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. Use this webpage to develop your retirement budget and the "Retirement Timing" page to determine if/when you will have enough money to support your expected retirement lifestyle.

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, Mint, YNAB, etc.) 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.

By adding up the current (pre-retirement) monthly and/or annual expense of all the items shown below, you will know how much money you are spending and how you are allocating your income among the various expense items. This is a critical step in retirement planning.