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?
If we want to have a secure retirement, we need to predict how much we will spend when we stop working. When we are working, we do a lot of budgeting. We know how much money is coming in and how much money is going out. We cannot really control our income, but we try to control our expenses. We know that if we spend less than we earn, we 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.
How to predict retirement expenses?
Step 1: Find out how much money you spend today.
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?
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