struggling. I think the plan that I put together didn’t work out the way that I wanted it to.” Something has happened. They missed something along the way, or they made a bad investment. But the most typical thing that we see that starts disrupting someone’s life in retirement was that they overlooked some essential budget items in their retirement.

Bud Kasper: So true.

Dean Barber: Today, we’re going to talk about the most overlooked budget items in retirement and why they’re critical. It’s by no means a complete list of your budget items, but there are things that people they just don’t think about. We put together a list of what he sees in the industry as the seven most overlooked budget items in retirement.

Looking Back at Last Week’s Discussion on Price to Earnings Ratios

Dean Barber: But before we get to that, I want to back up and talk about our previous show. Last week, you and I outlined the absurd price to earnings ratio of Tesla. We outlined the extreme overvaluations that we have in both the S&P 500 and the NASDAQ.

Bud Kasper: Right.

Dean Barber: Right? Suddenly, we have a 10% correction in the NASDAQ in just three days. We had three substantial loss days in a row: Thursday, Friday, and Monday. So, I thought it would be good for us to talk about the sequence of returns and average returns here for just a few minutes before we get into these seven most overlooked budget items in retirement.

Bud Kasper: Okay. Let’s do it.

Breaking Down the Sequence of Returns

Dean Barber: So here’s the question. I want you to just think about this in terms of average annual returns. If you make 100% in the first year and lose 25% in the second year, what’s your average annual return?

Bud Kasper: You tell me.

Dean Barber: Well, your average annual return is 37.5%.

Bud Kasper: Right.

Dean Barber: Right?

Bud Kasper: But what’s the dollar amount?

Dean Barber: Well, so here’s the math. Remember if you made 100%, lost 25%, you’ve got a 75% over two years. Average that out over those two years; it’s 37.5%. Right?

Bud Kasper: Right.

Dean Barber: So you could look at that and say, “Well, average annual return over two years was 37.5%.” But the math doesn’t support it. So if I invest $100,000 and get a 100% return, that means that $100,000 will turn into $200,000. If I lose 25% of 200,000, I’m going to lose $50,000.

Bud Kasper:
Right.

Dean Barber:
Okay. So at the end of the day, even though you had an average annual return of 37.5%, your real return over two years was a total of 50%. Now you take that and say, that’s an average annual return of only 25%.

Bud Kasper: That’s right.

Dean Barber: Now, I don’t mean only 25% because we would love to have average returns of 25% year after year. Right?

Bud Kasper: Of course.

Dean Barber: That would be awesome. But my point is that the sequence of returns matters. When you start getting into periods where there is extreme market volatility like we experienced at the tail end of 2018. We experienced it again at the beginning of 2020 due to COVID-19. Bud, we’ve got these extreme valuations again today, and companies are still having a hard time projecting their earnings.

Valuations and Earnings Projections

Bud Kasper: They sure are.

Dean Barber: Right. Because we still are amid COVID-19.

Bud Kasper: Right. And the economy is questionable at this point. That’s even with the stimulus! Both from Congress and probably, more importantly, from the Federal Reserve and their policy on interest rates.

Dean Barber: You and I did a video about a month ago in which we discussed why the markets have been going up so fast. It’s mostly due to the Federal Reserve and the stimulus packages put forth by Congress.

Bud Kasper: Right.

Dean Barber: So we could say it’s somewhat artificial.

Bud Kasper: Yep.

Dean Barber: Now just because we have high priced earnings ratios doesn’t mean that stocks automatically just come down. Because you can have high priced earnings ratios for an extended period in the market, but eventually, something has to happen. You got to get back to the reversion to the mean, right?

Bud Kasper: Right.

Dean Barber: At some point in time, those valuation levels have to come down. There are two ways that could happen. One – companies start making a heck of a lot more money, and their earnings rise to catch up with the current price. Or two, the price drops.

Bud Kasper: Right. And you could build a case for both, by the way.

Dean Barber: Absolutely, you could!

