How to Budget for Retirement
One of the most important steps in developing a retirement plan is determining how much money you will be spending each year of your retirement. While we can’t plan for all eventualities, developing a budget for retirement around the expenses we can predict will help determine how much needs to be saved prior to retirement and help make your retirement as relaxed as possible.
Your retirement budget will depend a great deal on your desired lifestyle, geographic location, discretionary spending, and healthcare expenses. For example, a retired couple living in a paid-off house in rural Iowa will have a very different monthly budget than a couple living in a rented apartment in Palm Beach Florida. Health expenses can be a source of worry; however, planning for adequate health insurance and Medicare coverage can build some certainty into budgetary models.
Creating a Retirement Budget
It is easy to assume that your spending will decrease during retirement, however, while certain categories of expenses like clothing, mortgage payments, and restaurant meals may decrease, others such as spending on hobbies, travel, and healthcare may increase. It is important to get an accurate picture of your retirement expenses early in the retirement planning process so that you can plan around them.
One way to approach a retirement budget is to list your current monthly expenses (this is an excellent plan for any budget) and then start thinking of how those expenses might increase or decrease after retirement. Our Retirement Budget Worksheet can be used by you and your spouse to begin the budgeting process.
The worksheet has a fairly comprehensive list of expense categories as well as space to include monthly income before and after retirement.Since humans are notorious for budgetary wishful thinking, it’s best to gather up all bills, receipts, and credit card statements that you can find prior to beginning a budgeting session.
To better illustrate, let’s talk about Ann and Bill, a couple in their mid-fifties who are starting to get the retirement itch and plan to retire in January 2021. Currently, they make $8,000 jointly each month after taxes and after filling out the worksheet, discover that their current monthly expenses (including retirement contributions) total $6,900.
After doing some thinking, they decide that they will have the house paid off by the time they retire, and will no longer be making retirement plan contributions. Since they don’t know how much traveling they will be doing, and aren’t certain about the other categories, they leave them the same. Their total monthly estimated expenses during retirement are $3,800 in today’s dollars. Since they know they should be conservative with the estimate, they decide to add another 20% for fudge factor, and come up with $4,560.
Using the Social Security Administration’s nifty Social Security Benefit Quick Calculator, they determine that their future monthly Social Security income will be (roughly), $4,586 jointly in inflation-adjusted dollars. They don’t anticipate having any additional sources of income such as rental property or side jobs, so any shortfall must be made up by their retirement savings.
Estimating Inflation and Cost Increases
One of the difficulties of estimating retirement expenses prior to retirement – especially if you are doing it many years in advance, is that your calculations will need to account for inflation and increases in certain categories of costs such as medical costs. Fortunately, there are several online calculators available to help estimate the effects of these costs on your budget. Coupled with a future value calculator, you can begin to get an idea of how much money you will need to have invested in order to retire comfortably and cover all your anticipated expenses.
The 2004 National Health Expenditure Survey reported that seniors can only expect Medicare to pay about half of their medical expenses; further, the survey determined that on average, seniors paid $4,888 per year out-of-pocket for medical expenses.
Going back to our example couple Ann and Bill, they estimated that their monthly expenses during retirement will be $4,560; however, they need to adjust that amount for inflation. Using an inflation calculator based on the Consumer Price Index, they determine that their base monthly expenses will be $5,580 in 2021 dollars.
Since Ann and Bill know that medical expenses often rise more rapidly than everything else, they decide to work out a separate estimate for that. Taking the 2004 Healthcare Survey estimate of $4,888 for annual medical expenses and plugging it into a healthcare inflation calculator, they estimate that their individual annual medical expenses in 2021 will be $9,365 or jointly, $1,560 per month.
After accounting for inflation and increased medical costs, Ann and Bill’s estimated monthly expenses will be $7,140 in 2021. Since their estimated Social Security benefits will be $4,586 each month, they have a shortfall of$2,554 that must be made up by investment income each month. This calculation does not include taxes, which cannot be estimated quickly, since we don’t have enough information about where they are living and how their investments are structured.
After completing an estimated retirement budget, Ann and Bill have a much better idea of what their expenses will look like once they retire. Although they had hoped that their expenses would drop, it is very likely that increased healthcare spending will end up costing them a fair amount each month. By using a retirement calculator, they determine that in order to meet their expected shortfall of $2,554, they will need to have at least $550,000 saved at retirement.
Since this was a quick and dirty example, there are several areas in which numbers could be tweaked and adjusted. The main assumptions used are an inflation rate of 3.9%, an investment growth rate of 7%, and taxes were excluded.
How to Lower Retirement Expenses
No article about retirement budgets would be complete without a discussion of how to lower retirement expenses. The two simplest ways to reduce or defray post-retirement expenses are to: increase income and change geographic locations.
Increasing post-retirement income can be done passively through rental income or retaining an interest in pre-retirement businesses or partnerships. While purchasing a rental property can seem like an easy investment, it is only advisable if the mortgage can be almost entirely paid off prior to retirement, the house is located in a thriving rental market (such as in a university area), and you are fully aware of the responsibilities involved with being a landlord. If none of these factors are present, you’d be better off steering clear of rental properties.
Many retirees are choosing to get side jobs to increase their income during retirement. Doing so can make retirement dollars stretch farther and can reduce dependency on investment income during bad investment years. Some seniors choose to work easy retail jobs while others use their pre-retirement career experience to land consulting gigs.
Moving to an area with a lower cost of living can be an excellent way to lower retirement expenses and engage in a little real-estate arbitrage. By selling your residence in a high-priced real estate market and moving to a modest house in a lower-cost area, you can pad your retirement account while buying a new house with cash. Adventurous retirees in search of extreme price differences might even consider moving to an expat zone in a developing country such as Mexico, Nicaragua, or the Turks and Caicos.
Don't Put It Off, Jumpstart Your Retirement Plan Today
A comfortable retirement can only be secured with prudent planning, aggressive saving, and disciplined investing. Online research is a good start, but consider the benefits of discussing your options with a qualified financial advisor. The alternative could mean lost opportunities, higher fees, and lack of discipline. Request a free, no-obligation consultation today.Speak with an advisor over the phone about your retirement plan for FREE.