The Center for Retirement Research at Boston College has published a new in-depth analysis of the emergency spending challenges facing U.S. retirees, and the results are "discouraging," the report's authors wrote.
“Only 58% of all older households have enough cash to cover their unexpected expenses for just a single year," they warn. "An additional 16% of households could cover their expense shocks for a year if they also tapped their 401(k) or IRA assets. That leaves 27% of households unable to cover just one year of unexpected expenses, even after spending all their cash and retirement assets.”
As the analysis uncovers, the typical retired household is predicted to spend 10% of annual income on unexpected expenses, suggesting that retirees should set aside at least 10% of their annual income as emergency savings. At this rate, the median older household would need about 2.5 years’ worth of retirement income to cover all the unexpected expenses over a 25-year retirement, although the full amount would not need to be in a liquid account.
An Understudied Challenge
As the CRR report details, determining how much emergency savings people should have requires knowing how often they face expense shocks, the size of these shocks, and how well prepared they are currently. The literature is "not exactly clear" on these questions, the authors note, particularly for retirees.
“Previous research on unexpected expenses among retirees focuses almost exclusively on health care shocks and finds they are a big risk,” they point out. “One of the few studies that looked at a broader set of unexpected expenses for retirees found that the incidence of more general needs, such as major home or car repairs, is similar to working-age households.”
One challenge in determining how much retirees should set aside for unexpected expenses is that the costs can vary dramatically, the report states. In one related survey from 2017, a quarter of respondents reported spending less than $800 on unexpected expenses while another quarter reported spending at least $6,000, with a median expense of $2,000.
“One reason for the large variation is that households have a degree of flexibility when deciding how to address expense shocks,” the report explains. “For example, if a household needs a new refrigerator or new tires, there are different tiers of refrigerators or tires to choose from.”
As a result of this dynamic, the 2017 survey found, the cost of shocks increases for those with higher socioeconomic status, as they are less likely to defer or forgo home maintenance expenses and more likely to pick higher-end replacements.
“Our study builds on this prior work by exploring a full set of unexpected expenses that retirees face and comparing these expenses with their liquid assets to assess preparedness,” the authors state.
Retirees' Emergency Expenses
From this baseline, the authors go out to calculate how much households spend annually on various unexpected expenses in retirement using three broad categories. These include “rainy day” expenses like home or auto repairs, family-related events like deaths or marriages, and direct health care costs for retirees.
Once they documented the typical expenses retirees face as a whole, the authors examined the variation among groups, with an emphasis on measures of socioeconomic status.
Then, using the incidence and average cost of each shock for households with various characteristics, they calculate the predicted cost of annual unexpected expenses that different types of retirees will face over their lifetime. They also tabulate the size of these expenses relative to income and assess whether retirees have enough liquidity to cover them.
“Together, these measures can help retirees assess the risks of expense shocks and determine if they have sufficient emergency savings to weather these expenses without having to liquidate investments or borrow,” the authors explain.
The findings show that, in any given year, 83% of all retired households will experience some unexpected expense. In terms of the type of expense, 60% of all households will face a rainy day shock; 29% will have an unexpected family-related expense; and 58% will confront an unexpected health care expense.
Notably, as income rises, the prevalence of each type of shock also rises. For example, roughly 45% of the lowest-income households (those with less than $50,000 in income) face a rainy day or health care shock in a given year compared to roughly 80% of the highest earners ($100,000 or more in retirement income).
“This finding highlights the fact that households have some control over when and how much they spend,” the authors observe. “As noted above, those with higher incomes are more likely to incur unexpected expenses on, say, home or car maintenance when these needs arise, and they have the resources to buy higher-end options.”
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