There is a fear of running out of money in retirement among many baby boomers. As boomer women, we live longer than men, but our savings are not always enough to last long in retirement.
The main goal of retirement planning is to see how to cover your retirement expenses while living on a fixed income. Part of creating a solid retirement plan is to understand your retirement income and expenses. That means you need a retirement budget.
The best advice is to start planning when you are still working and can adjust the numbers. Preparing retirement budget will help to see if you have enough money to retire. If you are still working you have time to add to your savings, pay off debt and change your spending habits.
How do you prepare a retirement budget? I will take you through 5 simple steps.
Step 1. Calculate your retirement income
The more sources of retirement income you have the better off you will be in your golden years. The income in retirement will come from different sources. For many retirees, a Social Security paycheck will be the ONLY income. Other retirees will have an additional income coming from 401(k), IRA, Roth IRA, savings, annuities, dividends, and/or rental properties.
Start with Social Security and find out how much you will get paid once you retire at 62, at full retirement age which 66 or 67 for most of us or delay it until you turn 70.
Social Security website will help you to open an account if you do not have one and find out the size of your guaranteed paycheck.
The next source to consider is pension income. Most Americans do not have pensions anymore. But if you are lucky and have a pension add the estimated paycheck to your Social Security.
Then, look at your retirement accounts including 401(k), IRA and Roth IRA and calculate the balance on all of them.
After you calculated your retirement savings balance, find out how much it will grow in the next 5 or 10 years. For example, you have saved $200,000 on your retirement accounts. If this money grows at 6 percent per year, it will be worth $267,645 in 5 years or $358,170 in 10 years. I like to use an online calculator for estimating my investment portfolio growth:
Smart Asset investment calculator
Using a 4 percent safe withdrawal rule will help to see how much income you can generate from retirement accounts. It would generate around $10,405 or $14,326 a year of income.
Finally, calculate the total of your combined retirement income:
SSB + pension + retirement accounts + bank savings balance + rental income + business income = combined retirement income.
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Step 2. Estimate your retirement expenses.
Step 2 will help to find out how much money you need in retirement by accurately projecting your retirement expenses. It is easier to control your spending than retirement income. And we all know that if we spend less than our monthly income, our retirement funds will last longer.
A simple way to estimate your retirement expenses is to know where and how you spend your money today while still working.
Divide your expenses into 3 main categories:
- Essential – need to have
- Non-essential – want to have
- Unexpected and/or one-time expenses
Label your expenses as either essential or non-essential. It will help to see where your money is going.
Essential expenses – need to have:
Your essential expenses are expenses you cannot live without in retirement:
- Mortgage or rent
- Utilities
- Transportation
- Food
- Medical
When you retire, you will still have to spend money on these expenses each month. But how it will change in the future when you stop working?
Here are the same budget categories but the cost of it might change when you retire.
- Housing – Are you planning to downsize, pay off your mortgage, rent, or relocate to a more affordable place? You have to include the property taxes and maintenance costs if you’re an owner.
- Utilities – Cost of utilities might go up or down. If you relocate to a warmer state, include the additional cost of air conditioning.
- Internet/ cable/ phone – Are you planning to spend a lot of time at home reading and gardening or some of your hobbies include using the internet? You should include the approximate cost of the internet and cable in your retirement budget. Many people cut costs by switching from cable TV to a streaming service.
- Transportation – How your transportation needs will change in retirement? How many cars do you have? Are you planning to downsize your vehicles? Will you buy a new car or a boat? Calculate how much you pay each month for gas, car insurance, and parking and decide how it will change when you stop working.
- Food – How much you will spend on food depends on your eating habits. Most retirees start eating out less and prefer to have homemade meals. This budget category expense can be significantly reduced.
- Medical – It is hard to calculate medical out-of-pocket expenses, along with premiums for Medicare. Yes, Medicare provides health insurance, but it does not pay for all medical bills and it does not pay for long-term care at all. There is no way to know how much it will cost. But according to Fidelity Investments, a healthy couple can expect to spend on average, a total of $275,000 out of pocket on healthcare expenses in retirement. And a long-term care cost is not included in this number.
Non-essential expenses – want to have:
These expenses are your extras. Make sure to leave room for fun when calculating your future cost of living. You worked hard most of your life while saving and planning for retirement. Traveling, camping, attending a concert, or eating dinner with friends will be part of your fun years. You need to plan for that and include the cost of it into your retirement expenses.
