By Judith Ward on September 24, 2012
Understanding your spending is important at any age, but it can become especially significant as you prepare to leave your career and stop drawing a steady paycheck. You may want to think of your strategy as a road map. Knowing where you are now and where you want to go can help you understand your future income needs and how to get there. Begin by documenting your current expenses, both essential and discretionary. Then add a projected column to get a sense for what you may spend in retirement.
Your spending patterns will change as you move through retirement. The chart illustrates how, in general, they may evolve. A few specific things to keep in mind include the following:
- Some expenses in retirement will be lower because of lifestyle changes—for example, commuting and clothing costs may decline, and you may choose to relocate to a less expensive area. Other expenses such as your payroll tax, including payments into Social Security and Medicare, may be eliminated altogether.
- On the other hand, there are expenses that may increase significantly. One of the greatest concerns for many individuals is the cost of health care, which is projected to rise at a rate beyond average annual inflation. Individuals age 55 to 64 pay an average of $4,000 a year, while the amount is more than $5,000 in retirement.*
- Consider the lifestyle you want to lead: Will you travel extensively or participate in expensive hobbies? For many expenses, you can estimate its future cost using a simple inflation calculator at an average inflation rate of 3%. However, for some expenses like health care, you may want to consider a higher rate.
Our research shows that you can build a sound retirement income plan if you follow some standard guidelines. A rule of thumb is to plan on replacing 75% of your preretirement income to maintain your current lifestyle in retirement. As much as 50% of this amount may come from investments, 20% from Social Security benefits, and the rest from other sources such as a pension or part-time work. Most individuals need to save at least 15% of their annual income, including any employer contributions, to have enough savings to draw from throughout their retirement. Creating a spending and savings plan will set you on a path to achieving your goals.