A widely accepted tenet of retirement planning is that you
need to replace just 70% to 80% of your pre-retirement income to maintain your
standard of living after you call it a career. And on the face of it, this rule
of thumb seems to make sense. After all, since you'll no longer have to funnel
money into 401(k)s and other retirement savings accounts and many of your
expenses are likely to drop after you retire, you should be able to live
as well, if not better, on considerably less income than you earned during your
But while "replacement ratios" may be useful for
gauging how much you need to save each year to build an adequate nest egg when
retirement is decades away, they're less helpful once you're within 10 or so
years of retiring. At that point, you really want to base your planning on
something more concrete -- namely, how much dough you'll actually have to come
up with to cover your expenses and maintain an acceptable post-career
Fact is, retirement spending can vary tremendously based on
one's personal circumstances. For example, a new study from the Employee
Benefit Research Institute shows that even though spending by retirees
dropped roughly 6% in the first two years after retirement and continued to
decline the next few years, there was considerable variation around that trend.
Outlays fell by a lot more for some retirees -- roughly four in 10 saw their
spending drop 20% or more -- while nearly half (45.9%) of retired households
actually spent more in the years immediately following retirement, with many
boosting expenditures by more than 20%.
And contrary to what you might expect, it wasn't just the
wealthiest whose spending climbed. Those who spent more freely spanned the very
bottom to the very top of the income scale.
This isn't the first research to challenge the conventional
wisdom about spending in retirement. For example, contrary to the accepted
notion that retirees increase spending throughout retirement to maintain
purchasing power in the face of rising prices, a 2013 study by Morningstar found
that inflation-adjusted spending declines slightly at first, falls off more in
the middle years of retirement and then picks up a bit in the final stages,
tracing a pattern the study calls a "retirement spending smile."
In short, like much else in life, retirement spending
doesn't always adhere to simple rules or patterns. Which is why if you really
want to know how much you're likely to spend and how much income you'll need --
and whether you have the resources to generate that spending --
you've got to do a retirement budget.
You can create such a budget the old-school way --
i.e., using a pencil and pad. But you'll find it easier to track and
periodically update your spending -- and you'll be less likely to overlook expenses
-- if you use one of the free retirement budgeting tools available online. Two
in particular are worth mentioning. BlackRock offers a Retirement Expense
Worksheet with eight major categories of expenditures. Fidelity's
budgeting worksheet, which you'll find within its Retirement Income
Planner tool, lets you tag expenditures you consider essential as opposed to
discretionary, a nice feature that can come in handy for estimating how much
leeway you'll have for paring your spending down the road if necessary.
Don't get too concerned about whether your estimates are
100% accurate. They won't be; emergencies and unanticipated expenses will
always pop up. The important thing is to establish a reasonable baseline for
planning, and then refine your budget periodically based on your experience
once you retire.
Once you've created a budget, you want to see how well it
squares with the reality of your retirement resources. You can do that by
revving up a retirement income calculator that can assess the
probability that you'll be able to sustain your projected spending throughout
retirement. If the chances of your resources supporting you throughout
retirement are uncomfortably low, you can see how changes such as living a more
modest lifestyle or simply postponing retirement a couple of years
might improve your retirement outlook.
Finally, remember too that your spending may also change
over time to reflect your changing needs (think more outlays for medical care
as you age). So you'll want to repeat this process every year or so to be sure
you're not going through your nest egg too quickly -- or too slowly
for that matter, as you don't want to end up late in life with a big pile of
savings and regrets that you didn't spend more freely early in retirement when
you might have enjoyed it more.
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