Q: I know I need to calculate my annual spending so I can plan for what I’ll need in retirement—but how do I arrive at that amount?
Identifying annual spending during your working years is a key piece to building a financial plan for retirement. This figure is one of the assumptions you’ll need to project how large your nest egg needs to be to support your goals and lifestyle throughout retirement. Other important assumptions can include inflation, portfolio return, and taxes, among others.
Below, we’ll look at an example of how to determine your net spending amount. These figures, based on 2024 tax brackets, represent a single tax filer living in Pennsylvania:
| Gross Salary | $80,000 | Federal Taxes* | $(8,432) | Dividends | $(2,000) | ||
| Interest | $600 | PA Taxes** | $(2,628) | Capital Gains | $(5,000) | ||
| Dividends | $2,000 | Local Taxes^ | $(800) | Reinvested Income | $(7,000) | ||
| Capital Gains | $5,000 | FICA Taxes^^ | $(6,701) | ||||
| Total Income | $87,600 | Taxes | $(18,552) | Bank Savings | $(500) | ||
| Brokerage Account | $(1,000) | ||||||
| 401(k) | $(8,000) | After-tax Income | $59,048 | Roth IRA Contribution | $(2,500) | ||
| H.S.A | $(2,000) | After-Tax Savings | $(4,000) | ||||
| Pre-Tax Deductions | $(10,000) | ||||||
| *22% marginal, 15% capital gains | Net Spending | $48,048 | |||||
| **3.07% | |||||||
| ^1% | |||||||
| ^^7.65% |
To calculate your annual spending, it’s not as simple as taking the wages reported on your tax return and reducing them by federal and state taxes. That’s a quick way to get a rough estimate, but to get the most accurate representation of your spending, you’ll need to dig a little deeper.
To start, consider all forms of income, including investments (interest, dividends, and capital gains), to get your total income. Then subtract your pre-tax deductions. These can include contributions to a 401(k), 403(b), HSA, traditional IRA, SEP-IRA, and others. (On your 1040 tax return, this total is referred to as your Adjust Gross Income, or AGI.)
From there, further reduce the total by taxes—including federal, state, local, Medicare, and social security taxes (also called FICA tax). The above example notes the different tax rates: The federal marginal rate is applied to wages after pre-tax deductions and interest. The federal capital gains rate is applied to qualified dividends and capital gains. Local and FICA taxes are applied to gross wages. And PA tax is applied to all income, minus HSA contributions.
Now that you’ve arrived at your after-tax income, it’s important to consider a few other factors:
- What is your after-tax savings? These are the funds you put into a bank account, brokerage account, or Roth IRA. You’ll want to subtract them from your total income.
- Have you spent your investment income (dividends and capital gains) or reinvested it? If you’ve reinvested it, you’ll also want to deduct that source of income from your total.
- Did you withdraw money from an investment account or bank account to make a purchase? If so, add back that amount to your net spending.
After you’ve run all these calculations, you should have an accurate picture of your annual spending. But why is it important?
For starters, it’s helpful to understand what sources of income you have, where you’re saving money, and how much you’re paying in taxes in a year. This exercise helps you better know your own saving and spending habits, so that in anticipation of retirement, you can make adjustments to reach your goals (for example, by improving tax-efficient savings or reducing spending).
Secondly, it’s important to nail down this number when you start planning for retirement so you have the most accurate financial plan. When working with a financial adviser, this is one of the first details they’ll ask for. It’s the basis for structuring a plan that supports your lifestyle throughout retirement. And if this number isn’t well represented, you could face challenges reaching your goals or living according to your means down the road.
We’d encourage you to run this exercise on your own spending, whether you’re beginning to think about retirement or simply want to better understand where your money goes. Then, when the time comes to work with an adviser, you’ll have a head start on knowing your retirement goals.
