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You can't plan for retirement without knowing what you'll need.

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Retirement Budgeting Overview

A key part of overall retirement planning is to determine just how much you will be spending in retirement and the amount and source of income to meet these expenses.  There are various rules of thumb regarding what percent of your pre-retirement income that you’ll need in retirement.  These vary widely (50% - 90%) based on your pre-retirement lifestyle and retirement goals/plans.

Some good news from recent research shows that you may need less income as you age.  According to a study from retirement researcher Wade Pfau, retires age 75+ spend on average 26% less than those age 65 - 74, who spend 20% less than those who are 55 - 64.  This may be due to people becoming lest active, requiring less housing, and a shift of expenses to subsidized health care.  On the other hand, it may be due to people having less money to spend.

Regardless of the amount of money you require to maintain your desired lifestyle, the biggest mistake is to underestimate retirement costs and overestimate income.  For example, travel, entertainment, and health care costs could increase just as significantly as income taxes, savings, and work-related (e.g., clothing & transportation) expenses decrease.  Also, keep in mind that most of your retirement expenses (food, housing, etc.) will probably increase each year with inflation while some or most of your income is fixed.

Instead of relying on rules of thumb to determine how much income you'll need in retirement, you will have a much more accurate estimate by developing a retirement budget and determining how many years of income you'll need.

Years in Retirement

You need to assume that you’ll live at least 15 years in retirement and therefore need to make sure that you don’t outlive your investments.  Following are the Social Security Life Expectancy Tables:

Social Security Life Expectancy Tables

Year

Remaining Life Expectancy at Age 65

Remaining Life Expectancy at Age 75

 
Male
Female
Male
Female

1940

11.92
13.42
7.11
7.90

1950

12.81
15.06
7.89
9.03

1960

12.91
15.89
8.02
9.47

1970

13.13
17.11
8.21
10.44

1980

14.04
18.35
8.80
11.52

1990

15.06
19.07
9.31
12.13

2000

15.91
18.98
9.73
11.92

2010

16.55
19.16
10.09
12.01

2020

17.18
19.71
10.55
12.44


Mandatory & Discretionary Expenses

The best way to develop a retirement budget is to start with pre-retirement expenses which should be readily available through your personal finance software (Quicken or Money) or manual check register.  Start by determining which expenses are mandatory (fixed) and which are discretionary (variable).  Mandatory expenses include food-groceries, health/medical, insurance, income taxes, transportation, and most housing-related expenses.  Discretionary expenses include food-restaurant, entertainment & recreation, education, clothing (to a large extent), some housing, and miscellaneous/other.

As shown below mandatory expenses should be limited to those items that you are obliged to pay due to legal/contractual, health and safety reasons – e.g., taxes, insurance, groceries, utilities, etc.  Whereas, you have a wide choice on how much to spend for discretionary items – restaurants, recreation, education, clothing, charity, etc.

Retirement Budget Items:

Mandatory Expenses
Discretionary Expenses
Food
    Groceries
Health/medical
    Doctors
    Medicine & Drugs
    Medical Equipment
Insurance
    Medical Insurance
    Dental Insurance
    Vision Insurance
    Accident Insurance
    Life Insurance
    Long Term Care Ins.
    Umbrella Insurance
Income Taxes
    Federal Taxes
    State Taxes
    Local Taxes
    Social Security
    Medicare
Transportation
    Public Transportation
    Auto Insurance
    Auto Registration
    Auto Fuel
    Automobile Repairs
    Auto Service & Tires
Housing
    Real Estate Taxes
    Home Insurance
    Home Repair/Upkeep
    Gas & Electric
    Water
    Basic Phone Service
    Trash Collection
    Security
    Homeowner Assoc Dues
Food
    Restaurant
Entertainment & Recreation
    Vacation
    Recreational Travel
    Fees & Tickets
    Books & Subscriptions
    Computer Hdw./Software
    Electronic Games/Devices
    Cell/Smart Phones
Education
    Coursework
Clothing
Housing
    Furniture & Appliances
    Cable/Satellite TV
    Internet
Miscellaneous/Other
    Church/Charity
    Gifts (e.g.,Birthday, X-mas)
    Spending Money
    Personal Care
    Merchandise
    Bank Charges

Adjustments for Retirement

Once you’ve established a pre-retirement expense budget, you need to review each category of expenses and determine which are expected to increase in retirement, and by what amount, and which are expected to decrease.  Use these estimates to come up with a tentative first-year retirement budget.  This will need to be reviewed and adjusted once actual retirement data are available as well as occasionally to reflect changing spending habits and cost-of-living adjustments.

Armed with a retirement expense budget, you are now in a position to determine how much retirement income you will need and correspondingly when you’ll be able to retire (see Section B - Retirement Investing Overview).  Retirement income is addressed in Section D.