You’ve done the work of properly saving and planning for retirement, but now that the time to retire is drawing near, it’s natural to be uncertain about how much you should spend or what lifestyle level would be appropriate for your current savings.
This is a difficult formula to calculate, and it’s a bit different for every retiree, so let’s dig into the details and offer some clarity.
The 3 Golden Rules of Appropriate Retirement Budgeting
The easiest way to think about appropriate spending in retirement is to view it in the context of your budget. In other words, what do you plan to make on a regular basis, what do you plan to spend on a regular basis, and how do those financial puzzle pieces fit together?
Throughout this guide, we’ll need to follow three golden rules of appropriate retirement budgeting:
Forecast accurately: You need to be able to forecast accurately. If you don’t understand how much money you have coming in, or if you don’t understand your necessary expenses, you won’t be able to make an assessment of how much money you can spend on unnecessary items. The more information you have, the better decisions you’ll be able to make.
Live below your means: It’s also important to continue living below your means — a habit you probably established many years ago. The idea here is to continue living at a lifestyle level at least slightly below what you could reasonably afford. This is a way to almost guarantee you’ll outlive your savings.
Be ready for increasing healthcare costs: The most volatile and potentially significant variable in your math is going to be your healthcare costs. As you get older, health insurance is going to become more expensive, you’re going to need more medical treatments, and health care and medical spending are going to take up a bigger portion of your budget. This is an irreversible path, and one that’s hard to predict, especially as overall healthcare costs continue rising as well.
Calculating Your Income (and Distributions)
Before you can figure out an appropriate spending level, you first need to understand the total income available to you. These are some of the most common sources that retirees should take into consideration:
Retirement accounts: Some of your biggest income sources will likely be your retirement accounts, including your IRAs, 401(k) plan, etc. Hopefully, you’ve been growing your money in these accounts for many years, so you have ample savings here. Plus, the tax advantages can really help you financially.
Social Security benefits: If you qualify for Social Security benefits, factor these payments into your calculations as well.
Pension payments: Pension plans are growing rarer, but there are still millions of Americans paying into and accepting distributions from pension plans.
Job earnings: If you have a part-time job in retirement, or if you’re working a side gig, be sure to count that income as well.
Rental income: Rental properties are a common source of passive income for retirees, so if you have any properties in your name, forecast their collective income accurately.
Investments: If you have any investments that aren’t in your retirement accounts, estimate income and distributions you take from them.
Annuities: Some retirees enjoy the safety and reliability of annuities; these payments are very consistent and easy to calculate.
There are two key considerations you’ll need to bear in mind when forecasting income from these sources.
First, you’ll need to optimize your distributions. For some of these income sources, distributions aren’t in your control. For example, you may receive a monthly pension payment with a fixed amount, with little to no say in the matter. But for other sources, most notably your retirement accounts, you’ll be in charge of making distributions as you see fit, following the rules and guidelines for each specific retirement account.
Distributions are essentially withdrawals. Different retirement accounts come with different rules, but you’ll usually be allowed to start making distributions at a certain age, and in the future, you may be required to make minimum distributions. Only withdraw what you need for the best possible long-term results.
Second, you’ll need to consider the 4% rule. If you’ve appropriately saved for retirement, you’re probably already familiar with this rule. It essentially states that, if your investments are properly diversified, you can safely withdraw up to 4% of your principal every year without ever having to worry about running out of money.
As an example, if you have $1,000,000 in a Roth IRA, and your money is appropriately distributed across a wide range of different assets, you should be able to safely withdraw $40,000 per year without worrying about tapping into your principal. Depending on your risk tolerance, you may want to distribute more or less than this figure, but it’s a good starting point.
Total up all your income from all your sources, so you can work with this figure in the next few sections. For most people, it’s most convenient to calculate income at a monthly level, since many of your expenses will be paid monthly.
Calculating Your Expenses
Once you have your income appropriately documented and forecasted, you can begin calculating your current expenses. The idea here is to get ballpark estimates for what your expenses could be, so you can manage your income more effectively.
Keep in mind that all of these expenses are highly variable, but almost all of them are at least somewhat in your control.
Let’s start with (mostly) necessary expenses:
How much are you currently paying for your housing? Make sure to factor everything you can into this equation. If you’re currently paying a mortgage, incorporate your payments on the principal, your interest payments, property taxes, insurance, as well as repairs and maintenance.
If your house is paid off, you’re still responsible for paying for insurance, property taxes, and maintenance. This is one of your biggest expenses, and just as it was before you retired, this shouldn’t be more than 30% of your gross income (ideally). If you find your housing expenses are uncomfortably high, consider finding alternative housing. Moving to a smaller house or to a different area could slash your biggest expense dramatically.
