Let’s face it: Most people apart from accountants don’t like to think about creating a budget. Yet when building retirement plans with our clients, we can’t help without knowing how much they plan to spend after they stop working.
In our AGILE method, the A phase is the first step—taking an inventory of assets to develop a net worth statement. Step two is helping the client determine how much they spend now, which serves as a template for creating a unique retirement spending plan.
Notice that we said spending plan and not budget. There is a difference between these two concepts.
Budgets are restrictive. The point of a budget is to limit categories of spending. We’ve seen that the restrictive nature of budgeting, as well as the fact that it can be complicated and time-consuming, causes people to give up.
Yet everyone needs a way to keep finances on track, especially when planning for (or living in) retirement. That’s why we advocate creating a spending plan. A spending plan helps to ensure our clients can fund their priorities, while giving them freedom to do what they want with the rest.
A spending plan isn’t final or permanent. It changes as our clients move through the five phases of retirement, evolving along with their priorities and goals. A spending plan is more of a roadmap than a rulebook. Detours may be required; the destination might even change. The spending plan serves as a guide, helping the client determine where their money goes each month and providing peace of mind that they’re living within their means.
How to make a spending plan
When creating a spending plan, start by covering your priorities. For many people, this includes housing, utilities, transportation, food, and any other essentials.
Next, consider spending for flexible areas, such as entertainment, recreation, dining, and travel. You’re trying to allocate general categories, not account for every penny spent.
When determining a total amount for the plan, it’s best to review current after-tax spending—a good predictor of how your spending will look in retirement. We suggest using take-home pay for anyone still working, which already excludes payroll taxes (including Social Security and Medicare) and retirement savings (like 401(k) or 403(b) contributions). This provides a good picture of available monthly income.
The next step is to look ahead at retirement. Subtract any expenses that will be eliminated or reduced. Examples could include mortgage payments if your home will be paid for and college expenses if children have graduated. Then add any expenses that might increase in retirement, such as travel or leisure activities.
Finally, subtract all income taxes, including federal, state, and local. (If you are using take-home pay as a starting point, taxes will already be subtracted.) Why remove income taxes? Taxes in retirement depend on the source and taxability of your funds, which is typically different from wages. An adviser can help you project tax liability and plan withholdings based on your expected sources of income.
Another way to plan is to consider different spending amounts for different time periods of retirement. Consider these phases:
- Early retirement (ages 62–72): the “On-the-go Years” of good health and travel, which can increase spending
- Mid retirement (ages 72–84): the “Slow down Years” of health concerns and less travel, which can decrease spending
- Late retirement (ages 84 and up): the “Aging-in-place Years” of health complications, which can impact spending
One way to understand how much you’re spending in different categories is to charge all your regular expenditures to a credit card for one to two months. Most credit card companies offer a summary of charges via an online portal or app. Having a comprehensive breakdown of expenses by category (e.g., groceries, dining, utilities, subscriptions, etc.) can help you uncover opportunities to adjust your spending plan.
We advise living on your projected spending plan for an entire year before retiring. This serves as a good trial run to determine whether the plan is realistic or needs to be adjusted.
- Everyone needs a way to keep finances on track, especially when planning for retirement.
- Spending plans are proactive, whereas budgets can be more reactive.
- Current spending is often a good predictor of what retirement spending might look like.