Pretty much everybody who has thought about retirement knows that the key requirement for financial security post-career boils down to being a relatively serious saver. There are exceptions, but by and large a single person or a couple needs a nest egg of at least $1 million to live a relatively comfortable middle class lifestyle — and this assumes you’re good at monitoring spending.
This may sound like a lot, but savings of $1.18 million are required to generate $40,000 a year for 30 years — the preferred retirement planning period – assuming average annual returns of 6% and inflation of 2.5%, according to investment research giant Morningstar. Couple this with Social Security, and you are financially OK.
Let’s say you’re well on your way to achieving this goal, or already have, and perhaps have added an annuity to the mix so that some of your income is guaranteed for life. An important consideration is still probably missing. Have you determined whether your retirement assets are enough to replace 70% to 80% of your past salary (or salaries, if you are married)?
Odds are, you have not.
This is no small thing. If you know what you have but don’t have a good handle on your rate of spending, you have a problem, whether you know it or not. You’re either spending too much and jeopardizing financial security in the later years of retirement or you’re needlessly spending less than you would like, undermining your lifestyle for no good reason.
The 70% to 80% Guideline
The 70% to 80% estimate has been a conventional guideline for decades. It’s a good starting point to get a handle on your spending habits – use 75% as the guideline if you haven’t been tracking them – and it needs to be replaced with solid budgeting later. The only important footnote to bear in mind at the start of your analysis is that the 75% figure is too low for some people and too high for others.
On the plus side, new retirees find themselves in a lower tax bracket. They’re also no longer paying Social Security and Medicare taxes – a 7.65% bite out of your past paycheck – and they no longer make retirement account contributions. Work-related expenses, such as commuting, are in the past, and so, too, for most retirees helping your children foot the bill for higher education expenses. In addition, the new federal tax law now provides a much higher standard deduction.
On the other hand, multiple variables can push spending higher. Many new retirees, for instance, travel much more and spend more lavishly on entertainment, especially in the early years of retirement. When you have time on your hands, it’s natural to do more discretionary spending. Depending on the luck of the draw and whether they have insurance to supplement Medicare, medical expenses could also be much higher.
A 2017 study by the Employee Benefit Research Institute found that almost half – 47% – of surveyed retirees said their healthcare expenses were higher than anticipated. And more than a third – 37% – said non-healthcare expenses were similarly higher than anticipated.
Do Serious Budgeting as You Approach Retirement
Financial planning pros say the best strategy is to follow the 75% guideline during the bulk of your asset accumulation phase and then amend it with serious projected budgeting roughly five to seven years before retirement. That’s when you have a much better feel for actual and projected expenses. You’ll also have a better feel for whether you want to maintain your current lifestyle or, if possible, spend more to improve it. To accomplish this, a good route is to use an online budget tool.
This worksheet is very comprehensive, allowing you to enter several dozen expense items in eight broad spending categories. The tool also lets you see how much of your spending goes toward essentials, such as food and healthcare, versus discretionary expenditures, such as entertainment and dining out. This breakdown gives you a good idea of your ability to trim expenses down the road should an unexpected development require that.
While an online tool is helpful, you can also can do the calculations on your own if you’re relatively thorough. Use your current spending as a starting point. Take into account expenses that will disappear, such as an expiring home mortgage. Consider other areas in which spending may increase once you actually retire, such as traveling. And, once again, think hard about whether you want to maintain a relatively simple lifestyle or live more luxuriously in retirement if possible.
This exercise could turn out to be simpler than you think. The fact is, your expenses are unlikely to change much in most spending categories. Think about it. After shopping for groceries for decades, your purchasing patterns are unlikely to change just because you have entered retirement. Most people just don’t change lifelong spending habits much.
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