- Understanding your budgets is an important step in the retirement planning process.
- Knowing which expenses are necessary and which are not can help you identify the minimum income you’ll need in retirement and where you can make adjustments.
- Don’t neglect major items that may not show up in your current budget, such as unexpected expenses or long-term care.
Typical retirement expenses include housing, health care, food and transportation. Creating a budget for retirement is a simple matter of gathering and analyzing your essential and nonessential expenses and comparing your spending with your income. Understanding how your budget matches with your retirement income sources, such as Social Security, retirement accounts and pensions, can alleviate stress and allow you to reach your retirement goals.
Creating a Budget
Budgeting for retirement is similar to budgeting at any other stage of life. The steps are the same, but the income sources and allocation of money are different.
For example, you may not be collecting a paycheck anymore, but you are probably collecting Social Security and taking distributions from a 401(k) plan, IRA, annuity or other retirement savings vehicle.
Steps for creating a budget:
- Collect your financial records.
- Identify your expenses.
- Separate your expenses into fixed and variable, and take note of which items are essential, such as food, and which are not, such as entertainment subscriptions.
- Identify all sources of retirement income, including Social Security, retirement savings distributions and annuity payments.
- Compare your expenses to your income.
- Determine whether you need to make adjustments in your spending.
- Consider your personal goals and your ideal retirement lifestyle, and adjust accordingly.
What To Consider When Budgeting for Retirement
If you are nearing retirement your current lifestyle is a good approximation of what you’ll experience in the first few years of retirement. However, remember that retirement can last several decades, so things will change.
The average retirement budget is based on income sources and expense categories that differ slightly from those in earlier stages of life. For example, the Center for Retirement Research at Boston College reports that “the average household spends 30% of its income on out-of-pocket medical expenditures near the end of one spouse’s life, with lower-income households spending an average of 70%.”
Factors That Affect Retirement Income
Retirement planning can be very different for someone that doesn’t have adequate savings compared to someone that does.
Planning for retirement early can make budgeting at this stage easier. If you started saving for retirement when you entered the workforce, or shortly thereafter, your budget won’t feel as constrained. You’ll also run a lower risk of running out of money.
If, however, you don’t have much in savings, you’re not alone. According to the Center for Retirement Research (CRR), “nearly a third of all households nearing retirement have no retirement savings.”
A realistic budget is important for everyone, and it is indispensable for people without adequate savings. Start with a complete picture of your estimated income during retirement. It may not reflect your pre-retirement income, so this step is crucial to setting up a reliable retirement budget.
Account for any factors that may affect your income, including:
- Rate of return on investments and savings accounts
- Annuity payments
- Pension distributions
- Retirement date
- Retirement age
- Passive income sources, such as rental properties or book royalties
- Earnings from part-time, consulting or contract work
- Social Security benefits
Once you have a good idea of how much money will be flowing in each month, consider your personal needs and lifestyle goals.
Ask yourself the following questions:
- What do I want to do with my retirement years?
- What parts of my current lifestyle am I unwilling to change or give up?
- How much financial support will I provide for my children and grandchildren?
- What kind of inheritance do I want to leave behind?
- Is it important to me to stay in my current home?
- How do I cope mentally and emotionally with being alone?
Mapping Out Your Retirement: Are You on Track?
According to CRR researchers, married retirees ages 53 to 64 spend 77% of their income on housing, health care, food, clothing and transportation. These basic needs account for 79% of their income.
Aside from the basic fixed expenses, retirees must plan and budget for taxes, any intended bequests, entertainment, travel and unexpected expenses, referred to as “shocks,” that they can’t accurately estimate.
The Bureau of Labor Statistics published a breakdown of expenses in retirement across three age groups: 55–64, 65–74 and 75 and older. For all three age groups, housing was the highest expense, as reported by the Consumer Expenditure Survey.
Average Annual Expenses for People Ages 55 and Older
|Expense||Ages 55 to 64||Ages 65 to 74||Ages 75 and older|
The analysis also indicated that health care expenses increase with age. When you combine the health problems that occur naturally as you age with the probability that your social network will shrink over time, the need to budget for entertainment becomes more obvious than ever.
Remember, the idea is to create a realistic budget. Don’t trick yourself into thinking you have a lean budget by trying to cut expenses that may actually be important. One area where you may be tempted to do this is entertainment and leisure. The point is to enjoy retirement, and cutting out the things you enjoy can even have profoundly adverse effects on your health.
