Creating a budget or spending plan for retirement is one of the first things you’ll need to do to create a confident retirement plan. Working with hundreds of people getting ready for retirement has shown me that each person and couple has a slightly different way of handling their own money. I don’t think there is one “right” way to budget. The way we make decisions around money is heavily impacted by the experiences we had during our formative years. In this article, I’ll share the approach I have found most helpful when working with retirees, but it is by no means the only way to create a retirement spending plan. To help you better understand my money perspective, I think it will be helpful to look at a money experience I had during my formative years. You can also think about experiences you had with money and experiences your spouse had. Reflecting on these formative experiences can help you understand your preferences toward spending and help you have empathy and understanding for your partner’s spending and saving behaviors as well.
When I was 10 years old, I made my first monthly budget. Shortly after my parents got divorced, my mom had to sell our family home. My sister and I moved all of our belongings into a small two-bedroom apartment. My mother spent the last 25 years raising children, so she worked 11-hour days as a proofreader to barely pay the bills. One night, while my mom and I watched the old sitcom ER, I decided to make a budget. If you think that last sentence sounds strange, that’s because it is. As a poor kid, I was always interested in money. I was mostly interested in how some people seemed to have all the money they needed, while my mom and I never seemed to have enough. I asked my mom how much she made, and she gave me a number. Then I listed our expenses: rent, groceries, utilities, etc. For each category, I asked my mom how much we spent on that item each month, and she gave me a number. When I subtracted the expenses from the income, I found that we had $100 left over at the end of the month. Ironically, I thought this meant we were rich. You might as well have told me that we were millionaires! After I got my degree in Personal Financial Planning and started working with retirees, I thought that budgeting wasn’t something I would need to talk about with my clients. I was surprised to find that most people who are about to retire have a hard time figuring out how much money they will need each month to pay their bills and live the way they want to live. The first step in figuring out if you are financially ready for retirement is to know how much money you will need each month. In this article, I’ll talk about my favorite way to create a budget for retirement. This budgeting strategy was not revealed to me atop a mountain. If something doesn’t resonate with you, toss it aside and just keep what is useful.
The top-down method
Step one: How much after-tax income do you receive each month in your bank account? Say the number for your household is $8,000.
Step two: Do you have money left over at the end of the month after paying all of your bills? If the answer is yes, then we already know you could live on $8,000 when you retire.
Step three: Do you regularly invest a portion of your monthly net income? For example, say you put $500 into your Roth IRA every month. Since you won’t be putting any more money into your Roth IRA once you retire, you only need $7,500 ($8,000 – $500) per month.
Step four: Are there any obvious expenses that will probably change when you retire? For example, let’s say you give your daughter $1,000 a month to help cover her costs until she finishes school. You would only need $6,500 for your retirement budget ($7,500 – $1,000).
Step five: Does this number feel good to you? Even if you don’t keep a spreadsheet of your monthly expenses, you probably have an idea of how much you need to cover your living costs. Now, life is unpredictable, so I always try to leave a little room for the surprises that life throws at you. I like to add 10% to my previous number to cover the “what-ifs.” This brings our retirement budget up to $7,250 ($6,500 + $750). I refer to this number as your “survival budget.” This is how much money you will need to live comfortably in retirement.
Now that you have a good idea of how much you’ll need each month to live, you can add the costs of any extra things you’d like to do when you retire. You don’t want to be stuck on your couch watching old episodes of Mash and Little House on the Prairie for the next thirty years because you can’t afford to go anywhere. So if you’d like to go out to lunch with friends more often or regularly travel to visit family, add extra money to your budget to make sure you have the retirement you deserve. Prioritizing activities that bring you joy is how you go from having a budget to survive to having a spending plan to thrive in retirement. If you’re single, you can think about this number overnight and see if you still like it in the morning. If you are married, you can now share your spending plan with your spouse. If your marriage is anything like mine, your partner will give you a skeptical look as they try to be polite and listen to you talk about how You read a blog post about retirement budgets and are pretty sure this is how much money you’ll need each month when you retire. At this point, your partner will start a barrage of “What about this?” questions. And have you considered that? Going through it together will show you things you might not have thought of, and it can be a great way to think and dream together about what you want your retirement to look like.
Two last expenses to consider:
You may have noticed we haven’t addressed taxes or healthcare costs. I didn’t include either of these because your health insurance and taxes can vary widely depending on your sources of income. I have seen retirees who make $10,000 a month pay no taxes and others who make the same amount pay 25%. I have also seen retirees pay $10 a month for health insurance and others pay $1,800 a month. Due to the special tax rules for retirees, smart tax planning can make all the difference. I will cover taxes and health insurance in a future blog post. With your retirement budget in hand, you are ready to start building your retirement income plan and are one step closer to confidently transitioning into the retirement you deserve.
Mark Whitaker, CFP® is a Certified Financial Planner™ professional, but he is not providing specific investment advice through this blog. This blog is for educational purposes only. Before making any financial decisions, you should consult with a qualified financial planner who can provide tailored advice based on your individual circumstances. Please visit https://earlyretirementadvice.com/online-booking/ to schedule a free one on one retirement consultation.
