My clients Bob and Linda came to me having already estimated their retirement expenses at $50,000 per
year. How did they determine this figure?
There are basically two ways to estimate your spending needs in retirement — bottom-up and top-down
budgeting. Of the two, I’ve found the top-down method to be the easier and more productive, but it might
be a good idea to estimate both ways and compare the results.
The bottom-up method requires you to develop a budget — I recommend an annual budget — to identify
and quantify all of the things you’ll need to spend money on each year in retirement to maintain your
desired lifestyle. Essentially, you decide how you’re going to live and make a list of expected expenses.
Add up the amounts, and you have a retirement spending budget.
Using the top-down method, you start from your current spending level and make adjustments for
changes you expect in retirement. For example, if you currently earn $50,000 per year, contribute 10
percent of this amount to the Thrift Savings Plan, pay about 30 percent on the remainder in federal taxes,
and save another $1,000 per year after that, you are spending about $30,500 per year. If nothing
changes and you’d like to maintain your current lifestyle in retirement, you should plan on spending about
$30,500 per year, adjusted for inflation and any extraordinary expenses or savings.
In general, you should separate your regular annual spending from intermittent or one-time expenses,
such as new cars, weddings, vacation homes and the like.
So the retirement spending budget in the example above might be $30,000 per year for the first 10 years
until the mortgage is paid off, then $36,000 per year, with an extra $5,000 every five years for new cars,
$10,000 in three years for a daughter’s wedding and $2,000 every other year for travel.
A few tips to make the process easier and more productive:
- Plan annually, rather than monthly. You can always convert your annual budget to a monthly allowance later.
- Think in today’s dollars and adjust for inflation during the testing and analysis process. I usually ask my clients to pretend that they are retiring today when they decide how they’d like to live.
- Remember that it’s only necessary to consider extraordinary expenses if they can’t be covered by your regular spending allowance.
- Don’t forget to consider potential reductions in your spending, such as might occur when you pay off a
mortgage, move to a smaller home or when one of a couple dies. - Don’t try to be too specific. Remember that you can’t accurately predict the future, so don’t spend too
much time trying. Estimate the big picture, then review and adjust your plan at least once per year to
accommodate changes and keep things on trac
Written by Mike Miles
For the Federal Times
Publication June 20, 2005