Planning for Retirement Expenses: Why Budgeting Is Mission Critical

You will want to retire some day, and without proper retirement planning, the type of lifestyle you’re hoping to enjoy in your later years may not be possible. The fact is that most Americans underestimate their financial needs in retirement. We are living longer and the cost of living continues to rise, so if you fail to plan ahead, you won’t save enough to cover your retirement expenses.

In general, Americans are not saving nearly enough. According to a Bankrate survey, 20 percent of those polled don’t currently save anything, 21 percent save less than 5 percent of their annual income, and 25 percent save between 6-10 percent. Only 16 percent of those surveyed save more than 15 percent of their earnings for retirement, and even that won’t be enough to retire on.

As we described in another recent article, Social Security typically only accounts for 40 percent of most people’s retirement income. Even though experts say that retirement living should cost about 70 percent of your current expenses, you will still have to make up the balance from savings or other sources of income.

The only way you can be sure to save enough for retirement is to estimate your retirement needs in advance. If you calculate what your expenses will be at age 62, or 65, or 70—whenever you want to retire—you can start budgeting now and begin working toward your savings goals.

Setting a Budget Baseline

Accurately budgeting your current household expenses will give you a baseline to create a working budget for retirement planning. The first step is to take stock of your current monthly income and expenses. You can use your last 12 months of bank statements, credit card statements, and bills as a guide. From there, you can determine what is likely to change in retirement.

Start with your income and list the total monthly amount from paychecks and any other sources of income. Once you have a sense of your typical monthly income, you can inventory your fixed and variable expenses.

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Your fixed expenses will include monthly fees for housing (rent or mortgage), loans, insurance, utilities, and other recurring payments that are the same every month. You can use an average for variable expenses such as food, gas and/or transportation costs, clothing, and entertainment. Be sure to account for annual expenses as well, such as tuition or taxes, and include occasional expenses such as car repairs, doctor visits, and travel. When you compare your expenses to your monthly income, you can see how much money you have left over to put toward retirement savings. If you don’t have enough to save, try cutting back on some of your variable expenses, especially on “wants” such as travel, clothing, or entertainment.

Now that you have the framework in place, you can start making some assumptions about retirement budgeting. What expenses are likely to change? For example, it’s probable that most of your debt will be paid off by the time you retire, such as with a mortgage. Credit card debt will diminish, student loans will be paid off, and it’s possible that you won’t have car payments to make. All in all, it’s likely that you will be spending about 70 percent of what you spend today.

However, other costs will increase. Even with Medicare, your medical expenses and the cost of insurance will go up. The average spending on health nearly doubles from age 45 to age 65. You should also account for inflation for groceries, gasoline, clothes, and other expenses. Using these guidelines, map out a potential retirement budget that would cover all of your future living expenses.

Calculating Adjustments for Your Retirement Planning

The next step is to make some lifestyle assumptions that will affect your retirement planning. One of the biggest decisions to make is when you will retire. You can start collecting Social Security as early as age 62 and still receive 80 percent of your benefits. However, most people prefer to wait until age 66 so that they get their full benefits, or even age 70 in order to collect a higher amount each month. How much you collect in social security will affect your retirement budgeting plan. Remember, too, that your spending will continue to change as you get older.

As you calculate your monthly income and expenses, be sure to account for taxes. Social Security income is considered taxable, as are individual retirement accounts (IRAs), which are tax-deferred. If you want to avoid paying taxes at retirement you can consider pre-taxed retirement savings options such as Roth IRAs.

Another important consideration is whether you plan to relocate in retirement. If you are planning to sell your home when you retire, can you use the equity as part of your retirement fund, or would you rather buy a home somewhere else? What are the differences in the cost of living where you live today versus where you would like to retire?

Also consider any plans that may affect your retirement budget. For example, have you always dreamed of that Mediterranean cruise or taking regular trips to visit your grandchildren? If you have dreams or hobbies that you want to pursue, add them into your retirement budget and start saving now.

Start Saving Today

Now that you have a basic picture of your financial retirement needs, you can work backward to see what you need to save today. There are various ways you can save for retirement:

  • Make the most of employment pension plans. Contribute to your 401(k) at work, even if your employer doesn’t offer matching funds, and take advantage of tax-deferred retirement savings.
  • Use IRAs to save tax-deferred money for retirement, or Roth IRAs if you don’t want to pay taxes later. If you change jobs, you can roll your 401(k) savings into an IRA.
  • Certificates of deposit (CDs) give you a better return on interest than savings or money market accounts in exchange for committing your money for months or years before withdrawal.
  • Investment strategies are a great way to add to your retirement income, especially if you have a good investment advisor and plenty of time to let your money work for you.

If you start planning now, you will be able to adjust your retirement budget as your situation changes. Taking these steps today will put you in a better position to enjoy a financially secure retirement.

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