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ON THE JOURNEY to retirement, should you focus on setting a retirement spending budget or on making sure you have adequate retirement income?
I think the answer is obvious: There’s no point deciding on a budget until you know how much money you’ll have available to spend. And yet I hear about people who devote endless hours to detailing precisely how much they’ll spend in retirement on everything from housing to travel to health care to dining out. This strikes me as a colossal waste of time—until they know how much income they’ll have at their disposal.
In the 10 years before I retired, my compensation came in three parts: my base salary, annual incentive compensation and long-term incentive compensation. Base salary and annual incentives were paid in cash, while long-term incentives consisted of stock options and restricted shares.
My wife and I based our ongoing expenses—our lifestyle—on what was left of my base salary after taxes were taken out, and after deductions for 401(k) contributions and premiums for health, dental, group life and long-term-care insurance. Meanwhile, we sometimes used my annual incentive pay for onetime major purchases, but mostly we saved the money.
What about long-term incentive pay? That was more variable and depended on the organization’s performance. For example, stock options could be worthless upon vesting. Restricted shares go up or down. I once exercised stock options and immediately sold the resulting shares, so I could put an addition on our vacation home. The rest of the time, I kept the stock upon exercising options—a strategy I’m told is rarely used. I did the same with the restricted shares. Over several years, I used all this stock to create a healthy stream of dividend income, which is reinvested in additional shares and which I view as a financial backstop, in case inflation starts to crimp our retirement lifestyle.
Notice that I haven’t mentioned a budget. My take-home pay set our budget. We would never spend more each month than could be paid for in full that month.
During the years leading up to retirement, my focus was on having at least enough income to maintain our preretirement lifestyle. There was no immediate plan to relocate and downsize to lower our expenses, though eight years into retirement we did opt to move into a nearby 55-plus community.
As I was getting closer to retirement, I monitored my accrued pension and Social Security benefit. When I finally retired after nearly 50 years on the job, that combined retirement income was slightly more than my gross base pay. That had always been my goal.
I never tried to budget for retirement. Instead, my focus was on funding what I wanted to spend—and that funding goal had no better target than what I was living on just before I retired.
Do I spend more or less in retirement? On average, I spend about the same each month, though “spend” includes discretionary amounts, 529 plan contributions for the grandchildren, travel and saving. Yup, I said it, I still put money aside in retirement for contingencies, just as I did while working.
There are tradeoffs in retirement spending. I no longer pay payroll taxes, but my health insurance premiums are five times higher. I don’t put money into a 401(k), but I spend thousands on travel and leisure activities. I don’t buy new suits, instead living in jeans and shorts (as long as my wife approves), but I spend $60 per week on golf.
Many people are convinced their expenses will be vastly different in retirement. Different perhaps. Lower? Not so much. “I’m moving to a lower-cost part of the country, so I’ll save money,” I’ve heard. Good for you. But you might want to use those savings to build up a financial reserve, because your expenses are sure to grow, by choice or by chance.
Having a pension, as I do, isn’t typical. What if you don’t have a pension? The notion that retirement income—and not a budget—should determine spending still applies. If you have $1 million in retirement funds, your spending possibilities will be around $40,000 a year, assuming a 4% withdrawal rate, plus whatever you get from Social Security.
That’s the reality. It doesn’t matter what your retirement budget says. The chicken is your retirement income—and that produces the egg of spending possibilities.
Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. Follow him on Twitter @QuinnsComments and check out his earlier articles.
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I really like the way you explained how and why you segmented earnings. Treating short-term as you did really creates so much opportunity for a big impact on savings/investing/major purchases without getting lulled into accidentally needing it. It reminds me of a family friend we had when I was a teenager. He worked an hourly job. He worked overtime for so long that at some point it wasn’t extra money but money he had come to depend on.
Regarding your short-term incentive comment “Meanwhile, we sometimes used my annual incentive pay for onetime major purchases, but mostly we saved the money.”
What do you recommend for tools for an emergency fund?
The driver for the question is the quandary between keeping loss-risk low and availability high for an emergency fund vs inflation eating away at it if it’s just parked in savings.
For money beyond emergency, I assume when you say ‘mostly saved the money’, you mean invested not just parked. True?
I knew I’d spend less in retirement, because I couldn’t really afford to stay in NYC without my job and so planned to retire to Mexico for better weather, lifestyle and cost of living. I moved three years ago, and am building a house that will be more than covered by the proceeds of selling NYC apartment. Since life is very affordable here, including good private healthcare, I don’t really need a budget or keep track of what I spend, but I know it’s much less than when I lived in the U.S.