- Traveling/ vacations
- Hobbies
- Entertainment
- Gift/ charity
Many of my friends who already retire admitted that every month of their retirement look different than the month before. Some months they spend a lot of time at home. Other months, they are on the road visiting friends and family or traveling abroad.
Unexpected and/or one-time expenses:
- Urgent medical expenses
- Unexpected car or home repairs
- Home improvement
- Wedding
- Grandkid’s college tuition
- Funeral
By including these expenses into your retirement budget, you will minimize the chance to be surprised by these events. You wanted to be sure that you have enough money to cover these expenses. One way to deal with unexpected is to have an emergency fund. Instead of panicking at every unexpected bill, you will have a small pot of money at hand and ready for use.
For our retirement expenses I like to use a worksheet from Vanguard:
Vanguard retirement expenses worksheet.
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Step 3. Compare your retirement income and expenses.
After calculating retirement expenses compare it with your retirement income and see how much you have left over.
Retirement income – retirement expenses = cash flow
Once you stop working you can rely only on the income generated from your savings and Social Security. And if you do not have enough retirement savings, you will have to rely only on one source of income – Social Security. Even Social Security is considered a guaranteed income, but it might be not enough to cover all your expenses.
It is important to have enough income to pay for your monthly essentials. Thus, first look at your Social Security benefits and see how much it will cover. Next, calculate how much money you have to withdraw from retirement savings to cover other expenses.
You can boost your retirement income by downsizing your home or delay retirement for a few years. But those may be not the options for everybody. Most baby boomers will need to reduce their expenses and change spending habits so they can live on their available income.
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I calculated that Roman and I will need to have $60,000 a year ($5,000 a month) to cover our expenses for the first 5 years of our retirement. We plan to downsize, sell our house and rent an apartment before we decide if we want to buy a condo. We like to travel and have a long bucket list of places we want to visit. If we do not delay our benefits until age 70, our estimated Social Security paycheck will be $42,000 a year ($3,500 a month).
Thus, we will need to withdraw an additional $18,000 a year ($1,500 a month) from our savings. Many advisors recommend withdrawing 4 percent from savings so your retirement funds last longer. We can withdraw up to $20,000 a year from our savings to follow this rule and feel safe.
If I want to bump that number to 5 percent and withdraw $25,000 a year from our savings, we will spend our retirement funds faster. I would rather adjust our lifestyle and reduce our expenses to fit a safe rule of 4 percent withdrawal than to deplete our funds fast. The goal is to adjust our lifestyle to fit our available income.
Even the whole process looks like a lot of work, remember that calculating these numbers now will make life in retirement much easier.
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Step 4. Add inflation and taxes to your retirement budget.
Inflation is real and it will erode the value of today’s dollars over time. Many advisors suggest including 2 or 3 percent inflation to retirement budget. But if you are like me and have no intention of moving your retirement portfolio out of the market, you should expect that keeping money in the market will help to fight inflation.
When you start preparing a retirement budget first thing you want to know is how much income you have available to pay the bills each month. But whatever number you calculated in Step 1 may not be yours to keep in full. Your withdrawals from retirement accounts like 401(k) and IRA will be taxed year after year. And depending on your retirement income so might be a portion of your Social Security paycheck.
Hence, instead of being surprised by taxes, budget for them. Look at your current tax brackets and try to figure out yours in retirement based on estimated income. Then add that money to your retirement budget. You will pay lower taxes in retirement because you will have less income. But you still need to have money to pay taxes every year.
Step 5. Keep updating your retirement budget.
I know that my retirement budget is not perfect and needs to be updated. But it is a starting point that allows me to learn how much income Roman and I need to replace when we stop working.
Budgeting for retirement is not a do-it-once-and-forget exercise. Retirement budgets are living things that need periodic checkups. Once you retire you need to keep updating your spending, income, and withdrawal numbers, because spending in retirement could go easy out of hands.
Also, you need to keep an eye on your retirement portfolio growth and make sure that all is going according to your plan. Otherwise, you need to adjust and fit your lifestyle to available income.
Final Thoughts
None of us wants to spend our fun years worrying about money. Everyone wants to enjoy retirement. Follow these 5 simple steps and start preparing your retirement budget. It should help you to stay on track financially so you can enjoy your fun years and avoid stress.
Do you have a retirement budget? Have you thought about preparing a retirement budget? Share your ideas with us in the comments below.
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Disclosure: This information is only educational. The intent if this post is to provide a simple guideline for an extremely complicated matter. I am not providing any specific financial advice or recommendations to any of my readers.