Bud Kasper: Right now, the economy is having some difficulties. If the economy picks up, then earnings pick up. That substantiates the difference between the earnings and the price level. However, that isn’t generally the way it works. If earnings pick up, the multiple then increases even further. So, you haven’t had the reversion to the mean to clean the slate.

Dean Barber: Exactly. Perhaps the markets think that as the economy comes out of COVID-19 and people get back to work, earnings can pick back up? I think that could be the case.

Bud Kasper: I hope so.

Dean Barber: Bud, you have something you wanted to bring up about the sequence of returns and their importance. Especially in retirement, I think the five years leading up to retirement is a critical timeframe.

Bud Kasper: It is, because those are the worst times to suffer losses. After all, you have less time to be able to rebuild.

Dean Barber: Right.

Bud Kasper: With the sequence of returns, people must understand what we’re talking about. First off, it’s “What did you earn the first year? The second year? The third year?” And so forth. If you’re taking distributions, which is what people do when they’re retired, and if you get a sequence of returns, do you want to have your most significant gains in your portfolio at the end of, let’s say ten years, or at the beginning of ten years? And so the answer, just to cut to the chase here, is you want your returns for distribution purposes. So your more significant returns to come at the beginning.

Dean Barber: Right.

Bud Kasper: You have no control over that. All you can control is the build of your portfolio and get a certain percentage of that. But more importantly, if you have the lower returns at the beginning, now you’re going to have more difficulty because you’re going to have to get higher returns later on. Significantly higher if you have a series of negative returns early in the sequence.

Dean Barber: An example would have been retiring January 1, 2000, where there were three years in a row of lousy market returns. Or retiring October of 2007, and going through to March of 2009, and having almost 18 months of negative returns. Those moments hurt. So it’s critical. That’s one reason why we talk so much about the bucketed approach of making sure you have three to five years’ worth of income distributions. It doesn’t have to be in a money market, but it needs to be in a more conservative portfolio.

Bud Kasper: Sure! Where the loss of principal is almost nothing, and you’re still getting an interest rate that at least appreciates the principal value.

The 7 Most Overlooked Budget Items in Retirement

Dean Barber: Right. But that’s a topic for another show. Let’s get into what we promised to talk about today, which was the seven most overlooked budget items in retirement.

Health Insurance

The first one on our list is health insurance. And I don’t want to say that people don’t think about health insurance as part of their expense, because they typically do. But there are several components to health insurance as you budget it into your retirement that you need to be aware of. The first thing is that if you retire before age 65, which is your Medicare age, you’re going to need private health insurance.

Bud Kasper: Right.

Dean Barber: That’s going to be significantly more expensive than if you wait until 65 to retire and strictly go on Medicare. Medicare itself is not free. Medicare costs money, and it comes out of your Social Security check.

Bud Kasper: Yes, it does.

Dean Barber: So when you’re looking at your Social Security statement, and it says, this is how much you’re going to receive. Well, that’s your amount of Social Security, but that’s not how much you’re going to receive. The amount you’re going to receive is your Social Security check less your Medicare premium.

Bud Kasper: Right.

Dean Barber: And Medicare premiums are not the same for everyone. If you have higher earnings or higher taxable income in retirement, your premiums actually increase based on your income.

Bud Kasper: Which is another thing that you have to plan for.

Dean Barber: Exactly. And then Medicare doesn’t cover all your costs, so you’re going to need some sort of Medicare supplement insurance. And there’s a lot of those out there.

In our podcast, The Guided Retirement Show, in episodes six, seven, and 22, we do a deep dive into health insurance and Medicare and retirement. So check out episodes six, seven, and 22 of The Guided Retirement Show on your favorite podcast app to understand more about what you need to be aware of when it comes to budgeting for health insurance and retirement.

Lumping Health Care Expenses

The other big thing, Bud, I think that happens that people miss is, we see it all the time. They’ll lump all of these expenses together. Then they’ll say, well I need $7,000 a month. Or, I need $6,000 a month. Whatever your number is, that’s what my budget is. And so some, maybe not so sophisticated financial planners, will take that number and they’ll just put it into their system. And they’ll apply, say a 3% inflation rate to the whole budget.

