How to Budget for Retirement
One of the most important things you can do to prepare for retirement is to measure and understand your annual living expenses.
Why is this so important? Our living expenses have an impact in a few ways; first we need to know exactly what we need to live on, and second, we need to know if our retirement income sources and wealth building efforts will be enough to provide the desired quality of life.
In light of budgeting, we’ve found that the majority of people don’t fully understand where their money and resources go over time. Things tend to get a bit more specific as we grow closer to retirement and start pinning down estimates of major expenses, but we’ve found there are many unanswered questions around budgeting and cash flow in every stage of retirement planning from starting out to the eventual transition to retirement.
How do we take control? The key is to dig deep into where your money goes. You can start by reviewing and categorizing all of your spending over the last 12 months. Budgeting isn’t a fun exercise, but we’ve found one of the benefits can be a deep feeling of relief for people who have completed the process.
Let’s take a look at some of the key players in your current and projected expenses.
Housing is typically the biggest expense for most households. It includes your mortgage payment, property taxes, homeowners insurance, and utility bills, as well as maintenance and other household expenses.
You may also consider these questions; As a percentage, how much of your income goes toward housing? Do you plan to carry a mortgage into retirement? Will you relocate?
Housing is one of those really interesting questions. Pre-retirement we tend to require and want the bigger house for our family needs, and with the bigger home comes bigger expenses. Most often this decision is tied to a location based on employment, school systems or both. Housing can be emotional so it’s important not to reach.
Alternatively, there are really interesting options to look at in retirement; relocating, downsizing, or buying a second home may all be viable options and there are a lot of creative ways to approach it if you aren’t emotionally tied to your family homestead. It’s important to plan in advance so that you are on the same page with your spouse, have time to research and explore all of the options, and look at the financial impact. For example, if your strategy will require financing that is something best accomplished while you still have earned income to show a lender. Some other creative options we’ve helped with include finding telework positions, and relocating to finish out the final years of work from a new location.
Alongside housing, health-care is a major player in your retirement budget. Insurance, Health-care provider costs, prescription drugs and long-term care are the major components.
According to a study by Fidelity Investments a couple retiring in 2019 can expect to pay more than $285,000 in health care and medical expenses throughout retirement1. For those in private industry and retiring with Medicare benefits this requires careful attention.
Being a federal employee may provide an advantage in being able to carry your health insurance (FEHB) into retirement and also have a pretty good idea what it’s going to cost. The federal government pays on average 72-75% of the retirees FEHB premiums, this may significantly reduce the cost of out of pocket expenses.
What can you do to plan for health-care expenses? To start, you might look into long-term care options and plan to set aside a portion of your assets to pay for prescription drug costs.
While housing and health-care usually dominate the conversation, taxes are another issue we can’t overlook. The good news is that your tax footprint may generally be lower in retirement as FICA taxes drop off potentially saving you money. Although, most retirement income sources will be subject to some level of federal and state income taxes.
Saving and Investing
Many people who attempt to track expenses and build a budget overlook this category. This can be a big mistake as it is paramount to continue to save and invest with purpose and in a very intentional way to meet your goals. It’s important to continue with your savings and investing habits right up until your eventual retirement.
Auto and transportation costs.
Loan payments, insurance, maintenance and fuel expenses all come with owning an auto. Planning for replacement of older vehicles and purchasing slightly used vehicles can help manage this category of expense, as well as using public transportation options.
Some of the more exciting items to discuss in the budget are your discretionary expenses. This includes planning for entertainment and vacations, clothing purchases and personal care, eating out at restaurants, and anything you enjoy spending your money on. The key to this expense is to understand how much you can spend on these lifestyle choices. Prior to retirement, it's important to meet your savings and investing minimums before allocating capital here. In retirement you will need to adjust your discretionary expenses based on the retirement income available to you.
Taking care of the ones we love can be pricey. Notable expenses may include kids activities, education expenses and today many families find themselves helping adult children financially. This can be one of the categories that can have a major impact if not managed carefully.
It’s true, giving just feels good. It’s important to give back and plan for contributions to support the people, organizations and initiatives that you care for and are passionate about. Charitable contributions may also provide tax benefits.
Putting it All Together
Now that you have an idea of the most common major expenses players in your cash flow plan, you may be able to complete the analysis and fill in the rest of your annual expenses in other categories from your spending reports. Once you have an estimate of what you are currently spending and would like to spend, you’ll need to put together an inventory of available future retirement income sources, including amounts, start dates, and all relevant details. You should also create a list of all your assets and single out those that have the potential to produce income. This should give you an idea if you are on track or facing a potential retirement income shortfall.
At this point you should have some clarity to assess your options which typically include: earning more income, saving and investing more toward your assets, spending less, or some combination of all.
I’ll leave you with a few final thoughts. Something that has been helpful for my family is automating. Setting up auto contributions to retirement and 529 accounts can be helpful to get used to living without extra income. We also use bill pay and budget alerts to avoid missing payments and overspending. Lastly think about visualizing your retirement. Take a few minutes to sit down, close your eyes and really create a picture of your life in retirement. Not just the travel and entertainment, but the day-to-day. What does that look like? Make note of how you will spend your time, where you want to live, and what will be important to you to work on.
Prioritizing and creating better financial habits takes time but it is liberating. Remember, no purchase feels as good as watching your balance sheet grow and creating financial freedom.
What are your goals for retirement income and how do you plan to meet them? If you’d like to discuss your plan, I welcome you to reach out.
Justin Holtz is the managing director at District Financial Advisors. He is passionate about helping federal employees pursue their financial goals.
District Financial Advisors, Justin Holtz and LPL Financial are not affiliated with or endorsed by the Federal Government.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This is a hypothetical example and is not representative of any specific investment. Your results may vary.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.