Tips for Making a Retirement Spending Plan

To create a solid retirement spending plan, it is important to have a good estimate for your retirement expenses. First, using an expense tracker or bank statement, gather all of your essential expenses. A typical retirement budget would generally include housing (if renting or owning and still carrying a mortgage), healthcare, food, utilities, and transportation. Remember that some of these expenses in retirement may be less than what they were during your working years. There are a few reasons for this. For example, transportation costs could be significantly less because you may not be commuting to work. The decrease in the amount of driving could also result in lower insurance rates.

 
According to an analysis of Bureau of Labor Statistics data, Americans 65 years and older spend less than the average American, and those expenses continue to decrease as retirees age. For the 12 months ended June 2020, the average American spent $61,749, which comes out to about $5,145 each month.² In contrast, those who are 65 years and older spent an average of $48,106, or about $4,009 each month. These expenses drop even more at age 75, when the average is $41,479.

The next step is to estimate what your income will be in retirement. In most cases, your retirement income will be dependent on the amount that you have saved for retirement in accounts like an Individual Retirement Arrangement (IRA) or 401(k), but also include Social Security, any pension that you might qualify for, and income from any side projects, rental properties, or businesses that you may decide to run in retirement.

 
According to the latest data from the Social Security Administration, approximately 30% of the average person’s retirement income came from Social Security benefits in 2015. About 25% came from part-time income and about 36% came from pensions accounts.³ The amount received in Social Security income will vary depending on when you decide to draw on the funds. The longer you wait, the higher your Social Security income will be, because it increases by approximately 8% each year you wait to collect until you reach 70 years old. This is one reason why it is important to strategically withdraw funds from your retirement accounts, but how much should you withdraw and from which accounts?

The 4% rule is one of the most common retirement withdrawal methods. It suggests that you withdraw 4% of your total retirement account balance each year and adjust that amount for inflation in subsequent years. For example, someone with a balance of $1,000,000 in their 401(k) account would withdraw $40,000 in their first year of retirement. Before accounting for taxes, this would mean that their retirement income before Social Security and other factors will be about $3,333 per month.

 
With this number in hand, you should have a better idea what you can afford to spend in retirement. If there is a shortfall, and your expenses exceed your annual income from 4% of your retirement account, that is where Social Security or a part-time job enter the picture.

Keep in mind that the 4% rule is not perfect – it does not take into account the potential impact of rising interest rates or market volatility. Consider meeting with a financial planner to decide if the 4% rule is right for you or if there is another strategy that may work better.

As you spend money in retirement, you will have to choose which account to withdraw from and in what order. The order of withdrawals matters, as it could have an impact on your tax situation and the longevity of your retirement savings. The most common method here is to begin spending from your taxable investing accounts first, followed by any tax-deferred retirement (traditional IRA, 401(k), etc.) accounts. Again, these are the most popular strategies, and should be tailored to your specific situation with a financial planning and tax professional.

Let’s say you decide to retire at age 65. After adding up all your expenses, you determine that you need $3,500 per month to pay your expenses, which works out to $42,000 in your first year of retirement. If you decide to take Social Security benefits now, you will receive $1,400 each month (or $16,800, annualized). By contributing to your 401(k) over your career you have saved $800,000. Using the 4% rule, you could withdraw $32,000 of that $800,000 in your first year of retirement, or $2,666 per month. That amount, plus your Social Security benefit, equals $4,066 each month (before factoring in taxes), or $48,800 for the full year. In this simplified scenario, your retirement income exceeds your expenses and you’re good to go.

 
If you run into a scenario in which your annual expenses in retirement are higher than your retirement income, then you may have to consider other options, such as working longer or taking a part-time job to offset the deficit.

Creating a retirement spending plan can be broken down into three major parts. The first is understanding and gathering all your expenses. Next is finding your sources of income in retirement. Then finally, deciding how much of that income you will use each year.