We all need food, and it doesn’t usually make sense to skimp on this expense. The quality of your food is important, and you need to eat a healthy mix of different food groups and types. That said, you can keep this cost reasonable by shopping around for the lowest prices, utilizing coupons, and taking advantage of specials. If you spend a large portion of your budget eating out at restaurants, it might be time to check out some new budget-friendly recipes at home.
Utilities are another major and necessary expense, but again, you can exercise at least some control over how much you spend. Simple steps like keeping your house a bit warmer in summer and a bit colder in winter can add up to massive savings in the long term — though, of course, this isn’t always necessary.
There are many transportation costs to potentially consider, including your car payment, fuel costs, maintenance costs, bus fare, and more. It’s worth considering walking and biking wherever you can. This is not just a tip to save money, but it can also help you stay physically active.
As addressed previously, health care is going to be one of your biggest and least predictable expenses. You can start forecasting this expense by looking at what you’ve spent in the past, but understand that these costs are only going to increase over time. You can also consider taking advantage of an HSA if you want to make your savings go even further for healthcare and medical expenses.
Don’t forget about taxes! Since you’re no longer a full-time employee, you may have additional tax obligations or considerations. Be sure to consult with a tax professional or financial adviser so you fully understand your responsibilities.
Health insurance, car insurance, and other insurance policies are less frequent expenses, but they need to be incorporated into your overall budget.
Then there are unnecessary expenses. This is the real heart of your retirement spending decision making, since none of these indulgences are truly necessary to live a healthy life.
Most people like to travel in retirement, but how much do you want to travel and what are your trips going to be like? There’s a big difference between taking a luxury vacation every month and taking a road trip once a year.
Entertainment comes in many forms, such as eating out, paying for streaming services, or seeing live shows. Everyone deserves at least some entertainment, but we often end up overspending on these experiences. There are many free activities available each month, and checking out the alternatives available near you can help your retirement budget.
It’s important to maintain at least some hobbies, especially as you get older, to stay mentally active. But some hobbies are much more expensive than others; you can do crossword puzzles for free (or nearly so) but collecting vintage coins could be extremely costly.
Luxury expenses range from minor things like household fixtures to more extravagant purchases like a sports car. While most of these expenses are entirely unnecessary, they do have the potential to significantly improve your quality of life in some cases.
Companionship can be extremely valuable, but nobody truly needs a pet. Be sure to factor in all the costs of pet ownership if you want to have a pet in retirement, including food, veterinary expenses, and emergency expenses.
Don’t forget to budget for gifts as well. Birthdays and Christmas come around every year. You’ll likely want to spread your wealth to family members and friends.
How to Find the Right Balance
Now that you have a general idea of how much money you’re going to have in retirement and what your most important expenses are, you can start making tweaks to your lifestyle and spending to find an appropriate balance.
These are the most important factors for doing it:
Always plan slightly more conservatively than you think you need to. This can shield you from unplanned expenses and unforeseen emergencies, and serve as an insurance policy for your retirement money. For example, instead of following the typical “4% rule,” you can follow a “3% rule.”
Carefully monitor your gains and losses.
If you remain invested, your wealth is going to fluctuate over time. It’s important to carefully monitor your gains and losses. That way, you can adjust your spending accordingly. For example, during an economic downturn, you may need to cut some of your luxury expenses.
Assess the value of each indulgence.
Don’t just think about the dollar amount; think about the value. A trip to Las Vegas might cost a few thousand dollars and keep you entertained for a few days, but a year of subscribing to Netflix could provide you with more entertainment for a fraction of the cost — it all depends on what you get out of each experience.
Resist the temptation to hoard.
Most of us spend our lives pinching pennies and worrying about money. So during retirement, it’s natural to hold onto those tendencies. But in reality, many financially savvy retirees could afford to spend more than they do. Don’t be afraid to spend what you’ve saved.
Be prepared to make adjustments.
It’s unlikely that you’ll find the perfect lifestyle balance from the outset, so be prepared to make some adjustments. Once you get some more experience making distributions and spending your hard-earned savings, you can plan with greater accuracy and confidence.
Take it one year at a time.
Periodically reassess your financial plans, and don’t be overwhelmed at the thought of planning for your entire retirement. While you can make a 5-, 10-, or 15-year plan, it’s also alright to take things one year at a time.
The right lifestyle balance for retirement is going to be slightly different for everyone. Some people barely have enough money to retire, while others are practically rich. Some people are extremely risk averse and conservative, while others aren’t afraid to push the limits. There are no right or wrong answers. What’s most important is that you find a lifestyle management strategy that you’re comfortable with.
[Related: 25 Ways You’re Killing Your Savings]