Are You California Dreaming About Retirement? What to Consider About Spending Your Golden Years in the Golden State
Retirees in California enjoy sunny days, tasty meals and more, but the state comes with some unique financial considerations. Here's a guide for DIY retirees.
California can be a wonderful place to retire. The great weather, access to outdoor activities, good food and diverse culture are some reasons retirees choose the Golden State.
That said, retiring there comes with its unique financial considerations. The cost of living is high, state taxes can take a big bite out of retirement income, and housing, transportation and healthcare costs can add up quickly. The overall cost of living in California is roughly 40% to 45% higher than the national average.
Retiring comfortably in California requires careful planning and consideration. If you're taking a do-it-yourself approach to retirement in California, here are a few areas to consider.
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Get a good handle on your expenses
One of the first steps in planning for retirement is understanding what it costs to maintain your lifestyle. This might sound obvious, but many of my clients come to work with me at Halbert Hargrove because I am a CFP® professional and wealth adviser.
I review my clients' bank and investment account information and help them analyze and understand how much they spend on a monthly or annual basis. While many of my clients know how much money they have in their bank accounts, they often don't have a clear understanding of how much they spend on a regular basis.
I recommend starting with your regular fixed expenses. Think housing, utilities, insurance, transportation and healthcare premiums. Then consider the expenses that don't occur every month: Vacations, home repairs, property taxes or helping family are examples of some.
Knowing your nondiscretionary expenses (what you need to spend), vs your discretionary expenses (what you want to spend), is helpful. If the stock market has a challenging year, knowing where you have the flexibility to cut back can help you adjust your withdrawals while you wait for the market to recover.
Plan for healthcare beyond Medicare
California is home to some of the greatest medical institutions and hospitals in the nation including Cedars-Sinai Medical Center, Stanford Health Care, UC San Diego Health and UCLA Ronald Reagan Medical Center. But medical planning goes beyond finding the best doctors for the care you need.
California retirees need to budget for Medicare premiums, Medigap or Medicare Advantage, Part D (prescriptions), dental, vision, long-term care and any out-of-pocket expenses. Knowing the average cost of healthcare as a starting point can help, but age, location and tobacco use can impact costs.
There's another issue: Higher taxable income can increase Medicare premiums through IRMAA (income-related monthly adjustment amount). This is a surcharge added to your monthly Medicare Part B and Part D premium if your income is above certain limits.
What this means for retirees is a large IRA or 401(k) withdrawal might create a tax bill today and potentially higher Medicare premiums later.
Pay attention to California taxes
In addition to a higher cost of living, California has one of the highest state income taxes in the U.S. State income taxes start at 1% and go up to 12.3%, plus an additional 1% for taxable income over $1M. This matters quite a bit when retirees are drawing from large IRAs, 401(k)s or pension plans, as the net distribution from a pretax account can be considerably lower after you account for taxes.
Long-term capital gains tax, which is triggered by the profit you make from the sale of an asset held for more than a year, is also taxed in California using the same ordinary income rate that's applied to withdrawals from pretax retirement accounts.
At the federal level, long-term capital gains are taxed at a more preferential rate, so California is unfortunately unique in this regard. For retirees with substantial investment income, this can really increase their tax liability.
One silver lining — California does not tax Social Security benefits, disability or survivor benefits, so retirees who live primarily on these types of income have less tax exposure.
Don't forget housing, property taxes and home insurance
For many retirees, homes can make up a large portion of their net worth. This is especially true for California, where the prices of homes have skyrocketed throughout the years.
I frequently hear my clients recount how they bought their first homes for tens of thousands of dollars, and have watched the property grow into a multimillion-dollar assets.
A retiree in that situation might have substantial equity in their home, but a low-cost basis and property tax assessment. That can make a decision such as downsizing or moving to a retirement community much more complicated than simply looking at the price of the new home.
Before moving, consider the complete cost of the new property, including property taxes, homeowners' insurance, homeowners' association (HOA) dues and maintenance.
A smaller or less expensive home might not lower monthly expenses by much, all things considered.
When it comes to property taxes, keep in mind that Proposition 13 imposes a 1% cap on the tax rate and a 2% maximum for annual increases, offering some protection from long-term owners.
If you're a homeowner age 55 and older who wants to move from one California home to another, Proposition 19 allows you to transfer the lower assessed value of the primary residence to a newly constructed or replacement principal home. Eligible adults can use this tax transfer benefit up to three times.
Keeping your California retirement on track
Retirement in California can be expensive, but for many people, the lifestyle is a significant factor in their decision to live here. Understanding the costs, staying flexible and recognizing how each financial decision affects others can help you make informed choices while enjoying this chapter of life.
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