Your retirement budget will evolve…
Detailed Retirement Budgeting is Important
Budgeting can sometimes feel negative. It can feel like you are depriving yourself the things you want to do. However, a retirement budget isn’t about depriving yourself. It is about making sure you have prioritized what is really important and insures that you won’t run out of money in the future.
Many financial advisors over simplify retirement budgeting. They suggest that retired people will spend approximately 20% less per year in retirement. And, that may be true if you were to average your spending over the 20-30 retirement years.
Make it Count
However, in many cases that rule of thumb is completely incorrect. This system of budgeting does not consider that retirees need access to different amounts of their savings at different times in their lives. A detailed retirement budget will help determine the optimal asset allocation and withdrawal strategies so that you have access to money when you need it.
Retirees expect that their budget will change once they retire. But they may under-estimate just how much expenses will evolve, and in what spending categories. Overall, your spending is likely to decline once your retire, but spending may increase for part of the time and not all areas of your expenses will see the same changes.
Here are tips for creating a reliable and detailed retirement budget:
Start with the 3 Big Budget Busters
There are three categories of a retirement budget that are far more costly than the others:
And, these are three areas where you might see very different spending levels throughout your remaining years.
When it comes to one of your biggest expenses (housing), there could be some good news for your financial plan later in life. Housing is expensive, but you generally need less of it as you age.
- If you own your own home, you could see your average housing costs drop by the time you retire if you’re able to pay off your mortgage.
- You could also move into a smaller home or into an area with lower property taxes that could reduce your overall housing expenses.
- However, housing expense can also increase if retirees decide to move into senior housing.
- A reverse mortgage is also a way that you may reduce your housing cost or generate cash flow if you have enough home equity and can qualify based on your age and financial factors.
Tips for Your Retirement Plan: Planning ahead for where you want to live can help you better calculate what your housing expenses will be in retirement. Housing is the most valuable asset for most households. As such, you may want to consider using it to help fund your retirement.
2. Out of Pocket Medical Costs
Healthcare is getting more expensive and you need it more as you age. According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2019 may need approximately $285,000 saved (after tax). This is to cover health care expenses in retirement (not including any long term care expense).
So, how do you plan? When will those hundreds of thousands be spent? To start, think about different phases of your life:
Early Retirement: If you retire before you are eligible for Medicare at age 65, you need to be prepared for hefty premiums. Here are 9 ways to prepare for early retirement health costs. Once you have estimated these costs, they can be entered into the NewRetirement Retirement Planner for more accurate projections.
Out of Pocket Medicare Expenses: Medicare is not free. You have premiums, co pays, deductibles, co insurance and more. The Retirement Planner will estimate your out of pocket Medicare costs based on where you live, your health status, the type of coverage you choose and more.
Long Term Care: About 70% of of people who turn age 65 will need some type of long term care in their lifetime. According to the U.S. Department of Health and Human Services, but few are prepared to pay for that care. The Department also estimates that the average cost of long term care is $225 a day or $6,844 per month for a semi-private room in a nursing home. This really adds up quickly and few can really afford these costs. Insurance may be a good way to insure that you are taken care of (at least for some period of time).
3. Retirement Spending on Transportation
Transportation is typically the second largest expense for most families, according to the Federal Highway Administration.
Once you leave the workplace permanently, you could end up saving a lot on daily transportation needs. Especially if you were spending a lot to commute to and from your job. If you end up driving less, you’ll not only save your gas money. But you could also end up saving money on your insurance and maintenance, significantly reducing your transportation expenses.
Consider Stages of Retirement and How They’ll Impact Your Retirement Budget
Your retirement is probably going to last 20 or 30 years. Have your expenses been the same in the last 20 years? Probably not. Similarly, your expenses are going to evolve throughout the next 20 years.
But, once you have accounted how your retirement budget will change for the big three categories, you can better adjust your retirement spending in the other categories. Furthermore, your spending probably won’t be a roller coaster. You can think of retirement in three stages. Each stage has fairly predictable spending needs and levels.
Phase 1 – Early Retirement: The first stage of retirement, especially these days, is generally characterized as a time of adventure and experiences. Many retirees start retirement with travel, hobbies or helping grandchildren (or their own aging parents). These activities can be expensive. For example, you may still have dependent children or be paying for college.
And, once you retirement you’ll have more free time and relative health. There are a lot of opportunities for spending money. Some experts recommend that retirees budget for spending 20 percent more in this phase. But we think that you should assess your own projected spending.
Phase 2 – Middle Retirement: While you may still be enjoying adventures in middle retirement, many people find that they simply spend more time with friends and family and stay a little closer to home. In this phase, your retirement spending may be at its lowest levels — especially if you choose to downsize.
Phase 3 – Later Retirement: No matter how healthy you are and how well you age, there is no denying that health care expenses ramp as you get older. In fact, healthcare costs grow so much that this last phase of retirement is usually the most expensive phase of life.
Out of pocket medical spending and long term care costs absolutely sky rocket.
Get Even More Detailed with Your Retirement Budget
It can be difficult to think about total spending for different phases in retirement. Many people find it easier to plan for each budget category.
More Detailed: With 13 expense categories and more than 75 subcategories, detailed budgeting makes it easier to think through your expenses and create a stronger plan.
Changes to Any Category: Document changes to any individual expense instead of your total expenses – it’s a more manageable way to plan your future.
Better Tax Handling: Add tax deductible status to each expense item to enable better tax planning.
Best Case / Worst Case Spending: When budgeting, it can be useful to break out your spending into needs and wants. Your needs are things that you must spend money on to get by: groceries, utilities, transportation, health care, and housing. Your wants are things that are nice-to-haves — but not necessary to survival — travel, hobbies, entertainment, etc…
Documenting what you must spend vs. what you would like to spend cab help define your:
- Ideal asset allocation
- Retirement income / withdrawal strategies
Most people underestimate the impact inflation will have on their retirement budget. Even at relatively low rates, inflation is a real thief of buying power over time.
Inflation planning should be a significant concern when crafting a budget.
You should assess the health of your retirement finances at various rates of inflation. (Don’t just trust the default values seen in many simple retirement calculators.)
Compare Retirement Spending with Income and Withdrawals
One of the best — and easiest — steps you can take for a better retirement is creating a written retirement plan and updating it regularly.
This simple task is proven to insure better financial outcomes and reduce ongoing stress.
Creating a detailed retirement budget — determining what you want to spend is only half of the equation. You also need to think carefully about your retirement income and make sure that what you earn matches what you want to spend.
Do You Need to Reduce Spending? Can You Spend More?
Once you have created a budget including a detailed plan for spending and income, you can see if you have budgeted too conservatively or extravagantly.
A recent study published in the Journal of Financial Planning, researchers found that retirees in the top quintile of financial wealth were spending nowhere near an amount that would place them in danger of running out of money. In fact, the average financial assets of wealthy retirees increased during this period. Beyond the wealthiest, the study also found that retirees in the third and fourth quintiles also spent less than their income.
Keep Updating Your Retirement Budget
Budgeting for retirement is not a one and done exercise. You need to reconcile your spending, income and withdrawals at least quarterly. You should also keep tabs on inflation and your rates of return to make sure that all is going according to plan. And, if it is not, then make adjustments.
The post The Retirement Switcheroo: 6 Tips to Flip Your Mindset from Saving to Efficient Spending! appeared first on NewRetirement.