One of the single greatest variables to impact your retirement—and the one you have the greatest control of—are your living expenses. Understanding and anticipating living expenses is critical to retirement planning. Most people tend to hear the word ‘Budget’ and quickly change the subject to avoid the painful practice of accumulating, organizing and analyzing your living expenses. So how can we make this process more practical, pain free and accurate?
There is a common rule of you will spend 75% of your last year’s wages during retirement. We view this to be a failed assumption. Why would someone who has more time and money than at any point in their life spend less than they did when they were working? Building a financial plan with the goals of spending 100% of your pre-retirement income in retirement is our goal for you. Let’s first start by identifying all of your expenses
Monthly Retirement Expenses
Public Service Announcement: We aren’t going to ask you to create a spreadsheet of annual expenses. Although this is a welcome discipline, we understand 75% of us don’t like doing this. Fortunately there is a simple way to understand your monthly expenses. Begin by compiling 12 months of credit card and bank statements (checks written, cash withdrawn, direct payments, etc.). Simply add up the monthly spending amounts for these two statements and divide by 12. This provides your monthly spending average during the last 12 months. This number would include mortgage payments, property taxes, insurance payments, holiday expenses, food, utilities, entertainment, support to kids or grandkids, gifting, and more. Now that wasn’t too painful, right?
Many retirement plans suffer a shortfall because people fail to anticipate ‘lumpy’ or one-time expenses, even though these expenses are easy to anticipate. Lumpy expenses you want to plan for include:
- Home Repair or Remodel: you know you’ll need a new roof, furnace, AC, driveway, etc. eventually.
- Weddings: If you have unmarried children, it’s likely they will eventually get married. To anticipate the cost of Johnny or Suzie getting married, reference http://www.costofwedding.com/
- Cars: You know your vehicles won’t last forever. Review how frequently you have purchased new cars. In the past and budget for typical purchases moving forward. Be sure to factor in a sale price for your current car to determine your next cost.
- Family: Will you plan a 50th wedding anniversary trip? Do something special for your family? Support a child or grandchild that needs assistance? Anticipate as many as possible.
- Other: It’s your retirement. What other lumpy expenses will you spend money on?
Healthcare Expenses in Retirement
For many pre-retirees, you have employer sponsored health insurance. Although you are likely paying a portion of the premium, co-pays and deductibles, these expenses are likely to go up when you retire. When budgeting for healthcare in retirement, don’t forget to anticipate vision and dental expenses, and understand people tend to spend more on these two areas as they age.
If you AND your spouse are age 65+, you’ll qualify for Medicare. For a relatively healthy couple on Medicare, with a Medicare Supplement Policy and Prescription Drug Plan, we recommend a budget of at least $12,000. If you’re not yet 65, anticipate much higher expenses from the purchase of an individual health insurance policy. You may need to budget $18,000/year or more for this expense. In either instance keep in mind what health expenses you were already paying for and anticipate the added cost.
Phases of Retirement
There are three common phases of retirement and they each have their own spending patterns.
- Go-Go Retirement: From retirement until approximately age 80, people are typically healthy and able to do all of the things they have dreamt about. They tend to spend 100% of their pre-retirement income during this phase.
- Slow Go Retirement: From approximately age 80, or whenever the body begins to slow, until the late 80’s, people’s spending habits begin to diminish. You purchase cars left frequently, travel less frequently, eat out less often, etc. During this phase you’ll typically spend 85% of your Go-Go Phase.
- No-Go Retirement: Typically around age 90, or the stage when only one spouse is alive, client’s tend to spend less than 80% of their Go-Go Phase.
Safe Withdrawal Rates & Successful Strategies
Much has been written about safe withdrawal rates during retirement. The most commonly cited withdrawal rate begins at 4% of your assets and is inflated by the CPI inflation rate each year. This is a reasonably good starting point, but we prefer to create customized spending plans that meet your goals. Some clients are willing to sacrifice lifestyle and some financial security in the future for a higher standard of living earlier in retirement.
We have seen several monthly expenses creep into our life over the years. These are monthly reoccurring expenses that didn’t exist 30 years ago, but which few of us live without. These include cell phones, high speed internet access, cable/satellite TV, Netflix, Starbucks, gym memberships, and more. Be sure to review every automatic withdrawal coming from your checking account and reduce those you can live without.
Be wary of lifestyle enhancements you have made over the years which may not be sustainable in the years ahead. Review how much you’re spending on automobiles, homes, travel etc. today, relative to 15 years ago. How often do you eat out? Is your monthly clothing budget higher than it needs to be? There is little correlation between spending and happiness, but a direct correlation between peace of mind and financial resources. Focus on what’s most important in life and remember you can do just about anything you want to in life, you just can’t do everything.
Retirement Budget “Check-Up”
It’s critically important to review your actual spending in retirement each year relative to the amount budgeted for in your financial plan. It’s common for actual spending to be both higher and lower than anticipated, depending on numerous circumstances. Run new projections with actual numbers to see the impact on your plan and make adjustments where necessary. Above all else, know that retirement planning is a process and you have to be ready to make adjustments as needed.