The reason you saved and invested in your 401k and IRA is so that one day you will have saved enough to be able to retire. But what is enough? How much do you really need to retire? In order to have confidence that you have saved enough you need to know that your retirement savings can support a lifetime of retirement spending. There are plenty of rules of thumb about how much you can withdrawal from your investments. One of the most popular is the 4% rule. But if you don't know how much you spend then these withdrawal strategies are meaningless. If you are trying to understand if you have saved enough to retire with confidence you are going to want to start with a good spending plan and then determine if your investments will support the spending. We developed the Retirement Budget Calculator to start the retirement exercise by developing a spending plan and using the spending number to help create a retirement plan that allows for greater confidence as you prepare for retirement.
Many times people have a negative association with the word budget. For many people they think of a budget as having to cut back or having to clip coupons. And for retirees these days, many of whom have saved hundreds of thousands and even millions of dollars this idea of budgeting or pinching pennies heading into retirement does not match up with the vision they have. Developing a retirement spending plan is not about trying to cut back or pinch pennies or even track your every day expenses. Rather it is having a realistic expectation for how much you actually spend so that you can have confidence that you can retire and not have to worry about running out of money. Once you have a good handle on how much you spend the simple rule of thumb formula for knowing if you have saved enough is to multiply your annual spending by 25. For example if you spend $40,000 per year then you would multiply $40,000 x 25 and it equals 1 million dollars. This rule of thumb tells us that if you have one million dollars and you spend $40,000 per year then you should have enough to feel confident to retire.
Essential vs Discretionary Spending
Not all expenses are essential. For example as you begin to try to estimate your retirement spending you will likely want to spend more in the early years and plan to spend less in the later years. Retirement is often thought of as the gogo years, the slow go years and the no go years. During the gogo years you will be traveling the world, taking cruises, walking in the sands of exotic beaches, or so we hope. In the slow go years you may be spending more of your time with domestic travel and visiting with your grandkids. And in the no go years you might find that most of your travel is to the doctors office and post office and playing cribbage with the neighbors. As you craft a retirement spending strategy it is important to think of your spending as essential vs discretionary and also how that spending will match up with the different phases of retirement. The essential expenses are things like your electric bill, groceries, garbage, water, sewer. Some people might consider the cell phone essential while others would call it discretionary. Think of essential expenses as the things that are non negotiable. The things you can not do without. Discretionary spending might be cable tv, netflix, travel, gym memberships or dining out. Every person developing a retirement spending plan will need to determine what is truly essential vs discretionary. But you can see the exercise of retirement spending starts to get kind of complicated as you consider the different phases of retirement and you start to break out the essential vs discretionary spending. You will likely have some expenses early in retirement that you won't have later in retirement. The key is to be able to model when these expenses will occur. You can see that using a simple rule of thumb like 25x your annual spending starts to get messy when you think about the actual ebb and flow of spending in retirement. But don't worry in the Retirement Budget Calculator you can take all of these nuances into consideration and make a realistic spending plan.
Your spending won't be static in retirement. Once you create a spending plan based on what you spend in today's dollars it is important to factor in inflation to understand how much you might spend in future dollars. Inflation simply means that the dollars you need today won't be the same as the dollars you need in the future. Inflation means that we will need more dollars in the future to maintain the same level of consumption. Many calculators give you one inflation factor and apply a blanket inflation factor to all of your expenses. But that is not how inflation really works. If you have a car payment or mortgage heading into retirement that payment is fixed ,it does not go up with inflation and it will eventually go away. It would be a mistake to assume that a mortgage is increasing with inflation because the principal and interest payment is fixed. But you will likely want to assume that property taxes and insurance will increase with inflation. Inflation has impacted different segments of spending in different ways. For example you might want to assume that health insurance expenses will increase at 5-7% over time, food, grocery and other spending increasing at 2-3%. The key is to understand that not all expenses increase at the same rate and some expenses don't inflate at all. The retirement budget calculator allows you to assign a different inflation factor to each expense. And it allows for something like a mortgage that will be paid off in the future to go away. By including an inflation factor it will help you see how your expenses will change over time.
Taxes don't stop once you retire. Many people have a lot of their retirement money in accounts like 401k's and IRA's that are tax deferred. When you start to dip into these accounts to help supplement your lifestyle those dollars will get taxed as you take withdrawals. It is important to remember to plan for taxes as you make your retirement spending plan.
In the retirement budget calculator we break spending into seven categories. Within each category you might have both essential and discretionary expenses. The seven categories of retirement spending are as follows:
2.) Loans & Liabilities
3.) Food & Personal Care
4.) Insurance & Medical
5.) Vehicles & Transportation
6.) Travel & Entertainment
7.) Giving & Miscellaneous
Another thing that makes creating a spending plan a little tricky is that spending is not the same every month. Many expenses do occur on a monthly basis and that makes spending easier to understand. But some expenses happen once per year or semi annually or quarterly. Rather than averaging your spending it is nice to have a calendar of spending so that you can see that some months your expenses will be higher and some months the spending will be lower. By understanding the ebb and flow of spending you can make better informed decisions about when you will need to take withdrawals from your investments. You might be planning to spend $120,000 per year in retirement. But it is unlikely that the spending will actually be $10,000 per month. Your monthly expenses might only require six thousand dollars per month, but you might have a big trip in January to travel to some place warm, and your property taxes might be due in September and Christmas only happens once per year. Recognizing the ebb and flow spending and having a calendar view of your expenses makes more sense than just having an annual budget and taking monthly withdrawals that don't match up with your actual spending.
One way to make life simple as you prepare to retire is to set up expenses on autopay. Things like electric bills and and phone bills and car payments and mortgages can all be set to autopay. The simpler and more automatic you make paying these essential expenses the less time you will need to spend managing your finances and more time that you can focus on living your best life. At the same time there are expenses that will occur that will need your attention that you might not want to set up on autopay. It is unlikely that your trips to the grocery store or to the barber shop will be set to autopay. In the Retirement Budget Calculator you can specify how each of the expenses are paid so that you can identify any expense that you will write a check for or use your debit card or where you might want cash. It would be silly to pay late fees or have your credit affected negatively at this phase of life just because you are not organized. Taking a little time at the beginning of retirement to use a calculator to help you create a retirement spending plan can save you a lot of money and frustration as you venture into and through retirement.
Retirement is all about cash-flow. It is making sure that you have enough income to pay all of your expenses. By focusing on your spending rather than using generic rules of thumb you can start to understand if you have saved enough to retire with confidence. Deciding to retire is one of the biggest and most important financial decisions of your life. You will likely be walking away from employment at a time when your income is at the highest level you have ever known. Using our retirement spending calculator will help answer the question "have we saved enough?" and will give you confidence to make this very important retirement decision.