Bud Kasper: Right.

Dean Barber: That’s a big mistake. So what do we do, Bud? We apply different inflation rates to health insurance. Why? Because we know that health insurance is increasing.

Bud Kasper: Because that’s the reality.

Dean Barber: It is a reality! So we’re applying 6.5% to 7% inflation rates to health insurance. And remember when we first started the show today, I said that a lot of times if you don’t budget these things properly in retirement, it’s not the first or second or third year, it’s years down the road. So if you’ve got health insurance inflating at a much faster rate than the core rate of inflation, what happens is all of a sudden that health insurance and health costs wind up making a larger and larger and larger piece of your overall budget.

Which is why some people start to feel like I’m getting pinched. Or that they don’t have the money that they used to have when they thought they had their plan together. But if you don’t budget for health insurance properly, you’re going to be in for a rude awakening down the road.

Bud Kasper: You are. We’re using 6.8% for healthcare. We’re using 3.6% on normal inflation. Now, how does that impact the total plan? It does affect it. You need to understand the power of compounding with taxation as well.

When you look at that over time, it becomes a critical factor for you to work a plan that works for you. And one of the issues that I can just tell you, because I’ve done this so many times and for many years, is when somebody comes in and tells me they’re retiring. They’re going to retire, let’s say at 62 or 63, and inside my head, I’m rolling my eyes going, “Oh my God, do you have any idea what the health expense is going to be with that?” To get the reward for all the money you put into the system, you need to wait to 65. Why? Because boy does that back off some of the monthly expenses and annual expenses you’re going to have.

Dean Barber: But you know, Bud, I was just reviewing with one of my clients last week. He’s 56 and just sent his only daughter off to college. We went through, and we redid the plan. We upped the budget and we’re budgeting in $32,000 a year for health insurance cost for him and his spouse in the years leading up to Medicare. So I think we’re over budgeting there.

Bud Kasper: Good.

Dean Barber: But even with that, he’s okay to go. So the question then is: Do you want to continue to work just so that you don’t have to pay those health insurance costs? Or, are there things you’d rather do with your life? But that’s part of our Guided Retirement System. Our Guided Retirement System doesn’t leave anything untouched. It looks at every aspect of your life leading up to retirement, and then through retirement to the distribution phase when money goes to the next generation.

Dean Barber: And I’d love for those of you listening to experience that, and make sure that you don’t miss any of the budget items that Bud and I are talking about today. If you want to get a conversation started, we can do it through a quick 15-minute phone call with a CFP® on our staff. You can do an in-person discussion, or you can do a Zoom meeting. What we call it is a complimentary consultation.

It’s just an opportunity to visit with us to help you understand the opportunities and obstacles in your life based on what you’ve got going on today. For your complimentary consultation, fill out the form below, and we will be in contact with you.

Bud, let’s move on to the second item on our list.

Bud Kasper: Let me add one more thing to that because we’re using the designation CFP®, and a lot of people may not understand what that means. That stands for CERTIFIED FINANCIAL PLANNER®. It’s a program that takes approximately two years to go through, with subsequent tests all along the process. And on top of that, then there is a board exam you take before you get the designation of a CERTIFIED FINANCIAL PLANNER®. It’s the standard in the business for financial planning. And we have that in all of our offices to accommodate people with the best education possible.

Taxes

Dean Barber: Absolutely. I’m going to introduce the next subject – taxes.

Bud Kasper: Oh boy.

Dean Barber: If you’ve been listening to America’s Wealth Management Show for any time, you know that Bud and I are fanatical about long-term, forward-looking tax planning. But now we’re talking about budgeting for taxes in retirement. You have to understand how much your Social Security will be taxed and build it into your budget. How your distributions are going to be taxed and build that into your budget. You have to understand your Medicare tax, which is your Medicare premium, and build that into your budget. However, one important thing is making sure that you plan for what happens if you are not married any longer because of a spouse’s death. Because now you’re a single taxpayer.

