The 10-Minute Retirement Budget

You know that having an idea how much you will spend in retirement is important, but you also are probably dreading actually putting together a budget.  Maybe you have been given a big blank budget and asked to fill it out.  You know the kind, it lists things that most of us typically spend our money on; food, travel, cars, etc.  And then there is a blank field next to it, asking you to give each activity a dollar figure so you can determine  how much you actually spend each month.  And if you’re like most people this sheet of paper has laid blank for months, as you ponder how much you do or should be spending on each activity.  Well I have good news for you.  Throw that retirement budget away!  You will ultimately make one of two mistakes most people make filling out these budgets.  Either you will underestimate how much you spend on certain activities, for example, trust me you are probably spending more on food then you realize. Or, you will just forget to add certain expenses.  Will you remember to count every oil change, sporting event you attend, and round of golf?  

Creating your retirement budget should not take more than 10 minutes, and there should be one simple premise: You will spend about the same amount of money in retirement as you do in your working years.  Sure some expenses may go down; you may pay off a mortgage or the kids may graduate from college. And others may go up; buying a new car, buying your own cell phone, or maybe taking that vacation you have been dreaming of for years. The goal in retirement is that you can maintain the same standard of living that you have during your working career.  If you have been struggling to put a budget together,  I have a better plan for you, and it is a pretty simple equation.  

The amount you need in retirement (after-taxes)                

Your Current Take Home Pay

(minus) Known Expenses that will go down in retirement

(plus)     Known Expenses that will go up in retirement

(plus)     Healthcare Expenses in Retirement

(equals)  Your Retirement Budget

The equation starts off very simple by taking your net take home pay each month.  This is what your paycheck looks like after taxes, 401(k) contributions, and healthcare deductions.  This is the amount that is direct deposited into your checking account each month.   We are then able to subtract known expenses that will go away in retirement.  Yes, you may spend a little less on lunch by going out to eat less, or you may buy less dress shirts in retirement, but that’s not what I’m talking about here.  I’m talking about major expenses that we know will go down.

Expenses that may go down in retirement

  • Paying off a mortgage
  • Downsizing your home
  • College tuition or other costs for children
  • Additional savings (outside of retirement savings that comes out of your paycheck)
  • Commuting costs (remember you will still be driving a car, probably just less)
  • Additional Life insurance premium (no, you don’t need that life insurance policy any longer once you are retired)

Unfortunately, there are going to be expenses that also go up in retirement.  Sure, a lot of these are going to be fun things like travel and hobbies.  There are also going to be higher expenses on things that your company may currently provide, like cell phones or maybe a work car.  We need to add these expenses into our budget.  

Expenses that may go up in retirement

  • Renting a second home in the winter
  • Needing to buy things that the company currently provides (i.e. car or cellphone)
  • Travel
  • Hobbies (Golf isn’t cheap)
  • Taking care of an elder parent

Healthcare in Retirement

Yes, healthcare is important enough to be considered it’s own category.  If you are working for a company, there is a pretty good chance that you are currently paying for your healthcare costs from your paycheck, and prior to taxes.  That is about to change.  Healthcare needs to be added back to your budget because you will now be paying for it out of pocket and after taxes.  A general rule of thumb that I use is that typically one person will spend $4000 per year in healthcare in retirement ($8000 per couple).  Certainly this may vary, if you are retiring post 65 or have employer provided healthcare (lucky you!) it may be less.  If you are relying on private insurance or Cobra coverage it actually may be more than this before reaching age 65.  But if you haven’t even begun exploring your healthcare options, $4000 per person is a decent place to start.  Make sure you have a really good understanding of what this number will be before taking the retirement plunge, as it could make the difference between retiring early or not.  

An example of a retirement budget

We’ve discussed how to create a retirement budget, now let’s look how that retirement budget may look.  Remember, this is just an example, and yours will probably look quite a bit different.  

Current Monthly Take Home Pay            $7,000
Kids graduating from college        –  $1,000
Current Monthly  IRA savings        –  $500
Winter Home in Florida         + $800
Cellphone         + $100
Healthcare         + $670
Monthly Retirement Budget         = $7,070

Remember, we are subtracting IRA contributions.  IRA contributions are out-of-pocket savings that you are currently making after you get paid. This savings would typically stop in retirement.  We wouldn’t subtract a 401(k) or 403(b) contribution because this money comes out before your monthly take home pay.  We have to add back a cellphone because in this situation the cellphone was being paid by the company and now the retiree will have to pay for it.  In this case the retiree will actually have higher expenses in retirement than before he retired.  This happens frequently because we have to add back healthcare.   Prior to retirement, healthcare is typically paid pre-tax before your net pay.  In retirement, you pay for healthcare with after-tax money and needs to be added to your after-tax budget.  

Like your retirement plan, a budget shouldn’t be set in stone.  You will need a new roof at some point, a furnace will go out, car tires will need to be replaced, and these are very difficult to predict.  Also, I find the equation that many financial advisors use, 60-80% of your pre-retirement income, to be very inaccurate.  For higher income workers, couples that make over $120,000 per year, 60-80% of pre-retirement income is typically higher than you will need in retirement,  And, this doesn’t take into account if you have a mortgage paid off or not and if the kids are leaving the house.  Using the 60-80% rule is far too wide and can be much different than your actual spending.  

There is one situation in which tracking your actual spending is important, and that is when your retirement income doesn’t support your spending.  For example, in the scenario above the retiree would live on just over $7,000 per month but what if current savings withdrawals plus social security and pension don’t support that income level?  What happens after adding everything up you can only live on $6,000?  In this scenario there are two things that you can do.  Either work longer until your retirement income will support the higher expenses or cut your retirement expenses.  Cutting your retirement expenses may seem like the easier alternative of the two, but that’s not always the case.  

Yes, it may seem like you could easily cut a few hundred dollars a month from your grocery bill, skip a vacation, and stop eating out so much and voila, you meet your retirement expense goal!  Unfortunately, it typically isn’t that easy and how many sacrifices do you want to make just to retire a couple years early?  If you need to cut expenses in retirement you should be looking at larger fixed costs (i.e. mortgage, car payments) and not variable costs, such as food expense.  Sure it sounds easier to cut your grocery bill than your car payment, but it also typically isn’t as sustainable.  People tend to revert back to their old spending habits and it is easy for that grocery bill to start creeping up again after a few months of monitoring it closely. On the other hand larger fixed costs don’t creep up again so easily.  For example, if you downsize and can cut your mortgage expense, this is a permanent cut which won’t move higher.  By cutting a mortgage or car payment, your everyday spending habits can remain the same.  

Keeping your expenses in check is the most important variable to having a successful retirement.  The goal in retirement is to allow you to sustain a similar lifestyle that you had prior to retirement.  Luckily, it is pretty easy to determine how much you are spending prior to retirement, and therefore creating your retirement budget.  If you are forced to cut expenses, work on reducing fixed costs first.  No, it’s not easy to downsize your home but the cut is permanent.  It may sound easier to cut your variable costs, but the cuts don’t always last.  At the end of the day, you need to decide what sacrifices you need to make in order to retire.  If major cuts are necessary, consider working a few more years so that you can have a more enjoyable retirement.  

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