Is It Possible to Avoid Over- or Underestimating Retirement Budgets?

Is It Possible to Avoid Over- or Underestimating Retirement Budgets?

Regardless of when you decide to retire, you should estimate your retirement expenses to help guide your planning. Understanding how much you will need on a monthly and annual basis in retirement helps you figure out if you are on track to meet your goals or if you need to make some changes, whether that means reducing expected expenses or retiring later than expected.

While most people worry about underestimating their retirement expenses and draining their accounts too early, there is also some harm in overestimating expenses if it ends up causing you to work longer than expected or make sacrifices that you do not need to make.

The Complications Involved with Estimating a Retirement Budget

Figuring out how much money you will need in retirement is no easy feat. The primary way to build a retirement budget is to project current spending into the future or base your budget on current assets and savings rates. To be successful in either of these approaches, you need to understand how you spend money currently and think critically about which of these expenses you will no longer need in retirement as well as any new expenses that could arise. Figuring out where the money goes sounds simple, but it becomes quite complicated once you start to break down your spending. The major issue is that expenses tend to lump. For example, planning an annual travel budget can be difficult if you do not take a major trip every year. Also, many individuals pay homeowners insurance annually or taxes quarterly, so figuring out exact monthly expenses can be tricky.


The entire situation becomes even more complicated when you consider lifestyle inflation. Economic inflation is its own issue, but it is one that can be accounted for with average annual increases. Lifestyle inflation refers to the tendency to increase spending as individuals make more money. In other words, when you plan to maintain a similar lifestyle in retirement based on your current habits, it may not end up aligning with your actual lifestyle once you come closer to retirement. Some people understand this may happen and therefore round up when calculating their retirement budget, but it can lead to overestimates of actual expenses. At the same time, it could be an underestimation if they do not account for increased spending over time.

The General Shift in Expenses That Occurs after Retirement

One thing that you need to consider as you budget for retirement is the expenses that will no longer incur once you stop working. For example, your regular contributions to a retirement account stop once you enter retirement. These contributions can be up to $52,000 each year for someone over 50, which can account for a rather large portion of annual salary. When planning for your time in retirement, you no longer need to consider these contributions, so that will be a major part of current annual income that does not need to be replicated through Social Security, investment distributions, or other sources of income. Also, while you will pay taxes on some of your retirement income, you will no longer be liable for payroll taxes, especially withholdings for Social Security and Medicare, which is equal to 6.2 percent of income. Distributions from IRAs and brokerage accounts are not subject to these taxes.

Some other expenses may also go away once you retire. For example, many people forego life insurance upon retirement. The need for life insurance decreases once your children have launched their own careers and you build your investment reserves. Also, individuals who make contributions to 529 plans or tuition payments will likely no longer have this expense in retirement since any children will likely have already completed college and become independent.

Finally, unless you worked from home during your career, you can discount transportation costs, which can add up quite a bit if you have had a long commute throughout your working years. At the same time, you may have to factor in extra money for travel or visiting family.

The Important Things to Consider When Creating a Budget

Many of us can get bogged down by every little detail as we start to plan for retirement. Before stressing out, it is helpful to recognize that your expenses will change throughout retirement. For example, healthcare expenses tend to increase as we age, while food and travel generally decrease.

Spending will naturally ebb and flow throughout retirement, so predicting it is almost impossible. The better strategy is to figure out the expenses that will remain constant, such as housing, and then build a budget from that point. Detailed budgets can be helpful, but understanding how much something will cost decades down the line is not feasible. A financial planner can help you plan for contingencies, however, and create flexible plans.

Rather than focusing on spending throughout retirement, it often makes the most sense to focus on the budget for the few years leading up to retirement and immediately after stopping working. During this period, retirement savings are at their highest and thus vulnerable to volatility in the stock market. If the market is down, drawing heavily on accounts can lock in losses and create issues for the remainder of retirement. This period also often involves a surge in spending, so it is important to keep fixed costs low and perhaps maintain alternate sources of income. Keeping money in the investment accounts allows them to recover along with the market.