How to Budget for Retirement

If you’re within five years of your target date for leaving your full-time job for good, this is the time to develop a budget for retirement. That way, you won’t be blindsided when you stop bringing home that paycheck.

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There are two ways to calculate how much you’ll need during your retirement years.

One way is to estimate that you will need 70 to 80 percent of your pre-retirement gross income. That’s the rule of thumb many financial advisers use. The other way is to create a monthly budget.

This story focuses on the budget method, since hitting 70 to 80 percent of your gross isn’t necessarily going to work for everyone. “That’s a target, a benchmark,” said Joe Ready, executive vice president, Institutional Retirement and Trust, Wells Fargo Bank. You might be on track to replace your goal of 60 percent of pay based on the income you expect to have in retirement. Or you may realize you aren’t anywhere near the 70 to 80 percent benchmark and don’t believe it’ll be possible.

If you’re not close to being able to retire on 80 percent of your gross pre-retirement income, “back into a simpler, easier lifestyle,” Ready said, “especially if you have no dependents at this point in your life.”

Before you look at your projected numbers — expenses and income you expect to have in retirement — think in terms of longevity as well.

“The arc of life has lengthened,” said Andrew Scott, author of The 100-Year Life: Living and Working in an Age of Longevity and a professor of economics at the London Business School. “We’re fitter and healthier for longer. How long are you going to live? You have to think in terms of the future.”

For an estimate, you can use a life expectancy calculator, such as the one on the Social Security Administration website. Or you can begin by looking at how long your parents lived (or are living) and your own health. “Most people are going to live longer than their parents,” Scott said.

The actuarial table on Social Security’s site estimates that men who are 65 today are expected to live a bit older than 82½ and women to just over 85.

After taking your projected lifespan into consideration, create a budget that shows all your current and expected monthly expenses during the years when you’ll likely have less income than today. Create an initial budget based on what you expect to spend during the first year of retirement. Then, be prepared to adjust it as your retirement lifestyle develops over time.

When preparing your detailed budget, ask yourself: “What expenses will continue to exist and which will go away?” Ready said. “You might find some current expenses will not be there when you retire.” For example, if you’re considering downsizing your four-bedroom house to a townhouse, your housing expenses are likely to be less.

Most major financial companies offer retirement expense worksheets that can help you pencil out your budget. For example, The Vanguard Group has a monthly anticipated retirement expenses worksheet that lets you put in dollar amounts for categories ranging from housing to food to transportation to health, travel, entertainment and hobbies.

The numbers will be based on what you have been spending and how you expect them to change during the first year or two of retirement. Typically, people spend more on travel and leisure activities during the initial retirement years. Later, they’re likely to spend more on health.

Everyone’s situation is different, so this is the time to reflect on how you expect to spend money as you move into retirement. Will your income in retirement be able to support that lifestyle? If not, look at each category to evaluate where you may be able to trim your expenses.

Perhaps, you can find a less expensive cell phone plan or a more moderately priced combination phone/Wi-Fi/cable bundle, for instance. Maybe you can reduce the number of times you dine out each week.

See if you can avoid taking your Social Security benefit at 62, too, the earliest age you’re allowed to do so. By delaying your start date, you’ll increase the size of your benefit.

Set up a MySocialSecurity account at the Social Security site and you’ll get an estimate of how much you would receive by claiming benefits at 62, 66 and 70. If you were born between 1943 and 1954, for example, and begin claiming at 62, you’ll receive 75 percent of what you would receive monthly if you waited until 66.

One way to postpone Social Security to bolster your retirement income is with self-employment income from an entrepreneurial pursuit you develop before you retire. Another, if your employer is receptive, is to keep working at your job but cut back the number of hours so you don’t face income loss all at once.

Finally, when calculating your assets during retirement, think about how much you could comfortably withdraw — spend down — each year. For years, financial advisers recommended withdrawing 4 percent a year. But many have changed their minds recently, given current low interest rates on bonds and CDs.

Wade D. Pfau, professor of retirement income at the American College of Financial Services, says these days, the 4 percent rule “cannot be treated as a safe initial withdrawal rate.” Instead, you need to take into consideration interest rates, the volatility of your investments and your total resources when considering how much is safe to spend down annually.