The National Institute on Aging has found that social isolation and loneliness are linked to an increased risk of high blood pressure, heart disease, obesity, weakened immune systems, anxiety, depression, cognitive decline and Alzheimer’s disease.
Taxes and RMDs
Many retirees pay taxes on Social Security benefits in addition to withdrawals from 401(k) plans and IRAs. Annuity distributions are also taxed, although the taxed portion depends on whether the annuity is considered qualified or nonqualified.
When you are creating your retirement budget, make sure you take into account the state and federal income taxes you will be required to pay.
And if you plan to relocate to another state when you retire, consider the state income and property taxes, as well as sales and estate taxes.
Only seven states fully tax military retirement pay.
Required minimum distributions are another often overlooked factor when creating a budget for retirement. You will have to pay taxes on these IRS-mandated distributions, and failing to take them will result in a penalty.
Shocks and Other Considerations
It can be difficult to make decisions when faced with a shock, such as the death of a spouse, divorce, a disability or unavoidable home repairs.
In addition to financial strain, shocks in retirement take a toll on a person’s mental and emotional state. Having money set aside for such an occurrence can positively impact both your financial well-being and your emotional well-being.
Budgeting for shocks is essentially the same thing as having an emergency fund.
According to researchers from the Urban Institute, “more than two-thirds of adults age 70 and older experience at least one negative shock over a nine-year period.”
Common shocks among retirees include:
- Home repairs and maintenance
- Major dental expenses
- Extraordinary medical expenses
- Investment losses
Source: Society of Actuaries
Higher Health Care Costs
Health care is one of the most significant spending adjustments retirees have to make. Representing 16% of spending by Americans ages 65 to 74, health care is the second highest cost for retirees. Thus, the spike in medical expenses during retirement is considered a shock.
Medicare is the primary health insurance program that provides coverage for retirees, but it doesn’t cover all health services. For example, the program doesn’t cover most dental care.
A 2022 brief published by the Center for Retirement Research at Boston College examined how much money older Americans spend on uncertain health costs. The author concluded that “lifetime health care spending by retirees above and beyond predictable premiums is high and uncertain.”
It’s important to review your plan so you know what is and is not covered. You can purchase supplemental plans to fill the gaps, depending on your particular needs.
About two-thirds of people over 65 need long-term care at some point in their life, and that need lasts for about three years on average. Medicare does not cover long-term care, and long-term care insurance can be costly.
Ideally, Americans should consider the likelihood of needing long-term care before they retire because a shock of this magnitude is extremely difficult to overcome. Long-term care insurance, dedicated savings or an annuity with a long-term care rider are all options for addressing this potential need.
Providing Financial Support for Adult Children or Other Family Members
In April 2022, a Savings.com survey found that half of all parents with adult children are still providing some form of financial support, and these parents are giving their children an average of $1,000 a month.
Expenses Parents Cover for Their Adult Children
- Cell phones
- Student loans
- Medical bills
- Car payments
- Dining out
- Mortgage payments
The Atlantic published an article in 2019 that cited statistics from AARP, which revealed that grandparents in the United States provide financial support for their grandchildren’s education, living expenses and medical care.
In the United States, 53% of grandparents pay for their grandchildren’s education.
And while you may be more than happy to provide whatever financial help you can to your children and grandchildren, dipping into your retirement savings puts you at risk of depleting funds for your own living expenses. This, in turn, puts you at risk of becoming a financial burden to them in the future.
To minimize this risk, it’s essential to budget for these potential expenses and maintain a realistic assessment of what you can comfortably afford to provide.
The Nuts and Bolts of Creating a Retirement Budget
Budgeting programs and worksheets can streamline the process of planning and tracking expenses. A number of personal budgeting software applications now offer the convenience of linking to your bank accounts, automatically syncing your transactions and providing financial and budgeting advice.
Nevertheless, while number crunching and data entry are integral aspects of budgeting, these tools are only as effective as the information the user inputs into them.
This implies that you’ll need to engage in critical thinking and, perhaps, engage in some introspection before you make use of these tools.
In order to obtain a comprehensive view of your finances for creating a budget, you should gather all financial statements, both in paper and electronic format. You may find it helpful to get a copy of your credit report to ensure that you aren’t forgetting any open accounts. This way, you can see all of your outstanding debt in one place, which you will need to include in your budget.
