To ensure you have adequate resources to support a comfortable retirement, you need to project how much money you are likely to spend in retirement. Start with your current expenses, adjust your budget for items that will change in retirement and assume annual inflation of about 3%.
Studies show that most people spend about 80% of their pre-retirement expenses in retirement. However, this varies based on your lifestyle and where you live. Most retirees experience a reduction in expenses for housing, vehicle related expenses, professional attire, dry cleaning and eating out. They also spend less due to senior discounts, more time to comparison shop and more time to do their own chores such as housecleaning, cooking and home repairs. Alternatively, retirees usually spend more money on entertainment, travel, health care and expenses associated with long term care.
A common mistake made by many retirees is underestimating what they will need for a comfortable retirement. The following items are commonly missed; real estate taxes, insurance, home and auto repairs, a new vehicle, vision and dental care and hearing expenses. You also need to plan for major unexpected expenses and discretionary spending on gifts, charity and family support. The items that most frequently derail a retirement budget include expensive hobbies, home improvements and repairs, caring for a parent and financial support for an adult child or a special needs child. Increase your retirement budget if one of these categories is likely to impact you.
Your retirement spending needs don’t remain flat throughout retirement. Depending on your situation it’s typical to experience three phases of retirement. During the first phase of retirement you may spend more than while you were working - primarily on travel, entertainment, hobbies and home improvements. As you approach your mid-70s spending may decrease significantly until the end of your life at which time expenses may spike.
A study conducted by David Blanchett, head of retirement research with Morningstar, found that retirement expenses resemble the shape of a smile. They start out higher then gradually decline and increase toward the end of life. He found the increases toward the end of life were related to health care. A 2017 Bureau of Labor Statistics, Consumer Expenditure Survey, further corroborates this pattern. The study found that the average annual spending for households headed by someone 55-64 was $65,000, dropping to $55,000 for those between 65 and 74 and dropping further to $42,000 for those over 74.It’s essential to accurately project your retirement expenses to ensure you won’t run out of money. To get a projection on how well you are positioned for retirement, enter your expenses into a retirement calculator or use the 4% rule of thumb. The 4% rule assumes that your annual spending after retirement income, pensions and Social Security, should not exceed 4% of your retirement nest egg. Divide your annual net expenses by .04 to get a rough estimate on how much you need to retire.