A retirement budget compares expected income with planned expenses to see whether spending fits within available income. This process begins by listing income sources and savings and estimating how much they can provide each year. To show how a retirement budget works, let’s break down an example of a retirement profile with a $1.1 million in a 401(k), $80,000 in other savings and $2,800 per month from Social Security.
A financial advisor can help evaluate how these income sources and assets interact with projected expenses over time.
Core Retirement Budget Concepts
A retirement budget has two parts: expenses and income. Crafting the budget consists of making the two sides balance, so that expenses don’t exceed income. Income usually includes benefits paid by Social Security, as well as income from sources such as investments, private pensions, annuities and part-time work. Expenses consist of all the major costs of living such as housing, transportation, food, taxes and healthcare.
Building the budget can start with calculating expenses. Retirement planners can estimate these using rules of thumb, such as the one that states retirement expenses are often about 75% of the amount earned from working the last year before retirement. Another more personalized approach is to add up actual current expenses, subtracting those likely to go away. These probably include costs for commuting, work-related clothing and the like.
A budget process can also start with income. A first step is often calculating Social Security income, followed by estimating the likely amount that can be withdrawn from an investment portfolio. SmartAsset’s Social Security calculator can help with the first part of that step. And SmartAsset’s Investment Calculator can estimate how much a portfolio will grow by the time retirement arrives, given its size and an average annual rate of growth.
Just as a percentage of pre-retirement income can provide a rough guide to likely expenses in retirement, a rule of thumb called the 4% safe withdrawal rate helps calculate how much money safely be withdrawn from a conservatively invested portfolio without risking running out of money. To get the first year’s withdrawal using this approach, multiply the portfolio balance by 4%. The next year do the same, increasing the amount by the rate of inflation. This practice produces an inflation-adjusted stream of income that is highly unlikely to be depleted before 30 years.
Once you have filled in the numbers on both sides of your budget, you can consider ways to adjust them as necessary or desirable. For example, you may need to cut expenses or increase your investment’s growth rate. What’s important is that the income and expense sides balance so you aren’t planning to spend more than you will have.
Anatomy of a Retirement Budget
Your $2,800 in monthly Social Security benefits equals $33,600 ($2,800 x 12 months), an amount that adjusts annual to protect you against inflation. At a 4% withdrawal rate, you can take $44,000 ($1.1 million x 4%) out of your 401(k) account. This income will also be adjusted annually to avoid losing purchasing power to inflation.
The combination of $33,600 from Social Security and $44,000 from investments produces total annual income of $77,600. But, you may ask, will that be enough? If your retirement expenses are typical, it likely will. Based on your $2,800 monthly Social Security benefit, your current income is likely about $84,000 (the Social Security Administration says that benefits “will replace about 40% of your annual pre-retirement earnings,” but this will obviously vary on your specific earnings) 1 . And using the 75% of pre-retirement income guideline, anything more than $63,000 per year would meet the needs of a typical retiree.
Fine-Tuning Your Retirement Budget
Most retirees are not exactly average and your lifestyle may require more income. You may be able to obtain more income by changing the asset allocation of your portfolio from the 50/50 blend of stocks and fixed-income employed in the scenarios used to generate the 4% safe withdrawal guideline. A more aggressive asset allocation featuring more stocks could allow you to withdraw 5% safely, increasing the first-year income from your investments by about $11,000 to $55,000 ($1.1 million x 5%).
Another move you can make to increase income is to delay retirement. Every year you wait to claim Social Security, your benefit increases by about 8% until age 70 2 . If you wait until that age to claim your benefits, the monthly check could increase to $3,696 monthly ($2,800 x 132.0% for age 70 and older) or $44,352 annually ($3,696 x 12) 3 .
Waiting to retire would also allow you investment portfolio to grow. Using SmartAsset’s investment return calculator, if you assume an average annual return of 7%, your portfolio could grow to $1,347,547 in three years, allowing for a first-year 4% withdrawal of roughly $53,901 ($1,347,547 x 4%).
You can also make changes to affect the expense side. One common strategy is to downsize your home or move to a city where costs are lower. Housing is typically the largest expense in retirement, and housing is also the living expense that varies most by location. So, retiring to an area with a lower-cost of living could be a good way to make your retirement income go further.
Taxes are usually less important to retirees, since their incomes typically go down after they stop working. Required minimum distributions (RMDs) beginning after you turn 73 can push you into a higher marginal income tax bracket. If you expect to be in a higher bracket after retiring, you may want to explore a Roth conversion. This would allow for tax-free withdrawals and exempt you from RMDs on the Roth balance, at the cost of a potentially significant tax bill now.
An emergency savings account can help you feel confident about weathering any unexpected costs that come up, as well as helping avoid having to take out expensive loans to cover costly contingencies. Your $80,000 in taxable savings can fund this. A typical emergency savings account contains three to six months of expenses, which would be about $15,750 to $31,500 assuming your retirement expenses are about $63,000 annually. You could put this amount in a savings account or other safe, liquid vehicle, and invest the balance.
Healthcare is a final area to consider. Long-term care can be costly if needed. While long-term care insurance can help with bills for nursing home and other long-term care, premiums can be high and, generally speaking, the sooner you apply the better your chances of being approved for coverage.
Bottom Line
A rough estimate of the income side of your retirement budget suggests you’d have $77,600, including $33,600 from Social Security and $44,000 from your investments, using the 4% safe withdrawal rate. Employing the guideline that says annual retirement expenses are often about 75% of pre-retirement annual earnings and assuming you earn $84,000 a year now, you’ll likely need very close to the estimated amount of income to cover your expenses. You can use the $80,000 in savings for an emergency account and to invest. If you need to reduce expenses, you could consider downsizing or relocating. Waiting to delay retirement can be an effective way to boost income.
Retirement Planning Tips
- A financial advisor can help you determine when is the best time retire and manage other factors to maximize your benefits. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to build your savings up consistently, consider setting up automatic transfers from your checking to your savings accounts. This approach could help you make saving a routine part of your financial life.
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