One of the most difficult questions to answer while planning your retirement is how much you’ll need to spend to maintain your standard of living. A number of “rules of thumb” say that you should look to replace 70-90% of your take-home pay, but that type of very broad advice is too general for most retirees to follow. So much depends on your individual circumstances.
Here’s our process for determining retirement spending, with a special nod toward categories of expenses that will change after your transition to retirement.
To start, figure your current pre-retirement spending. Your bank account history can be a great help here. If you plan to stay in your current home, get a handle on your basic bills such as utilities, housing costs, and property taxes, as well as your average discretionary spending.
Once you have a base spending number, you’ll need to make adjustments to reflect common expenses that change during retirement.
Common Additions to Base Retirement Spending
Most clients of Baird Retirement Management worked for an employer that subsidized their health insurance, with any employee cost coming directly out of their paycheck. This means that you may have to add the full cost of healthcare to your retirement spending.
If You Retire Before Age 65
If you retire before you’re eligible for Medicare, your coverage will typically cost more. Some companies have dropped pre-65 retiree medical plans altogether, instead subsidizing the cost of COBRA coverage or another healthcare plan. Many have removed pre-65 retiree medical plans or subsidization altogether. This is a key expense you’ll need to factor in.
If You Retire After Medicare Begins
Monthly premiums for Medicare Part B vary based on your income from the prior two years. A couple’s premiums could be as low as $144.60 each or as high as $491.60 each, depending on income. Supplemental Medicare coverage will likely be prudent as well, but you’ll need to account for those additional costs. You should also consider long-term care insurance.
Travel and vacations are an important part of enjoying your retirement. Don’t deny yourself! This expense almost always increases from pre-retirement, remaining high early in retirement before falling off as you age.
Retirees often develop new hobbies and are more likely to eat out. Understanding your plans for spending money on entertainment or new toys is very important.
Your grocery bills are likely to increase, since retirees are more likely to eat at home and aren’t buying lunch every day at work.
Gifting and College Costs for Grandchildren
It is very common for retirees to have gifting or education goals for family members. Make sure to factor these into your plans.
Common Subtractions to Base Healthcare Spending
It is important to subtract retirement savings from your base retirement spending. If you contributed to a 401(k) or other employer-sponsored plan, your contributions will likely not have been reflected in your base spending since they were deducted from your paycheck. However, if you have regular savings, IRA, or brokerage account savings, these should be subtracted for base spending.
Remember to remove any parking, fuel, or public transportation costs that you used to get to work. Many couples also downsize to one car since they are not going to different jobs.
Typically, retirees reduce their overall wardrobe spending significantly. Golf shirts are less expensive than business clothes.
Your tax rate typically drops in retirement. You can control taxable distributions from your IRA or spend funds from non-taxable sources.
Large One-Off Expenses
Household projects are very common in retirement, as are aspirations for a second home, an RV, a boat, etc. Any down payment for a one-time expense should not be considered part of ongoing retirement spending, but needs to be considered as a capital expenditure that will reduce the overall asset base.
These types of expenditures can also have ongoing maintenance costs that you’ll need to consider as part of normal retirement spending. Any debt service, repairs, insurance, utilities, taxes, and maintenance need to be factored into the main budget before you realize any of these goals.
One Last Piece of Advice: Round Up
When taking the step into retirement, it is imperative that you do not underestimate your expenses. When planning, we recommend rounding up your total expenses by 10%. If you end up spending less than the rounded-up estimate, great - but it can be devastating to underestimate your expenses.