Many retirees find that even carefully planned budgets don’t hold up once the structure of a regular work schedule disappears. Spending can creep up in unexpected ways, and despite detailed worksheets and diligent tracking, it’s easy to exceed monthly limits. What looks solid on paper can often prove difficult to maintain in practice, especially when your lifestyle changes, your free time increases, and unplanned expenses become more frequent.
This pattern is increasingly common among the newly retired, which raises an important question: Why do well-crafted retirement budgets so often fall short? To understand what works, we also must understand the traditional way retirement budgeting is often done and the limitations to this approach.
Fixed, Discretionary, and One-Time Expenses in Retirement
The first step of creating a retirement budget is to list all expected expenses and then sort them into one of three categories:
- Fixed expenses are typically the non-negotiables of your budget. Do you have a mortgage? What does your average electric bill look like? Do you plan on paying for health insurance before Medicare starts? Listing out these expenses can be helpful in determining the minimum level of income you’ll need. It may also lend a hand in choosing your retirement income strategy.
- Discretionary expenses are what make retirement fun. Are you looking forward to spending quality time with your grandkids during the summers? Do you enjoy working on DIY projects around the house? Discretionary items are distinct in that, should situations warrant, they could be minimized or cut altogether. What’s discretionary to one person may be fixed for another, so if you find yourself unwilling to cut some of these expenses, go ahead and either sort them in order of priority or add an asterisk (*) next to those that are least negotiable. (A note for those married or planning with a partner: Don’t assume that you and your partner will create identical lists. Carve out some free time in a nice, relaxed setting to make your own lists and then compare. You might be surprised by what the other will say is most important!)
- One-time or large purchases are those things that you’ve been saving for in retirement. New countertops for the kitchen? How about that Alaskan cruise you’ve always talked about?
Listing the method by which you’ll pay for these expenses is equally as important as listing the total dollar amount for each purchase.
The Margin — Setting a Baseline
Many well-intentioned clients and their advisors have gone through this process only to find themselves off-target. Why was it that the most detailed Excel spreadsheets seemed to fall short while others who were more loose-fitting hit their mark? For many retirees, the answer lies in the margin.
Income – Savings – Actual Expenses = Margin
Or, stated another way:
Income – Savings – Margin = Actual Expenses
When you create your retirement budget, it’s easy to list out and total all of the fixed expenses. But for many retirees, their discretionary budget is hopeful, at best. There’s a big difference between creating a budget versus actually living on that amount.
Sure, there are some people who are natural-born savers, but for the average person, your budget ends up being whatever is deposited into your checking accounts. Add on the occasional raise or cost-of-living adjustment, and it’s not hard to see how someone’s budget could balloon 30% to 40% higher due to “lifestyle creep” spending that filled up the margin.
Let’s put some numbers to this. Say, prior to retirement, a married couple combined to earn about $150,000 (income), from which they contributed approximately $25,000 through their employer-sponsored plans (savings). At the end of each month, they put whatever money was left into their joint account, which averaged approximately $750 per month (margin). Based on those numbers, that couple might itemize their projected expenses and build a budget of $4,500 per month in retirement, or $54,000 per year.
But in reality, they may find they’re spending more in retirement than they had planned. With more free time than before, they may be taking on more home projects, experiencing higher utility usage from being home more often, or taking more frequent trips to their favorite restaurant downtown—all of which increases their discretionary spending, further accelerating their portfolio distributions.
Had that couple first investigated the margin rather than itemizing their projected expenses, they would have had a clearer idea of the actual cost of their current lifestyle. This approach prioritizes being realistic with what your current spending looks like before determining whether your sources of income can support your current lifestyle.
Dress Rehearsal for Retirement
In an ideal world, everyone would retire with the same level of income as their final working years, or better. But quite often, people must make sacrifices to give their finances the best shot at funding a 20-, 30- or 40-year time horizon.
For clients who will likely need to reduce their spending in retirement, consider a “dress rehearsal.” No show on Broadway would go live without doing a dress rehearsal first, so why not see how your retirement budget performs before going live with retirement?
To start, have your paycheck deposited into a separate account from that which you normally spend or withdraw money. Ideally, paychecks would be directed first into your savings account. Then, a recurring transfer deposits your budgeted amount into your checking account. If you’re able to customize the timing of your transfers, try to replicate the cadence of your current paychecks like on the 1st and 15th of every month.
Did you end the month with excess cash? Or did you have more “month” than you had money? Over the course of a few months, you’ll be able to recognize your spending patterns. This information can help you adjust your retirement budget to ensure that it more closely matches your actual spending.
Are Your Retirement Income Stream and Retirement Spending Sustainable?
Now that you’ve determined the cost of your current lifestyle relative to your fixed expenses and tested your budget during the dress rehearsal of your retirement, you can begin thinking about whether your sources of income can sustain this level of spending through a 20-, 30- or 40-year retirement.
If you need help formulating your retirement budget or adjusting your plan, reach out to your advisor or schedule a consultation.
The individuals and situations depicted here are hypothetical only, and do not represent the actual performance of any particular investments or strategy. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. The opinions contained in this material are those of the author, and not a recommendation or solicitation to buy or sell investment products. This information is from sources believed to be reliable, but Cetera Wealth Services, LLC cannot guarantee or represent that it is accurate or complete.
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