Your expenses will naturally fluctuate, so calculate the average of the last 6 to 12 months of expenses to get an estimate of your normal monthly expenses.
Consider Essential Expenses and Nonessential Expenses
Essential expenses are those that you must cover, and include categories such as food, clothing, housing, utilities, transportation, health care, taxes, insurance premiums and auto registration.
Nonessential expenses, also referred to as discretionary expenses, are those you could do without if needed. This includes things like cable, streaming services, club memberships and subscriptions.
It’s helpful to think about your expenses as a monthly average, so consider which expenses may not fall on a monthly schedule. For example, if your homeowners insurance premium is billed quarterly and your payments are $300, you may want to budget $100 per month for that expense.
Anticipate One-Time Expenses
Nonrecurring expenses include vacations, weddings and certain gifts or charitable giving. You’ll need to estimate these expenditures and include them in your budget.
Identify All Sources of Retirement Income
A large portion of your income in retirement will come from Social Security, pensions, 401(k) plans and IRAs.
In addition to these income streams, you may have annuity payments, earnings from part-time work or passive income streams, such as real estate or investment dividends.
Compare Expenses to Income
This is where the rubber meets the road. Comparing your expenses against your retirement income sources lets you know if you’re prepared to retire and how secure your retirement may be.
If you’ve planned ahead and have adequate savings, then it shouldn’t be a surprise that you have adequate resources to cover your planned expenses. That’s the whole point of starting early!
However, if your spending exceeds your income, you’ll have to make adjustments. If you have the ability to generate more income, perhaps by taking on part-time or consulting work, you can offset some of your costs. Otherwise, it’s time to assess your expenses and start cutting. If neither of those options work for you, then delaying retirement may be best.
Align Adjustments With Your Personal Retirement Goals
If you need to adjust your budget, then where you choose to adjust your spending is a personal decision. Only you know what’s truly important to you, and only you should decide what to sacrifice and what you’re willing to sacrifice for.
If you need guidance, enlist the help of a trusted financial expert. If they don’t listen when you describe your goals and your ideal retirement lifestyle, find a professional who does.
How and Where To Adjust Spending
Before you can create a plan for adjusting your expenses in retirement, you need to know where your money is going now. Once you have a starting point, you can review the essential categories where you predict an increase in spending, such as health care, and balance them against the costs that will naturally decrease, such as work-related expenses.
Then examine your nonessential categories. What are you willing to sacrifice? Do you have memberships or subscriptions you rarely use? Are you paying for services you can get for free? Is there a storage unit full of items that you should have donated or tossed a long time ago, draining hundreds of dollars a year from your bank account? These minor, regular expenses can accumulate and represent a substantial amount of money over time.
Mortgages and Car Payments
If downsizing is an option for you, consider the benefits of moving to a lower-cost home. Because housing is the largest expense in retirement, your budget would experience a significant boost if you were to lower or eliminate your mortgage payment. If you own your home outright, you may find that you can pocket a sizable sum of money by selling and moving into something smaller.
Car payments are another viable opportunity for cutting costs in retirement. While you may still need a reliable vehicle in retirement, you certainly don’t need to buy new.
Psychology and Your Retirement Budget
It’s easy to look at numbers on a spreadsheet, but remember, those numbers are a reflection of you, your values and your emotions. Before you start cutting things, consider why you have those expenses in the first place and the impact those cuts might have. Take the time to reflect on your budget and any changes before you commit to them.
The impact of mindful living on your retirement finances can make it much easier to stick to your budget and cut unnecessary expenses. And, as a bonus, it will reduce your stress and anxiety.
Using a Retirement Budget Worksheet To Adjust Spending
A retirement budget worksheet can be as high- or low-tech as you want. You can create a worksheet using a pen and paper, an Excel spreadsheet or a Google Sheet with the appropriate categories.
You can also use one of the hundreds of interactive retirement budget worksheets offered through banks and investment firms. If you use online banking, you may be able to download your transaction history and sort it within minutes.
Your financial advisor may also offer worksheet templates and guidance for completing the worksheet accurately.
The Financial Literacy and Education Commission’s MyMoney.gov offers worksheets and other financial-literacy related resources intended to “strengthen financial capability and increase access to financial services for all Americans.”
Editor Bianca Dagostino contributed to this article.