How to Budget Effectively When in Retirement

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If you think budgeting and financial planning is only for those getting ready for retirement, think again. Budgeting during retirement is as important and even more so than during your working years because you don’t usually have a steady paycheck to look forward to.

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That said, budgeting during retirement is based on the same principles as before. Nevertheless, there are new things to look out for that make it extra important to plan ahead, so you don’t find yourself old and broke during your final years on this earth. This is why, in this post, I’ll cover the most important steps to budget effectively during retirement.

Step #1: Set clear goals

The main goal of budgeting during retirement is for your money to last for the rest of your life while allowing you to live comfortably. However, there may be other important things you want to do, like a trip around the world, which can easily be accomplished with adequate planning. For example, maxing out your rewards credit card points or miles before and during retirement can help you travel the world for next to nothing.

Since there are no plans without goals, setting them is the first thing you need to do before you start budgeting.

Step #2: Determine your expected net income

You stop receiving your paycheck when you retire, but that doesn’t mean you won’t have any income to look forward to. You’ve been saving for years, building up your nest egg, so now it’s time to start cashing in. However, there are some key decisions to make when it comes to income:

Maximize your Social Security benefits.

Social Security benefits are the basic form of income guarantee for retirement, so you want that income to be as high as possible. In order to maximize your paycheck, it’s better to start cashing in later in retirement rather than sooner. Each year you add to your full retirement age before claiming Social Security will increase your monthly check by 8%. In the meantime, by starting a part-time job that increases your total earnings, your base check will get even larger.

Guaranteed income goes beyond Social Security.

While making planned withdrawals from your 401(k) or another retirement account is a way to turn your savings into income, there are other ways to secure income for retirement. One practical and straightforward way is to purchase a simple, immediate annuity that will start paying monthly income right away and for the rest of your life.

Other sources of income

Finally, the rest of your income during retirement can come from a combination of part-time jobs, side hustles and, hopefully, passive income streams. All of these have the potential to cover your expenses and allow you to postpone tapping your retirement savings as much as possible, allowing them to grow even more.

Step #3: Estimate your expected expenses now and in the future

Now that you have a good idea of what your income looks like, it’s time to see what you’re spending right now and to project that into the future. Items you shouldn’t forget when assessing your expenses during retirement include:

  • Housing.
  • Food.
  • Medicare premiums.
  • Other health insurance premiums.
  • Healthcare costs, including deductibles and anything not covered by Medicare or your health insurance.
  • Taxes.
  • New hobbies.
  • Entertainment.
  • Travel.

Since retirement is a process, not just an event, it’s important to remember that these expenses will change as you age.

Some of the most notorious ways your spending will change include higher healthcare expenses, possibly lower entertainment expenses as it becomes harder to move around, and you may end up needing long-term care in an assisted living facility such as a Continuing Care Retirement Community (CCRC), nursing home or similar. These expenses can set you behind on your budget considerably if you don’t plan for them in advance.

Planning for long-term care (LTC)

LTC is something you may or may not need, but if you do, you want to make sure you’re financially ready, so you don’t become a burden to your family. There are several ways to prepare that will help you offset most or all of these sorts of expenses, should they arise.

One way is to purchase LTC insurance. This means that you pay a premium to an insurance company, and they agree to cover your long-term care if and when you need it. However, premiums are very high for these insurance policies, and few insurers offer them.

Another way is to purchase an annuity with an LTC rider. This type of annuity guarantees a preset amount of income during retirement, and the rider doubles or sometimes triples the value of your account if you ever need long-term care. While these annuities can also come with high commissions and contract rider fees, they offer the benefit of allowing you to use your extra income as you see fit, something that doesn’t happen with LTC insurance.

Tax planning is even more important during retirement.

While your 401(k), IRAs and other retirement funds grow tax-deferred, they will be taxed as regular income once you start taking distributions (unless they’re Roth accounts). This means that you want to plan out your withdrawals carefully to save on taxes. The idea is to make sure to be in the lowest possible tax bracket. To achieve that, you need to do the numbers and factor in all your sources of taxable income and make sure that your withdrawals don’t exceed the maximum amount for your target tax bracket.

Some further tips to reduce taxes in retirement include:

  • Avoid two distributions in the same year. This can happen if you delay your first minimum required distribution to the year after you turn 72 since you’ll be forced to make the second one before the year ends. This can increase your tax bill considerably.
  • If you plan on making donations to a charity, you can make them with money from your IRA. Those withdrawals will not be taxed and will count as minimum distributions.
  • Don’t deposit any tax-preferred investments in retirement accounts since they’ll be taxed as income when withdrawn, so you’ll probably end up paying more taxes.

Step #4: Save and invest

The difference between what you earn and what you spend can be split between saving, spending on wants, reinvesting and, why not? charitable contributions. How much you spend is up to you, but you should always make sure to have enough saved as a liquid emergency fund that can cover your expenses for at least five months.

You should reinvest the rest to let it grow over time, just as you did with your retirement fund. If you retire at age 60, you probably have two to three decades of retirement ahead of you, so you need to keep investing to make sure your money lasts that long.

Step #5: Track your progress and correct your course when needed

A budget is a dynamic tool that needs to be checked frequently. You should check your total income and expenses at the end of each month to ensure you’re not overspending and everything is going according to plan.

If you find you’re falling behind, you may need to consider ways to cut costs. It may also be the case that you underestimated your spending or overestimated your income, so you should adjust your budget accordingly for the next month. Also, you should consider checking how far along you’ve come towards your financial goals at least once a year.

The bottom line

Budgeting is as important during retirement as it ever was. Instead of looking at it as a nuisance that prevents you from buying the things you want, you should look at it like you look at exercise and eating healthy food: it’s something everyone agrees you need to do at any age to keep healthy, and it becomes increasingly important as you age. As always, budgeting during retirement comes down to adequate planning and discipline.

It doesn’t mean living frugally and not having fun, but rather making the most of the money you saved and avoiding putting yourself and your family through unnecessary financial burdens in the future.

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