Yahoo Finance How To Draw Up a Retirement Budget in 6 Key Steps
Retirement is a crucial financial goal for many Americans. While you may have a goal of how much you want to save and how to get there, it’s equally important to plan how you’ll spend the money.
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One way to prepare is by making a retirement budget. Even if you’re not at retirement age, knowing where your money is coming and going once you’re retired can help you adjust your savings goals and better navigate your golden years.
Here are six key steps to build an effective retirement plan.
1. Review and Evaluate Your Expenses
The first step to creating a realistic retirement budget is to review your current spending habits. This means looking at your monthly expenses and how much you spend in different areas of your life. Reviewing your expenses can help you pinpoint areas where you can cut back and reduce costs.
There are typically two main buckets of spending: needs and wants. Needs are non-essential expenses, like rent or mortgage payments, utilities, groceries, gas, or insurance premiums. These expenses can either be fixed, meaning they won’t change month to month, or variable, meaning they’ll fluctuate. Variable expenses are a bit harder to budget for, but reviewing your overall monthly spending can help you get a more accurate estimate of how much you spend on average.
Wants are nonessential expenses or purchases you could live without, like a Netflix subscription or your weekly takeout order. Just because these expenses aren’t essential doesn’t mean they aren’t important — you may have to look closer at them when deciding where to cut back.
Next, review your current spending patterns and consider how your retirement habits could change. You may plan to downsize your home, reducing your housing costs. Or maybe you’re anticipating spending more on healthcare.
It’s important to enjoy your retirement and be realistic about your expenses. The last thing you want is to be stretched thin in retirement or feel stressed over unexpected costs. Take a moment to consider which expenses you can cut back on (or even eliminate) in retirement without sacrificing your quality of life.
2. Estimate Your Retirement Income
Now that you have a good idea of what your expenses will look like in retirement, figuring out how much money you’ll have coming in is essential. In retirement, you’ll likely have multiple income streams from different places. Make sure to add them to get a feasible estimate of how much you’ll have each month. This could include Social Security benefits, pension plans, annuities, retirement accounts, or any other savings you may have.
Many retirement accounts come with eligibility requirements, which means you may have to wait until a certain age to withdraw from the account or risk a penalty. Ensure you know these rules and any other factors that could affect the amount you receive.
You can begin taking money out penalty-free for most retirement accounts starting at age 59 ½. In the case of Social Security, you can start receiving benefits at age 62, but it may be advantageous to delay taking Social Security because your benefits will be larger.
It’s common for retirees to pick up part-time work or pursue passive income endeavors, like renting out a property or receiving investment dividends. While you should factor this extra income into your calculations, it’s important to be conservative with your estimates. For example, you may not be able to work as long as you want to or earn as much as you wish from passive income. You don’t want an income shortfall to create a hole in your budget.
3. Think About Your Goals
Now that you’ve estimated your retirement spending and income, think more broadly about what you want to get out of your golden years. You’ve likely already set a retirement savings goal, but you should also consider what you want to do once you’re retired.
Think about that ideal retirement lifestyle. Once you’ve defined your retirement goals, you can prioritize them, as you may not have the funds (or the time) to pursue all of them. Estimate how much different goals or priorities will cost you in retirement, and determine if they can fit into your existing budget.
Prioritizing what’s important to you will help you allocate your savings. Plus, doing this in advance of retirement can also help you make those adjustments to your budget. You can even make a plan to save more if needed.
For example, let’s say you plan to travel the first year of retirement. You can estimate how much that trip will cost, how much of your retirement savings you need to set aside, and over what period of time you’ll need it.
This step is really all about finding balance and potentially making trade-offs in your retirement budget that fit within your existing (and projected) savings.
4. Plan For Healthcare Expenses
Healthcare is one of the most significant expenses you’ll have during retirement. Many retirees underestimate how much they’ll spend on healthcare — not to mention that costs are rising faster than inflation.
While predicting exactly how much you’ll need is difficult, start by getting an approximation. It’s estimated that the average couple will need around $315,000 to cover their medical expenses in retirement — excluding long-term care. How much you’ll need will depend on your current health, where you live, when you plan to retire and your family history.
Most people will need to continue to pay for health insurance until they’re eligible for Medicare at age 65. If you plan to retire before that age, you should factor in expenses like insurance premiums, deductibles, copayments, and prescription medications.
If you’re still working, setting aside funds in a Health Savings Account (HSA) may be a smart idea. These accounts are tax-advantaged, meaning you can deposit pre-tax money and withdraw it tax-free on medical expenses and other healthcare costs. This can save you a lot of money on healthcare.
Once you turn 65, Medicare will cover some of your healthcare costs for free, like hospital stays (after your deductible is met). But additional coverage, like outpatient care or preventative services, often comes with an additional premium. Review the coverage details and costs if you plan to sign up for any supplemental insurance plans.
You’ll want to ensure you have coverage when you need it, but also know how much any extra coverage could cost.
5. Factor in Inflation
Inflation causes the cost of goods and services to rise over time — and when you’re a retiree on a fixed income, this can eat away at your purchasing power over time. That’s why it’s so important to consider inflation when building your retirement budget. You can use an inflation calculator to estimate how much your expenses will be worth when you retire. This will help you ensure you’re saving enough and budgeting effectively throughout retirement.
Inflation fluctuates based on consumer spending, and other macroeconomic trends can be challenging to predict. But a conservative estimate — like 2%-3% — can give you a baseline to anticipate potential price increases.
Unfortunately, not all spending categories increase at the same rate. For example, healthcare costs have outpaced inflation in most years. That’s why looking at other essential categories like groceries and housing is necessary to estimate how much inflation could impact you.
6. Review and Adjust Your Budget as Needed
Making a retirement budget isn’t a set-it-and-forget-it task. Even if you’re not in retirement yet, it’s essential to review your expenses and income regularly to ensure you’re on track to reaching your goals and can stick to your budget once you retire.
You don’t want to enter retirement with a budget that doesn’t match your reality or is restrictive. Continuously review your current spending and compare that to what you have outlined in your retirement budget. That way, you can make adjustments when you need to.
If you’re not doing so already, make sure you’re also reviewing your retirement savings and investments. Take a look at your retirement accounts and monitor your performance. Make sure your plan aligns with your overall goals and risk tolerance. For example, if you’re getting closer to retirement, maybe you want to shift part of your portfolio to more conservative investments.
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