Bud Kasper: Oh boy.

Dean Barber: You’re going to have higher taxes and you have to build that into your budget. The most significant thing on taxes is so today we’re building plans, and in those plans, we’re building in the expiration, or the sunset of the tax cuts and jobs act that President Trump signed into law.

Bud Kasper: True.

Dean Barber: Okay? So we’re planning for those higher taxes. We’re also building in what happens when required minimum distribution start. And what are the taxes going to look like then? And we’re trying to figure out how we can mitigate that by some forward-looking tax planning utilizing our CPAs. The big one that most people miss is the taxes on social security. A lot of people don’t think social security is taxable. And they missed how the tax rates go up on the same amount of income when one spouse passes away.

Bud Kasper: We talked on the tax side of this, and Joanne has shared this with our listeners often. It’s the effective rate that counts, because you’re really paying your taxes in what we refer to as tiers. And even though you want to spell that T-E-A-R-S, it’s T-I-E-R-S. And that’s because we have an exemption with the current tax strategies up to $24,000, approximately. Meaning that’s a personal exemption, so therefore you have no taxes on the first $24,000. And then it pops up to the next level.

And then further down the line even more. So depending on your income level, you’re not in a 10% bracket. You’re not necessarily in a 22% bracket. Right. But even if you were for, let’s say a little bit of your income, when you average that all together for what the actual tax rate is, that’s what we call the effective rate.

Dean Barber: But remember, we’ve done this on here before, that there are points in your income stream where taxes can get as high as 49% under the current law.

Bud Kasper: And people say, that’s nice. He doesn’t know what he’s talking about.

Dean Barber: It’s not possible? Yes, it is possible. I can show you exactly where it happens. It happens where you have a little bit more income than what you have to qualify to have social security not be taxable, and to have your qualified dividends and capital gains be tax free. You go up and you have too much income, too much taxable income, and suddenly that causes capital gains or qualified dividends that were prior tax free now to become taxable. And it causes social security that would have been tax-free to become taxable. So you’re being taxed on three different sources of income, because you had more distributions coming out of IRAs or some other source. And so you really, really, really have to budget taxes into your retirement properly, because taxes is by far the number one eroder of wealth in retirement.

Bud Kasper: Here’s a good question. Why would you ever want to pay more taxes today than later? And the answer is, because of the power of compounding for the tax benefit when you do Roth conversions.

Dean Barber: And we’ve talked a lot about that. And by the way, in the Guided Retirement Show, episode one and two, JoAnn Huber, our CPA, and I go into detail about the Roth conversions. Get out and pay attention to those because taxes is the number one wealth eroding factor in retirement.

Mortgage and Escrow Payments

All right, let’s move on to number three on our list of the seven most overlooked budget items in retirement, escrow payments. A lot of people will go into retirement with a mortgage, all right. So there’s a lot of things you need to be thinking about here. Firstly, if you have a mortgage, your actual mortgage payment is not going to inflate. So you don’t apply inflation to the mortgage rate. So the mortgage itself, right?

Bud Kasper: Right. 30 year lock-in, 15 year lock-in.

Dean Barber: Whatever it is. You may only have 10 years left on your mortgage. And your mortgage has a finite ending date. It will end at some point in time, so it needs to be put into your plan as such. What won’t go away though, even when the mortgage is paid off, is your taxes and your insurance. And a lot of people miss that. They think, well my house is going to be paid off. I’m going to save $1,000 a month, because that’s my mortgage payment. Well your mortgage payment happens to include your property taxes and your insurance. So you have got to break those out and understand that those budget items are still going to be there, even when the house is paid off.

Bud Kasper: And again, this is what happens in a comprehensive plan. We delineate all this information in a format that you can truly see what’s going to happen after the house is paid off, and what it’s going to be like prior to the payoff.

