retirement expenses

How to Prepare a Retirement Budget in 5 Simple Steps

two women with laptop at the table-retirement budget

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

bees flying over lavender-preparing retirement budget

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.

Social Security website

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.

Step 2. Estimate your retirement expenses.

man using notepad and laptop-preparing retirement budget

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.

Step 3. Compare your retirement income and expenses.

architecture - 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.

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.

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.

a woman on a suitcase-retirement expenses

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.

Why Predicting Retirement Expenses Is Important?

by Maggie Leave a Comment

Our ability to plan is one of the features which separate us from other species. And yet, most of us have great trouble thinking ahead or preparing for the long run. Our problem is that we’re continuously caught up in everyday tasks at home and at work. Planning for anything in advance like summer vacation, home renovation, or family visit is hard enough to fit into our routine.

How are we supposed to prepare ourselves for the distant future like retirement?

Yet, those thoughts are the key to be ready for the fun part of life. When we were young, retirement seemed like a distant future, but with every year this distant future comes closer. When we turned 50, we realized that the distant future is not so distant any more. It’s time to answer the key questions which will affect our retirement and the way we want to spend it.

When can I retire?
Did I save enough to retire?
How much can I afford to spend in retirement?
Do I have enough money to cover my expenses when I stop getting a paycheck?

To have a secure retirement, we need to figure out how much we will spend after we stop working. Most of us do a lot of budgeting. We know how much money is coming in and how much money is going out. Even we cannot control our income, but we try to control our expenses. Because we know that if we spend less than we earn, we’ll save more money for the future.

There is a fear of running out of money in retirement among many baby boomers. As women we live longer than men. But our savings are not always enough to last long in retirement. Accurately projecting your retirement expenses will help you figure out how much you need in retirement. After all, if my retirement income is $60,000 a year, but I spend $90,000, I will not be staying retired for too long.

There are several ways to predict how much money you will spend in retirement. Let’s discuss all of them:

Step 1: Find out how much money you spend today.

a notepad with charts for tracking spending

If you already have a budget, this part will be much easier. But If you don’t yet have a budget and don’t know how much your monthly expenses are, it’s better to start calculating them now.

So, grab your bank statements, bills, credit card payments and any other financial information you have in your household expense folder. Use a piece of paper or an Excel spreadsheet to record your monthly expenses.

I suggest you start simple and divide all expenses in the following categories: housing, utilities, transportation, insurance, groceries, personal. Then at the bottom of the spreadsheet calculate your subtotals for each category and see how much money you spend today.

Step 2: Find out how much money you will spend in retirement.

First, start with calculating your “need to have” expenses:

Mortgage or rent
Transportation
Utilities
Food
Medical

In retirement most of your money will be spent on 3 big categories – housing, transportation and medical.

According to the Bureau of Labor Statistics Consumer Expenditure Survey, for adults age 65 and older:

Housing cost represent 34% of spending
Transportation cost represents 16% of spending
Health care cost represents 13% of spending

It’s hard to estimate medical care out-of-pocket expenses, including premiums for Medicare. These expenses might take a much larger portion of your retirement expenses compared to when you are working.

To help you calculate those figures, you can use the online system developed by Health View Services, which estimates your medical expenses in retirement.

This calculator can be found at www.hvsfinancial.com

**Second, calculate your “want to have” ( I call it my wish list) expenses:**

Vacations
Hobbies
Entertainment
Dining out

When calculating your future cost of living, make sure to leave room for fun! You work hard for that most of your life. Traveling, going to the movies, attending a concert or eating dinner out with family or friends will be part of your fun years as part of your retirement expenses. You need to plan for that.

Third, consider the unexpected expenses:

As much as you want to predict your retirement expenses, there are likely to be unexpected costs.

So, my advice: budget for unexpected expenses. One way to deal with it is to have an emergency fund. An emergency fund brings stability to your financial life. Instead of panicking at every little unexpected bill or taking money away from other wants and needs, you have a small pot of money at hand, ready for use in case of:

Urgent medical expenses
Unexpected car repairs
Unexpected home repairs

It’s recommended to have 3 to 6 months of living expenses in your emergency fund. This will give you breathing room if you need a source of cash for an unexpected expense.

After you finished calculating your future retirement expenses, write it down in another column on the spreadsheet. Don’t forget to minus paid off debts if you’re planning to finish paying them off by the time you’re retired.

The total number on the spreadsheet is how much you think you’ll spend in retirement. But be realistic, this is not a final number of your future budget, this is just an estimate based on your current spending. But you can use this estimate to plan out what you’ll need in retirement.

Will you need less, the same or more money in retirement?

Overall the retirement expenses can change dramatically from what they are now. We all have different plans for our future retirement. Its hard to predict our retirement expenses accurately while we’re still working.

Retirement expenses will go down, if:

Your taxes are reduced.
You don’t save for retirement anymore. No more 401(k), IRA or Roth IRA contributions.
You don’t have any work-related expenses. No more office clothes or lunches with colleagues.
You spend less on commuting, possibly by owning just one car or by using public transportation.
Your mortgage is paid off, or you downsized to a smaller home, or you moved to a less expensive state.
You no longer have children living with you.

Retirement expenses will go up, if:

You’re paying more for health insurance, or you will need to pay for long-term care.
You’re traveling more.
You have expensive hobbies and vacations.
You want to buy a vacation home
You have dependent parents who need long-term care and your financial help.
You have children who need your financial help.
You have grandchildren who might need help with their college expenses.

A common rule of thumb recommended by financial experts is that you’ll need 70% to 80% of your pre-retirement income to cover your retirement expenses. Although this method is not completely accurate, it does start you off with a helpful starting estimate.

If you think you’ll definitely spend much less in retirement, calculate 70% of your pre-retirement income. But if you know that you’ll be spending more, use the 80% rule or even bump that number to 90%.

To know your current expenses and keep it under control is important when we are still working. When we work, we can get by month to month making ends meet. And there is always a paycheck tomorrow. However, when time comes to plan for retirement expenses, we need to plan it accurately, otherwise if we overspend, we’ll face a risk of running out of money in retirement.

Final Thoughts

If you want to retire some day, you need to start planning as early as possible. Calculating your future expenses now when you’re only 10 to 15 years away from retirement is more important than ever. It gives you the idea what kind of life you can afford when you stop working.

The more detailed you can be in predicting your future spending, the more secured retirement you will have in the long run. You can always tweak things as your situation changes or other things come up. Now is a good time to get started and figure out exactly how much you need to prepare for the future.

Did you start thinking about your retirement expenses? Did you make any calculations to predict your future cost of living?