5 Things That You Need to Know about Budgeting in Retirement

Americans are working longer and saving less for retirement. The average retirement age has increased from 57 to 61 during the last three decades, while the average non-retiree intends to work until they’re 66, according to a 2022 Gallup poll. Moreover, about one-fourth of working Americans don’t have any money set aside for retirement. Budgeting in retirement is difficult with diminished income streams, but even tougher without sufficient savings. Retirees can expect to spend upward of 80 percent of their annual working income each year in retirement.

Regardless of the amount you have saved and the type of lifestyle you intend to have in retirement, there are several things you should do to optimize your budget to ensure you have reliable monthly income over an extended period.

1. Calculate Total Income and Expenses

Add up all your sources of income to determine your annual income. These might include earnings from taxable investments, real estate, annuities, part-time work, retirement accounts, and Social Security. Project how much you expect to earn from these sources over the course of your life and divide that figure by the number of years you expect to live to determine your minimum required annual income. Divide that number by 12 to get your required after-tax monthly income.

Your monthly income should be greater than your average monthly expenses, i.e., mortgage payments, groceries, transportation, and bills. It’s best to begin tracking these costs before retirement so that you can find ways to lower monthly expenses or plan to increase your income if necessary. You may find you need to work an extra year or two to comfortably cover bills or need to downsize your home to accommodate an early retirement.

2. Carefully Plan Distributions

If possible, delay 401(k) and Roth IRA withdrawals as long as possible to avoid tax penalties. Depending on your birth year, you’ll have to start making required minimum distributions (RMDs) from most traditional retirement accounts at age 73. These distributions are taxed like regular income, however you can be subject to higher taxes in the form of a 25% penalty, if you don’t make the minimum withdrawal on time. Roth IRAs do not have RMDs for the account owner, but do have RMDs when left to loved ones — however, these required annual distributions are tax free! For this reason, IRAs converted to ROTH status are preferred accounts for those looking to leave money to loved ones.

Both traditional and Roth IRAs, however, are subject to early withdrawal penalties. The IRS levies a 10 percent early-withdrawal tax on all funds withdrawn from a traditional IRA before the owner of the account is 59 1/2. A similar penalty is also applied for withdrawals from a Roth IRA if earnings are withdrawn, although contributions can be withdrawn penalty free at any age. Many people use 4 percent as a guideline as to how much to pull out of these accounts every year. However, it’s best to consult with a qualified retirement income planning professional to help you plan when and how much to withdraw.

3. Don’t Forget Health Care

In a recent study, HealthView determined that a healthy 65-year-old couple retiring in 2023 can expect to spend $387,644 in health care costs over the next two decades. That’s over $1,600 a month. While this is just an estimate and will be significantly lower for some, it’s best to plan to spend at least 15 percent of total retirement funds on health care expenses, including long-term care costs.

There are things you can do to mitigate these costs, such as getting Medicare supplement coverage or long-term care insurance. You can also save money in a Health Savings Account, a tax-advantaged account for people with high-deductible health plans that can be used to pay for prescription drugs as well as qualifying medical and dental care.

4. The Zero-Based Budget

The zero-based budget is an ideal way to make sure you’re maximizing your monthly spending. The idea is that your monthly income minus all expenses should be zero. Start by figuring out your total monthly income from all sources and list all monthly and seasonal expenses, including utilities, shelter, transportation, groceries, insurance, and entertainment.

If your expenses add up to more than your income, then you need to look at what costs you can cut or determine if there’s any way you can earn additional income. Track your spending each month and create a new zero-based budget at the start of every month to hold yourself accountable. If you have more money than you need, how can you responsibly expand your discretionary spending without going beyond your means? Also, obviously, if you are in a position at any age to save some money every month, that is a big plus for many reasons, such as inflation planning, or legacy planning.

5. Review Your Budget Regularly

“Each family’s retirement situation is different,” notes Beau Zhao, director of Financial Solutions at Fidelity. “The amount of time until you retire, spending habits, travel plans, health conditions, and unexpected costs can all vary dramatically. That is why it is important to adjust the spending guidelines based on your own needs and wants.”

It’s important to review your retirement budget every year to make sure you’re still on track to cover expenses until the end of life. You may realize you need to cut back on traveling after your early retirement years or find that you’re spending less than expected and can instead direct more money into a child’s education fund. Retirees generally spend less on household items and entertainment but more on health care in their later years. Also, most people are less active ( including traveling) in their 80s or 90s, than they are in their 60s or 70s in retirement, so overall spending may decline enough at that stage to offset increases in the cost of living.