Dean Barber: Exactly! That’s a big one. And that one doesn’t get too complicated. It’s just, you need to make sure that you’re there. So let’s talk about now long-term care insurance premiums. Most people, they might say, well I don’t have long-term care insurance. Okay. You may not have long-term care insurance, but the odds of you or a spouse spending time in a long-term care facility, or needing in-home healthcare are pretty darn high. So you need to make sure that you’re taking into consideration that either A, you’re going to pay an insurance company a premium to cover that risk, or you’re going to bear that risk on your own.

Dean Barber: And either way you do it, it needs to be built into your plan. Typically, what we will do for you, is we will build both scenarios into the plan so that you can see which scenario gives you the best outcome.

Bud Kasper: And there’s a couple of ways of skinning that cat that we don’t have time for in this segment. Maybe we can drop into it in the next one. And that is, should I be getting long-term care insurance? Are there different types of long-term care? And by golly, they keep popping this premium up on me as I’m entering into retirement. Is there anything I can do about that?

Dean Barber: There is something you can do about that. Look, we want to help you. We want to help you make sure that your money does what it needs to do in order for you to live your one best financial life. We do that through a complimentary consultation where we can sit down and get to know you, what you’re trying to accomplish, and let you know what services we have and how we can help.

Long-Term Care Insurance Premiums

Dean Barber: Talk about taking care of business, Bud, this whole long-term care issue, we’ve seen it in cases where it was done right. Where it’s a beautiful thing, because it can create some amazing tax planning opportunities. And where it’s been ignored or hasn’t been planned for correctly, or the wrong type of insurance was purchased. It can be a disaster.

Bud Kasper: Yeah. I wish I could remember the percentage, but I don’t. In terms of, what are the probabilities of you or your spouse actually needing long-term care?

Dean Barber: It’s over 50%.

Bud Kasper: Then the issue associated with that is, well, are those folks that went in and did long-term care, let’s say 15 years ago when it was first introduced, they had very low premium payments. And as they paid these, and now they’re in retirement, let’s say they’re 60, 65, what’s happening? The insurance company is raising the premiums. At the wrong time. Why? Because we’re budgeting now. So with that, is there a better solution? Well, I’m not necessarily going to say this is the best solution, but I will make it a solution. And that is, you can actually go in and do a contract with an insurance company that it’s kind of a hybrid of covering long-term care.

Bud Kasper: And I’ll use myself as the example, if you don’t mind, in this case. I took out a one million dollar policy on myself, and my wife has the ability, if I go into long-term care, of accessing 60% of the death benefit. By the way, with no taxes, no repayment. 60% of the million dollars to be able to cover long-term care expenses. Let’s say I used all of that when I passed away, she still has another $400,000 remaining income tax free, which would go back to support her. Now for me, that was the right solution. But what’s the right solution for you? And that’s something that you need to understand, but that’s a part of the plan.

Dean Barber: Right. And the thing is that you bought one of those types of policies, you did right by explaining it as a hybrid. That you did a 10 year pay on it, so your premiums are done and you’re never going to have an increase in premium. Right?

Bud Kasper: Right. Because what I didn’t want to have was one additional cost in my retirement years. So therefore, that’s why I did it the way I did.

Dean Barber: Which is brilliant. And so that’s done right.

Bud Kasper: Did you hear that folks? He said I was brilliant.

Dean Barber: Your wife didn’t say it though.

Bud Kasper: No, no, no. I’ve never heard those words cross her lips. No.

Home Repairs & Remodeling

Dean Barber: Let’s move on. There are a lot of ways to attack that whole long-term care risk in retirement. And we explore all of those with you during the road and the journey through our guided retirement system. We do address all of those issues. Another thing that I see people missing in the top seven most overlooked budget items in retirement is, people don’t plan for home repairs and remodeling.

Bud Kasper: You’re so right. And the thing that bothers me when we go through that in the plan is, if you knew you were going to do this, why weren’t you doing it when you had a paycheck? Why are you waiting when we have a finite amount of money that we’re working with to try to be able to create your income stream from that point forward?

Dean Barber: But if you budget for it and you say, on average, budget $5,000 a year for home repairs and remodeling…

Bud Kasper: …you know you’re going to have it.

