Chicken or the Egg?

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.