How to create a retirement budget

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Published on February 28, 2024 | 5 min read

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Planning for retirement is about more than just building a nest egg. It’s also about understanding how to manage that money once you’ve left the workforce. One of the most important steps in that process is creating a retirement budget. A

well-planned budget can help you maintain your desired lifestyle, manage your spending and ensure your savings will last the rest of your life.

How to create a retirement budget: 4 steps

A retirement budget offers multiple benefits, including financial security when regular paychecks from work come to an end. A retirement budget gives you permission to spend within your means, provides peace of mind and helps you make adjustments to your spending as needed. Without a detailed budget, you face the risk of having to return to work or adjust to a less comfortable lifestyle if your funds deplete faster than anticipated. In short, creating a retirement budget is essential to enjoying your golden years stress-free.

Here are four steps to create your retirement budget.

Identify all sources of retirement income

Start by listing all possible sources of retirement income, including tax-advantaged retirement accounts (such as a 401(k) or Roth IRA), Social Security benefits, pensions, part-time earnings, taxable investments, real estate income and annuities. Total these items to get an annual income estimate, then divide that number by 12 to get your monthly income.

For more detailed planning, consider using tools like a retirement calculator or a retirement budgeting worksheet to estimate your income and expenses.

There’s plenty of debate about how much money you need to save for retirement, and what a secure yearly withdrawal rate looks like. You might use the rule of 25 to get a rough ballpark of how much money you should have invested before retiring, while the 4 percent rule can help you estimate a safe annual withdrawal rate from your accounts.

Add up your expenses

Next, identify all of your expenses in retirement. Check out your bank or credit card statements from the past three months to get an idea of how much you’re already spending. If you’re more inclined to use cash, make sure to retrieve any old receipts you might have.

Taking a look at your expenses over the previous quarter can provide a snapshot of your average monthly expenses. However, for a more comprehensive and accurate budget, look at your spending over the last six to 12 months. This will illuminate annual costs like annual car insurance payments and holiday spending.

Here are some common spending categories for your retirement budget:

Mortgage or rent
Property taxes and homeowners’ insurance
Utilities
Phone and internet
Home repairs
Medicare premiums
Health care, especially costs Original Medicare doesn’t cover, including dental, hearing, vision and over-the-counter medications
Income taxes on withdrawals from traditional 401(k)s and IRAs as well as capital gains tax on any investments you sell
Groceries
Dining out
Entertainment
Travel
Gas
Car insurance and repairs
Clothing

Some of your expenses will go down in retirement, but others may go up. Consider using the 80 percent rule as a rough guideline, which suggests you’ll need about 80 percent of your pre-retirement income to cover retirement expenses. Account for changes in expenses such as health care, which tends to increase, and housing, which may decrease if you downsize or pay off your mortgage.

Separate your expenses into fixed and variable

Once you’ve identified your expenses, separate them into fixed and variable costs. Fixed expenses are costs that largely remain constant and are paid on a regular schedule, such as rent or mortgage payments, car payments, insurance premiums, property taxes and utility bills. Variable expenses, on the other hand, change regularly and can be influenced by day-to-day choices, such as groceries and dining out, clothing, entertainment, gas, home and car repairs and medical bills.

Compare your expenses to your income and make adjustments as needed

Now that you have a clear understanding of your income and expenses, it’s time to compare the two.

If there’s a gap between how much money will be coming in and how much money will be going out, explore ways to increase your income or reduce costs. For example, you might consider working longer, delaying Social Security or boosting retirement contributions. Similarly, if your expenses are too high, you might consider downsizing, living with a roommate or even listing a room in your home on Airbnb.

It’s crucial to begin the budgeting process well before retirement to make necessary adjustments. Speak with a financial advisor if you need help developing a detailed retirement budget tailored to your lifestyle and goals.

Planning for health care expenses in retirement

Health care costs can skyrocket in retirement. According to Fidelity, a typical retired couple aged 65 in 2023 can expect to spend $315,000 on medical costs in retirement. That’s a huge figure, so it’s crucial to plan for these expenses.

Medicare will cover some health care costs once you turn 65, but it doesn’t cover everything. Original Medicare beneficiaries are still on the hook for long-term care, dental care, routine eye exams and glasses, hearing aids and over-the-counter medications. You’ll also need to consider Medicare premiums and deductibles.

To help manage these costs, consider using a health savings account (HSA) before enrolling in Medicare, and look into long-term care insurance to cover nursing home and assisted living expenses — two major costs that aren’t included in Medicare. Finally, it’s important to maintain an emergency fund to cover any unexpected medical costs.

Reassessing your retirement budget over time

A retirement budget is not a one-time task but an evolving document that should be reviewed periodically. It’s generally a good idea to reassess your retirement budget at least once each year and when major life changes occur, such as a job change, moving to a new home, marriage or divorce. Each phase of retirement may bring different income and expense levels that require a reassessment of your budget.

If you’ve experienced any major life changes or if your retirement dreams have changed, consider reviewing your budget with a financial advisor. They can help you determine whether your savings and investment plan need to be adjusted. An annual review can also be a great time to re-examine your risk tolerance and whether your asset allocation still aligns with your goals.

Bottom line

Creating a retirement budget is essential for maintaining financial security during your golden years. Taking the time to create a comprehensive retirement budget will give you the financial peace of mind to enjoy your retirement to the fullest. Remember, your retirement budget isn’t set in stone. It’s a living document that should be reviewed and adjusted as your needs and circumstances change over time.