How to Estimate Your Retirement Expenses

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How Will Your Spending Change?

A good way to start estimating retirement expenses is to use your current monthly income as a starting point and then add and subtract any expenses you expect to change during retirement. What is your take-home monthly income after taxes, retirement plans, and insurance? What expenses are deducted from your paycheck that you will have to pay out of pocket once you are retired (such as health insurance)? What additional expenses do you plan for during retirement? These can include things like travel or increased funds for healthcare expenses.

Be sure to build in monthly savings for items that you will eventually need to replace, such as major home repairs or buying a car.

You are also likely to see some expenses decrease in retirement. For example, if you have a long commute to work, your transportation costs may drop after retirement. If you have to dress well for work, your dry-cleaning bill may decrease during retirement. If you pay off your mortgage before retirement, you will significantly reduce your monthly expenses.

Adding the Numbers Together

Let’s work through an example to see how this can work. Current monthly income: $4,300 per month ($51,600 annually). Expenses covered by the employer: Currently, your employer pays your health insurance premiums. It’s estimated that once you retire, you will have to pay $350 per month ($4,200 annually) for this coverage. Additional expenses: You plan to travel during retirement, so you have budgeted an additional $500 per month ($6,000 annually) for travel. Housing: Your mortgage will be paid off, so you will only need to pay property taxes and insurance on your home. This may reduce monthly spending by about $1,000.

After adding those costs up, it’s estimated that your total expenses in retirement will be $4,150 per month, or $49,800 annually. Multiply this amount by the number of years you expect to live in retirement, and you will have a good target for your retirement savings calculations.

Make sure you take your time and be accurate in this step. It’s easy to forget to account for some expenses, whether they are annual items like property taxes and insurance payments, medical expenses such as dental and eye care, or periodic expenses like home maintenance and car repairs.

Estimating Taxes You Will Pay on Retirement Income

Unless your only source of income is Social Security, you are likely to pay taxes in retirement. You can use an estimated tax rate, such as 25%, which is better than not accounting for taxes at all. However, for an accurate amount—and to set up tax withholdings or quarterly payments—you will need to do a tax estimate.

A tax estimate is an estimation you perform before the end of the year that shows you how your tax return is likely to look. A tax estimate is important if you have mortgage interest or rental properties, or if the majority of your retirement income will come from investments that are not within a retirement plan.

If you have retirement income from a pension or if the majority of your retirement income will come from qualified retirement plans such as an IRA or 401(k), and if your home is paid off, your tax rate in retirement may be higher than you expect. Examples of pension plans include military pensions and payments from inheritances you may be the beneficiary of.

Putting It All Together

For simplicity, and to continue with the example we started above, we will use an estimated tax rate. Let’s assume the person in our example will be in the 15% marginal tax bracket, and that most of their income will come from withdrawals from fully taxable retirement accounts.

49,800

Dollar / (1-0.15) = 58,588 dollars

In the calculation above, dividing your net income by 1 minus the expected tax rate will tell you the total income you will need to pay taxes and meet your other expenses.

This specific retiree has calculated that they will need about 58,600 dollars of total income annually to retire comfortably. To clarify, here is the breakdown of total income, taxes, and expenses in the example:

58,588 dollars × 0.15 = 8,788 dollars (estimated taxes) 49,800 dollars (living expenses) + 8,788 dollars = 58,588 dollars

Once you have an estimate of how much you will need to spend each year, you can proceed to the next step in the planning process and start gathering your guaranteed income sources so you can see how close you are to covering your expenses.

Frequently Asked Questions

Where should I look to reduce expenses in retirement?

Those looking to reduce expenses during retirement may consider reevaluating transportation costs, mortgage costs, and life insurance costs. These costs tend to decrease naturally as people age, targeting them for expense reduction can help enhance those savings.

What are the expenses that increase during retirement?

Healthcare expenses increase for most people in retirement. Some retirees may also find that entertainment costs increase, as they have more free time to fill with activities they enjoy.

What inflation rate should I use for retirement planning?

You can calculate inflation expectations by comparing Treasury Inflation-Protected Securities (TIPS) to standard Treasury bonds. Subtract the yield on TIPS from the yield on standard Treasury bonds. Be sure to compare securities with matching maturities. If you used a 30-year Treasury bond, you should use a 30-year TIPS. While this won’t give you an exact measurement, it can give you a general idea of the inflation expectations currently priced into the market.

Source: https://www.thebalancemoney.com/how-to-estimate-your-retirement-expenses-2388830