How To Make a Retirement Budget: View Spending From the Top Down and Bottom Up

While you may not be able to control inflation or the rate of return on your invest­ments, you can control the amount of money you spend and the corre­lating draw from your invest­ments. Your current after-tax spending can be a good predictor of what you will spend in retirement. It is very important to know this number when you meet with your financial adviser to assess your readiness for retirement: it is an important deter­minant in whether your retirement will be successful. 

Some individuals have excellent records and can project what they will need. Many cannot. Here are two methods for gauging what your spending needs might be in retirement.

View From the Top Down

Take what you earn now (your gross income) and subtract:

• Payroll taxes (Social Security and Medicare)
• Current annual retirement savings (like 401k contri­bu­tions)
• Other regular savings contri­bu­tions

Also subtract other expenses that will decrease in retirement:

• Mortgage payments, if your home will be paid off
• College expenses, if your children will be out of school

Add in expenses that will increase in retirement:

• Travel
• Medical costs

Finally, subtract all income taxes (federal, state, and local).

Why subtract income taxes?

Your taxes in retirement depend on the source and taxability of your funds. This is typically different than in your income producing years. Your adviser should be able to project this for you and add it back in. Further planning can be done with your adviser and tax preparer to make the appro­priate estimated payments or withholdings to cover your taxes in retirement.

View From the Bottom Up

While far more tedious, the bottom-up view is important because it is how you antic­ipate what you will spend. You may need to consider different spending amounts for the three phases of retirement:

• Early retirement: Ages 62 to 72, the “Go-Go Years” – Great health, desire to travel, increase in spending
• Mid-retirement: Ages 72 to 84, the “Slow-Go Years” – Slowing down, possible decrease in spending needs
• Late retirement: Ages 84 and up, the “No-Go Years” – More health issues, can reduce or increase spending

You will need a thorough budget worksheet to accom­plish this task. Retirement Benefit Institute, Inc. has a helpful online calcu­lator.

If you have trouble accounting for your monthly expenses, one way to help under­stand how much you spend in different categories is to charge all of your regular expen­di­tures on a credit card for one to two months. Most credit card companies now offer a summary of your charges via an online portal or app. Having a compre­hensive breakdown of charges by category (e.g. groceries, utilities, subscrip­tions, take-out, etc.) can be a helpful tool for tracking your spending and uncov­ering oppor­tu­nities to adjust your budgeting. 

Try a Practice Run

If you are able, try to live on your retirement budget for an entire year before you hand in your notice. That should help you determine whether your retirement budget is realistic or if adjust­ments should be made.

Origi­nally published April 2015