Dean Barber: You don’t take that and put it in your bank account as part of your spending. You keep that in a separate account that is for your home repairs and remodeling. And maybe you may not have any for two or three or four years, but then suddenly something big needs to be done and you got $20,000 sitting there.

Bud Kasper: Yeah. And some of this is predictable, right? You know your roof is 10 years old. You know you’ve got five more years before you probably need to replace it.

Dean Barber: You know you’re going to need to paint, you know you’re going to need new gutters, you know that you’re going to need new windows, and you know that you might need a new air conditioner, or a new dishwasher, and on and on it goes.

Bud Kasper: And so we identify that as an ongoing need. And the question is, what’s the amount? Well people might say “I’m building a new garage because I want to be able to have a workshop in the back.” Okay. Well, we need to know how we’re going to fund that. What time are you going to do this? What do you anticipate the cost is going to be, so we can budget into that. And so we budget for that year, when that’s going to happen. But the next year we drop it down to maybe $1,500 a year that we’re just keeping, Hey, you may not ever use it for that year. Well that’s fine too. We just push it into the next one. We have more money, less demand on your savings.

Dean Barber: Exactly, right. But you have to really think through that. And it’s really important that you start keeping track of any home repairs before you retire. That should be a separate item on your budget list as you’re working so that you can get an idea of an average of what are you spending. And at what age do you remodel something? If you haven’t done something for 10 years or for 15 years, is it time then to remodel?

Bud Kasper: Re-carpeting, new windows, new driveways, you know? And the list goes on and on.

New Vehicles

Dean Barber: All right, now new vehicles, that’s another big one too. How often do you want to replace vehicles? And what a lot of my clients will say is, I’ll keep a vehicle for 10 years. So if a husband and wife both have a vehicle, what we do is we plan for a vehicle replacement every five years. So you’ve got a new vehicle and a five-year-old vehicle. And by the time you get the next new vehicle, you have one that you traded in or sold that was 10 years old. And now you have five-year-old vehicle.

That’s the way that we do it. And people may not want to replace them that often, but that is something that’s out there. And the vehicle maintenance and the vehicle repairs, that’s all got to be part of your budget.

Bud Kasper: Everybody now is still looking, when they’re financing cars, for that zero interest rate. And there’s some of them that are out there. And of course, that plays into it because we do need to know exactly how we’re going to pay for it.

Dean Barber: Yes. So definitely take into consideration all the expenses that are around your vehicle and the vehicle replacement throughout retirement.

Gifting

The last one is gifting. Now, you might say, I’m not charitable. Well, we may not be talking about charities. I’ve got, I don’t even have to tell you how many conversations I’ve had about it. I’ve got one client who comes in and says, “I want to spend $5,000 total on my granddaughters for Christmas this year.” Right? Well, we built it into the budget. Her husband says, “Well we can’t afford it.” I’m like, “No, we can because it’s already built into the budget.” Right? We go back to the plan. Here it is. It’s there. “Oh yeah. I forgot about that.” Right? So that was something that was critical to her so that she could do special things for her grandkids.

Bud Kasper: We’ve may also have issues associated to gifting. Well, as an example, people this year who were over 70 and a half, they didn’t have to do a required minimum distribution. That was a break, but it goes back at the beginning of the new year the way it was. But that doesn’t mean you can’t still do, in this current year through QCDs – qualified charitable distributions, which is a way of getting money out of an IRA without taxation, as long as it’s a gift to a charity. So whether you’re endowing a chair at a university. Or whether you’re giving the money to the church, whatever the case may be, this is an excellent way of using the tax law to your advantage. If, as Dean said, you’re charitably inclined.

Dean Barber: There you have it, the seven most overlooked budget items in retirement. I encourage you to get a complimentary consultation. We will start with a 15-minute phone call to try to understand what your needs are, what your concerns are, what your questions are. Many times, we can answer those questions and concerns and we don’t need to go any further. But if we do, then we can talk about how our process works and how we take the next step to begin to help you and taking you through our Guided Retirement System.