Create a Realistic Retirement Budget
The Vanguard Group

 

 

Once you've decided what you want to do in retirement, the next step is to determine how much your retirement will cost. Creating a realistic budget is one of the best ways to do this.

Get to know your expenses
Many people retire with no idea how much money they spend each year. If you don't know how much you spend, you'll have no way of knowing how long your retirement assets will last.

It's important to sit down with your spouse and make a list of all your projected retirement expenses so you'll have a better idea of how much money you'll need. When you do this, be sure to categorize your expenses as nondiscretionary (necessary items like mortgage or rent payments, utilities, and food) or discretionary (optional items like travel, hobbies, and entertainment).

Many retirees find that they spend more money during retirement—especially on things such as travel, hobbies, and entertainment—than they did while they were working. In addition, you may need to begin paying for some expenses such as health care or prescription medicines that are now paid for by your employer's insurance.

Now is a good time to contact your employer's benefits office to obtain a complete list of benefits you're receiving now and those you'll receive after retirement. This information will help you evaluate what benefits (primarily insurance coverage) you'll need to replace or supplement.

Learn more about health insurance for retirees, including whether you should consider long-term care insurance.

Life expectancies are longer
As you prepare your budget, be aware that people are living longer in retirement. A 65-year-old man has a 41% chance of living to age 85 and a 20% chance of living to age 90, according to figures from the Society of Actuaries. A 65-year-old woman has a 53% chance of living to age 85 and a 32% chance of living to age 90.

And as you'll see in the following chart, if the man and woman are married, there's a 72% chance that one of them will live to age 85 and a 45% chance that one of them will live to age 90. This means that, depending on your retirement age, your investment portfolio may need to last for 30 years or more. The chart indicates each spouse's approximate chances at age 65 of living to the following ages:

 

Life Expectancies at Age 65 Age Husband Wife Either Spouse 70 years 92% 94% 99.5% 75 years 80% 84% 97% 80 years 63% 71% 89% 85 years 41% 53% 72% 90 years 20% 32% 45% 95 years 6% 13% 18% 100 years 1% 4% 5% Source: Society of Actuaries Retirement Participant 2000 Table.

Plan for inflation and taxes
Another key concept to consider is the impact of inflation on the value of your investments. Since the 1920s, inflation has averaged about 3% a year, but there have been periods—such as the 1970s—when inflation has been much higher. Even at an inflation rate of 3% a year, you'll need about $72,000 in 20 years to buy what $40,000 buys today.

Keep in mind that prices for retirees could rise at a much different rate than the overall inflation rate. For example, the cost of health care and prescription drugs—expenses that typically affect older people much more than younger people—have risen faster in recent years than the overall inflation rate.

One bill decreases for many retirees—your tax bill. With no employment income, you no longer pay Social Security and other payroll taxes, and your income taxes may drop significantly.

But it's easy to forget that other taxes—property taxes, for instance—may increase during retirement. Even income taxes can rise again when you begin taking required minimum distributions from your IRAs or other retirement plans. So, when assessing your financial picture in retirement, don't forget that taxes can chip away at your income, just like other expenses.