As you make your retirement budget, it’s important to keep two issues in mind. First, understand your needs — what budget will you need to pay your bills, and what budget will you want to afford your lifestyle? And second, understand your capacity — what income can your portfolio comfortably and reliably generate for you?
Your retirement budget will lie at the intersection of these numbers, where your capacity meets your needs. In this case, let’s assume you have a two-person household. As the question states, you have $4,500 per month in Social Security benefits and a $1.5 million IRA balance. Here are a few things to consider as you prepare for building this retirement budget.
Step 1: Consider Your Goals
Before anything else, figure out your personal and financial goals for retirement.
For example, between returns and security, think about what you’ll prioritize when it comes to your finances. Do you want to retire right now at 63, or will you wait until age 67? Will you maintain your current lifestyle and location, or will you look for a change or cheaper/pricier area? Do you plan on continuing to work, and when will you start taking Social Security? Do you have any specific goals for estate planning?
This may seem like a wall of questions, but all of these factors will determine how you manage your money throughout the course of retirement. Being very intentional with your choices can allow you to maximize your money as you move through retirement. (And if you need help building a retirement plan, talk to a financial advisor.)
Step 2: Make a Budget for Your Needs and Lifestyle
Once you have a sense of your goals, it’s time to think about your spending. A good rule of thumb is that most households need about 80% of their pre-retirement budget to meet their in-retirement needs. Beyond that, some critical issues to consider include what’s below.
Housing
If you own your home, make sure to set aside money for taxes, insurance and maintenance. If you rent your home, budget for annual rent increases. These typically exceed core inflation, and sometimes by quite a lot depending on where you live. After all, rent is expensive, but so is a new roof.
Location and Personal Inflation
How expensive is your hometown? Retiring to Michigan’s Upper Peninsula will cost far less than living in San Francisco or Boston. You should also expect prices to increase more quickly in an expensive city, a concept known as “personal inflation rate.”
Lifestyle and Hobbies
Do you want to travel, attend concerts or spoil your grandkids? Do you enjoy gardening, cooking or working on cars? Whatever your personal hobbies are, account for them in your budget. A good way to calculate this is to start with your current spending on entertainment and hobbies and tweak from there.
Healthcare and Insurance
While most of your budget will decrease in retirement, your healthcare needs will almost assuredly grow. Price out both long-term care insurance plans and Medicare gap coverage plans, since you may want both forms of coverage. Beyond that, talk to your doctor so that you can begin reasonably planning for healthcare spending in the future.
General Spending
General spending includes just about all consumer goods, ranging from a new iPhone to picking up groceries. This “other” category makes up a significant portion of your monthly expenses, and you don’t want a budget that pays the rent, but leaves no room for these basics.
Step 3: Invest and Build Income to Meet Your Budget
The final step is to decide how you will manage your income and your remaining assets over time. Here we have a two-person household with Social Security benefits and an IRA balance. Your Social Security income alone should cover much of your necessities. At $4,500 per month ($54,000 per year) between each of you, these benefits could cover many retired couples’ needs.
From there, lets’ look at your IRA.
One of the first questions for a household preparing to retire is how to handle debt. At age 63, you can withdraw money from your IRA with no tax penalties, though you’ll still owe taxes. As a result, you might want to consider taking a lump-sum amount to cover any remaining mortgage, auto, educational or other forms of significant debt. This will reduce your household’s fixed overhead and unproductive interest payments, but at the cost of cashing out some investments.
Then there’s the question of long-term withdrawals. You have $1.5 million invested in a pre-tax traditional IRA. At a 4% withdrawal strategy, meaning that you target 4% safe growth and draw down 4% annually, this account might generate about $60,000 per year in inflation-adjusted income for 25 years. Together with your Social Security, that will give you about $114,000 per year, or $9,500 per month.
These numbers can change depending on your investment strategy decisions, though.
For instance, you could purchase a lifetime annuity with your $1.5 million IRA, which might generate similar or higher guaranteed payments depending on the options you look at. However, this type of annuity income is fixed, so you will need a plan to keep your spending power from eroding with time.
You could invest for more aggressive growth too. This might involve building a mixed portfolio, seeking average returns of about 8%, or invest in an S&P 500 index fund, seeking average returns of about 10% based on historical averages. Both of these approaches can boost your potential withdrawals, but both come with periodic losses and down years.
Finally don’t forget to anticipate taxes. You will owe income taxes on your IRA withdrawals. You will also almost certainly owe taxes on a percentage of your Social Security benefits being that your income will likely surpass the income thresholds set by the IRS for this. Again, be sure to include this in your budgeting.
Retirement Budget Tips
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three 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.
- Building a budget in retirement can feel like a lot of guesswork. After all, it’s hard enough to plan for your needs and wants today, no less a hypothetical version of yourself decades on from now. But it’s still important to try and get this right, and the good news is that this is easier than it may seem.