This really depends the person. If you don’t know your budget, you can’t figure out what income you need. In your case, it was easy (as you noted). You had no specific plans to change location or lifestyle, and you were very happy with your lifestyle, so your egg was obviously at or below what your working chicken was. Therefore, replacing current income was reasonably prudent.
Other people will have other goals (e.g., living on the beach in Mexico, or moving to another part of the country), so starting with the retirement budget helps them figure out how much is “enough”. If someone doesn’t have a pension and started saving late, there might be no way they can replace 100% of their current income, so knowing what their “egg” is will be very important.
In our case, my wife only puts up with the climate here (northern US) because I like my job, so moving for retirement is in the cards. Some areas we’re looking at are more expensive, so getting a handle on our budget is very useful for helping to figure out if a certain area is within reach right now, or if we have to hope our investment do really well.
But no matter what, your budget cannot be larger than the income you can generate so if you are maximizing your savings, you can pretty much know your maximum budget. If you make changes that truly lower retirement spend, you just have a bigger reserve. The amount you save isn’t based on an assumed lower budget is i?
Most people get into the late 50’s and early 60’s pretty much knowing what they spend on a yearly basis and basically deciding if they can retire at 62 and be able to pay their current expenses and for any other necessary expenses they may have as a result of retirement like healthcare insurance due to retiring and/or by aspiration, like being able to travel in retirement. For most of us it is pretty easy to know how much your income is gong to be. It is easy to go to the SS website and do any number of scenarios to compare SS income at different retirement dates. The amount of income one will receive from savings is a little trickier to do but can be done with some help, if necessary. If you have a pension that makes the income calculation for the pension easy(like monthly $ X 12). It is a year by year process of evaluation that includes options like parttime work if it appears that the family may fall short. Filing later for SS is the other option, assuming health is not a limiting factor. Given that the amount of passive income(SS,pension, income from savings) one will receive at retirement is pretty much cast in stone for most people, it is expenses in retirement that people expect that is the principal factor determining whether or not there will be sufficient income in retirement to cover those expenses.
One of the best tools to simplify this exercise of “budgeting” has always been using Quicken for tracking both income and expenses. I don’t really use their built-in HH budget tool, per se’, but the ability to run quarterly and annual report comparisons are priceless in determining where we may have deviated from the mission on the expense side. Added bonus: most of our recurring bills are fully automated for payment, saving me time for things that I enjoy doing. I think I’ve cut all of 2 paper checks YTD in total.
I wondered if someone would mention Quicken or another program. Dick’s comment, “Notice that I haven’t mentioned a budget. My take-home pay set our budget. We would never spend more each month than could be paid for in full that month.” If you keep everything super-simple (one checking account, one credit card, etc.) it might be easier to monitor the in-and-out of your money. If you have multiples of various accounts it gets much more complicated. I use Quicken myself and I always discover some interesting trend when I run reports. (Generally, I need to spend less…)
Well said, and I strongly agree. I’ve been targeting 100% income replacement for years, though that’s changed recently. My wife and I both recently received significant raises, which is great for handling college costs and such… but I am pretty confident we don’t need THAT much income in retirement (it’s mostly gone to cover current college costs), so I’ve moved our primary target (to 90%, then 80%.) Those targets still assume most of our core expenses stay pretty consistent when we transition to retirement, except those you mentioned.
My sister made around $100K before she retired five years ago. She had no pension, only a 401k. House paid off. She gets about $30K in SS and has about $1 million in a Vanguard account. She will have to start taking RMDs next year. She lives in a high cost of living, high tax state.
I asked her how much she was spending per year in retirement and she told me $35K. That includes Medicare Part D, Medigap, and long-term care insurance premiums. She says she’s not skimping, and was planning a trip to Europe before covid hit.
I’m guess something is missing. Her medical premiums alone would be close to $6,000 a year.
It’s possible she has her Medicare Part D and Medigap premiums paid by her former employer. That’s a retirement benefit I will have.
I will continue to have paid work in “retirement”, full-time or part-time with benefits, until I can’t. Call me fortunate that I can; Additional security besides S.S and savings.
Never know what’s going to happen in the future.
Dick, I really enjoyed this. As my wife and i have moved from full time work, to part time work, to full retirement, I have been keeping track of our expenses. This has been someone dynamic as our home ownership has changed dramatically in the past three years. In parallel, I run detailed models that project our acceptable spending over the course of a retirement that could last to 100. I’m looking for the two sides of the ledger to match. I also have margin built in to both the expense and income sides. I think this all stems form analytic engineering background. I would not expect most people to go to these lengths.
I prefer a simple give 10%, save 10% and spend the rest…no debt please.
That works too, as long as the 10% gets you where you want to be to generate future income. My philosophy was always save first, what’s left can be spent as desired, but never credit card debt beyond what’s paid in full at month end.