Step-by-Step Guide to Creating a Retirement Budget

In our last article, we discussed when you should start saving and how much of your paycheck should go towards retirement savings. This time, we are focusing on how to figure out how much you’ll need during your retirement years. Creating a retirement budget is an essential step to taking a realistic look at what kind of life you’ll be able to enjoy after you say goodbye to the working world.

And, like most things, retirement has become more expensive in recent years. On average, American retirees spend about $3,700 per month or about $44,600 per year, according to the Bureau of Labor Statistics. Even after factoring in social security benefits, this means that you would need to have about $500,000 in a retirement account in order to cover these expenses.

Fortunately, you can decrease those costs by making some lifestyle changes. But let’s start at the beginning and work our way through to that…

Step 1: Figure out your income sources

Keep in mind that the $44,600 is just an average and not an accurate reflection of your real costs in the future. To figure this out, you’ll need to create a proper retirement budget. Your first step involves tallying up all sources of potential income.

Let’s run through each source to determine how much you’re likely to receive and how you can increase your income by retirement day.

1. Social Security

Social security provides a consistently and relatively secure flow of income each month, but it’s meant to supplement your retirement income rather than be the sole source. The average American receives about $1,350 per month in benefits, but the amount varies based on how much you earned in the past 35 years of pay.

To maximize your social security benefits, you might want to consider delaying the start of your claims. Technically, you can begin receiving benefits at age 62, but waiting a few years can significantly increase the amount you get each month. For example, someone born between 1943 and 1954 would receive 25% more if they waited to claim at age 66 rather than starting at 62, according to the Social Security Administration’s website.

2. Retirement Accounts

Let’s hope that you’ve put some money away into some sort of retirement account, whether this comes in the form of an employer-offered 401K, a traditional or Roth IRA or a fixed or deferred annuity.

Retirement accounts serve as a nice cushion by providing you with an accessible pool of money to draw from. If you are over 59.5, you have free reign to withdraw from your accounts. However, you may have to pay taxes in some cases, so you’ll need to include these in your retirement budget as well (For more detailed information on retirement accounts, visit part 3 of the series).

Financial advisors usually recommend pulling out about 4% of your savings each year, although this differs depending on your lifestyle. You’ll also want to consider interest and tax rates when figuring out your withdrawal strategy.

3. Rental Income

Some people are savvy (or lucky) enough to secure property in order to earn income from renters. This move can be a blessing and a curse because while a steady stream of income is great, you’re still expected to assume the responsibilities of owning the property. This means you’re on the hook for finding a steady flow of renters, along with paying for repairs. But for those who are up for the challenge, rental income can be a nice boost to your retirement cash flow.

4. Long-Term Investments

It’s always a smart move to diversify your portfolio to include more long-term investments, such as stocks, bonds, CDs, and mutual funds. While playing the stock market is a bit like riding a rollercoaster, the car is usually traveling upwards in the long run. According to Fidelity, the stock market posted a positive annual positive return 80% of the time over the past 35 years. These investments aren’t as liquid as typical retirement accounts, but they provide an easy way to build your wealth to either pass down to the next generation or cash out and enjoy yourself during your retirement years.

5. Part-time Job

While retirement can be a paradise for some, some people just like working and keeping busy. For these types, a part-time job can be a great way to earn some income, keep busy, and maintain an active social life.

6. Home Equity

Retirees often decide to downsize their home to save money after the kids have left the nest. This allows them to collect equity built up from the appreciated value of their homes. According to US News & World Report, 18% of Americans use their equity to fund their retirement. One caveat with this method is that homes aren’t guaranteed to rise in value, making it a riskier investment than the stock market. But if you spend years living in the home as it rises in value and don’t need the space anymore, downsizing can be a smart retirement strategy.

Step 2: Determine your fixed and flexible expenses

Much like retirement income, your future expenses are difficult to accurately predict. Interest rates, inflation rates, and your lifestyle all impact how much you’ll need to include in your retirement budget each month for expenses.

Fixed expenses are a bit easier to predict because they don’t generally change from month to month. The more fixed expenses you have, the easier it will be to track your budget. We’ll use average US spending data from the Bureau of Labor Statistics to figure out your expenses during retirement. However,  you’ll want to factor in price increases from year to year.

Fixed Expenses

1. Housing – $1,294 per month

In general, housing costs decrease during your golden years because most people have either paid off their house or have downsized to a smaller home. Obviously, these costs depend on where you choose to live. Retirement friendly states such as Arizona and Florida tend to have lower housing costs. The monthly costs include taxes, maintenance costs, utilities, and insurance.

2. Transportation – $571 per month

Here’s another cost that will drop once you retire, as you’ll be making less trips to the gas station. However, there are still costs associated with transportation, such as insurance and maintenance. You would also include travel (flights, accommodations, etc.) in this section, which vary depending on your post-retirement plans.

3. Healthcare – $480 per month

This is one of the few categories that increase upon retirement. Healthcare costs have risen swiftly for the past 30 years but may have hit their peak, according to some experts. Fortunately, you’ll also qualify for Medicare to shield from the real cost of healthcare. Even so, most of these expenses (an average of $324) will be spent on health insurance premiums.

4. Life/personal insurance – $228 per month

As you grow older, your life insurance premiums will rise, so expect this to replace your reduced car insurance bill. But life insurance is important to keep your family secure, so it’s not something you want to skip.

Flexible Expenses

5. Food – $459 per month

Everybody likes a good meal and this is no exception for retirees, who tend to eat out more often because they have more free time. But overall, retirees tend to spend similar to the average household in terms of food spending.

6. Entertainment – $205 per month

This category may increase upon retirement, depending on your lifestyle. While retirees enjoy going out to the movies or taking the grandchildren out, they generally enjoy less costly activities, such as spending time in nature.

7. Charitable donations – $191 per month

As you get into your twilight years, you’ll notice that you’re suddenly more charitable than you remember. Giving provides you with a sense of purpose that keeps you happy during your retirement years. Just don’t forget to budget it!

Step 3: Subtract your expenses from income

Okay, here’s the make or break moment. After you subtract your expenses from your income, you’ll either be in the black (good) or the red (not so good). This step will either make you jump for joy or not want to leave the house for a week. But there’s no need to worry because this exercise shows you which spending habits you’ll need to change. If your expenses outpace your income, then you can do one of two things:

1. Find ways to reduce your expenses, such as finding a less expensive place to live.
2. Plan to utilize additional sources of income.

The earlier you figure out your retirement needs, the less stress you’ll have in the future. Retirement might seem light years away, but time moves quickly and even more so when you’re not prepared. By getting in front of the problem and creating a retirement budget, you can make strategic moves that put you in control of your retirement finances.