Estimating Your Retirement Expenses isn’t Rocket Science… But Close Enough

Calculate your spending now, account for any additional expenses, and start saving for retirement.

You’ve probably been lectured a million times by your elders on the importance of saving for retirement—“start while you’re young and reap the benefits later!” And if it didn’t come from them, you’ve probably heard of the FIRE movement (financial independence, retire early) from influencers who claim they have the secret sauce to getting their quicker.

Either way, if you’re not already doing it, the idea of financial planning has probably crossed your mind.

We know this because the ages of people starting their retirement savings are getting young and younger. More specifically, “Generation Z workers started saving at age 19, while Millennials started at age 25, Generation X at age 30, and Baby Boomers at age 35,” says Catherine Collinson, CEO & President of the Transamerica Center for Retirement Studies. (Source: Manganaro)

So, whether you have or have not started your retirement savings, you’ve likely noticed that there’s a ton of misinformation out there (**Cough, cough, the tale on Social Security running out**).

You may have some questions…

What age can I comfortably retire?
What expenses belong in a retirement budget?
How will my spending change?
Where does my money come from?
How do I access that money?
And more importantly, how much savings is enough?

Did we get that right? No worries— we’re here to clear up the confusion. 🙂

Step One: Understand what you are spending right now.

Let’s be honest. Many of us may have a loose idea on what items we’re spending money on and how much we’re spending on them. It’s probably been years since we’ve taken a deeper dive and made a true budget. Here’s what we mean…

A true budget is a plan for every dollar you will earn. A general rule of thumb: a budget should cover all of your needs, some of your wants, and savings for emergencies and the future.

Get started by calculating what you’re currently spending, compared to your after-tax income. What are your living expenses? How much money is going towards bills, expenses, travel, hobbies, savings, and so on? Look at credit card statements, bills, and bank statements for the last 12 months. Don’t forget to look at last year’s tax return.

Let’s do some easy math here:

If my income is $100,000, I could use the 50/30/20 rule as my budgeting framework (Source: Bev O’Shea, Lauren Schwahn, 2021).

I can allow up to 50% of my income for needs. ($50,000)
I can put up to 30% of my income towards wants. ($30,000)
I can set aside 20% of my income to savings and debt repayment. ($20,000)

Budgeting is not a one-size-fits-all approach, so we recommend finding a method that works for you. Remember to monitor your progress as you go.

What you initially budgeted for may not make sense down the road as things change; you earn more money, start a family, go back to school, and so on. It’s helpful to plan ahead as much as you can, leaving room for flexibility. Life happens! J

Step Two: Determine what you will you be spending in retirement.

Now that you understand your current spending and you have a good budget, you are prepared to figure out what your future spending will be like in retirement. Short version—it’s not that dissimilar to your current spending.

We start by breaking it down by non-essential spending vs. essential spending. It’s pretty self-explanatory—non-essential spending is expenses you don’t need (subscriptions, clothes, makeup, video games, shoes, etc.) and essential spending is expenses related to living (mortgage, rent, utilities, groceries, medication, etc.).

Next, consider what items in the budget will change over time, and adjust for inflation.

➤ How many of your expenses from each column will still exist when retirement comes?

For example, your mortgage might be an essential item now, but it could be paid off before retirement, leaving you with some extra savings.

➤ In addition, think about the expenses that exist within your career.

You probably purchase and/or maintain professional clothing throughout the year. You also have a daily commute to work. You won’t have those expenses in retirement.

➤ It’s also helpful to think about what new expenses will exist in retirement.

You may have noticed that your back aches a bit more than it used to. Or those nights out aren’t so easy the next morning. From one grown person to another, we get it! We don’t say this to poke fun at ourselves; we say this because people often forget to account for future medical expenses, but it’s important.

➤ How will your hobbies change over time? What are the costs associated?

There’s no denying that golf is an expensive hobby. One set of professional golf clubs can get up to $5,000. And don’t forget about the mental cost, too, when that perfect putt jussst misses the hole. (Ok, that’s not an actual expense, but you get it!)

➤ Another thing to keep in mind: will you need to purchase a new vehicle at some point?

➤ What about an RV for travel?

➤ Will you be moving to a new city—maybe closer to your kids or grandkids?

Those can be significant costs you will want to plan for.

With these expenses in mind, you can create a decent projection of what you will probably spend each year in retirement.

But if you’re still having trouble, here’s some more context: according to the U.S. Bureau of Labor Statistics, a household run by someone 65 or older spends on average $50,220 per year (approximately $4,185 a month).

Step Three: Create a plan for where the money will be coming from.

A good chunk of your retirement income will most likely come from fixed sources, such as Social Security benefits, pensions, and annuities. But if you’re like the majority, most of your retirement income will come from portfolio withdrawals. Let’s talk more about retirement income—what is it, how it’s taxed, and how much you can contribute.

1. Personal savings – Checking accounts, savings accounts, etc.

We all know how these work, so we don’t have to get too far into the weeds. One tip we have is to automate your income from savings to checking on a biweekly basis. This may help keep you in a mindset of receiving a set working income, rather than spending too much money outside of your budget. You’ll still feel like you’re getting paid, like you would from your employer, even though it’s your own money.

2. 401K/403(b) –

For many people, their employer sponsored retirement plan will be their largest source of income in retirement. Contributions and earnings are tax deferred, meaning these withdrawals are taxed at retirement. If your employer offers a matching contribution, you should be contributing at least enough to receive the match. Although, we recommend a higher savings rate because it is critical to at least get the match.

3. IRAs –

Individual retirement accounts are also a great way to save for retirement. A traditional IRA is tax deferred with withdrawals taxed in retirement. With a Roth IRA, your contributions are after tax and earnings and withdrawals are tax free. Having multiple tax buckets in retirement can be a good way to diversify.

4. HSA –

Health savings accounts are becoming more popular. Unfortunately, we will still have health related expenses in retirement. HSA’s can be a great way to save with a triple tax benefit. Money goes in as tax deferred and grows as tax deferred. If it’s used for qualified expenses, it can be withdrawn tax free. Cha-ching! Many people aren’t aware that most HSA’s allow you to invest the assets, although the investment choices may be limited.

5. Pension-

If you are lucky enough to still have a pension, make sure you calculate the monthly benefit in retirement. We also recommend carefully considering the options to receive the benefit. In general, pensions pay a fixed monthly amount for the covered person.

6. Social security-

Will social security even be around for me? Most likely yes. While the current funding looks precarious, small changes to benefits would help keep it solvent. If you are nearing retirement, calculate your benefit on the government’s website. If you are a younger worker, plan on having a SS benefit, but it may be wise to be conservative with the amount.

So, what option(s) is right for you? There are many factors to consider, such as personal risk tolerance, funding needs, tax implications, etc. When deciding how much to contribute to what accounts, consider partnering with a good tax accountant and financial advisor. They can be critical in the planning process. However, if you are going at it alone for now, a general rule of thumb is to save 15% of your pretax salary to be able to retire.

Bonus tip for retirement saving

You know the saying “try before you buy?” Well, that works for budgets, too.

Yes, we know ‘budgeting talk’ doesn’t get the crowd roarin’, but the best way to know if a budget is realistic and will work for you in retirement is to try it now. Pretend you are working with your retirement budget only. Tweak as needed. You’ll be patting your own back later.

Final Thoughts

For the sake of your family, or even just yourself, you want to be prepared in the short-term, long-term, and everything in between. You’re smart and we like that about you.

But, we also understand that this stuff isn’t always easy to do for yourself. You may want a second set of eyes. In fact, we highly recommend it.

At Artesys, we are well-versed in working with investors to find an investment approach that works best for you and your goals, whether you’re an Offensive or Defensive investor.

Have your financial professional contact us today. Together, we can give you the best chance at a successful retirement.

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Sources:

https://www.nerdwallet.com/article/finance/how-to-budget

https://www.plansponsor.com/gen-z-workers-get-jumpstart-savings/