How to estimate your retirement budget

Estimating your retirement expenses well in advance can help ensure retirement bliss is in your future.

How much progress are you making saving for retirement?

According to a Bankrate survey, 56 percent of American workers said they were behind on their retirement savings goals. Meanwhile, 37 percent said they were significantly behind.

If you’re worried about falling behind, you may be wondering, “How do I know how much money I will need in retirement?”

Estimating retirement expenses can help you find the answer. Even if you’re still decades away from retirement, you can make a retirement budget to hone in on a savings target.

Creating a budget is important since most people have two income sources for retirement: Social Security and whatever they have saved,” says Derek Mazzarella, a financial advisor in Needham, Massachusetts. “Projecting how much you’ll spend is critically important to know if you have enough money saved and if it will last long enough.”

A woman sits at her kitchen table and works on her retirement budget, while her husband fixes dinner in the kitchen.

If you’re ready to dig into the numbers, use this plan to learn how to estimate your retirement expenses:

Use your current spending as a budgeting model

Data from the Bureau of Labor Statistics puts the average household spending for Americans aged 65 to 74 at $52,356 annually. Average annual spending drops to $40,839 for those 75 and older. While these types of figures can be helpful benchmarks, you can more accurately estimate your retirement expenses by calculating what you’re spending now.

When making a retirement budget, Mazzarella says it’s helpful to divvy up expenses into two categories: fixed and variable. Fixed expenses are those you pay every month, such as housing, utilities, groceries and debt payments. Variable expenses are costs that can fluctuate (think entertainment or medical costs).

Once you break down your current budget, you can start estimating retirement expenses by considering what costs may increase, decrease or disappear altogether when you retire, as well as those that will remain the same. Your budget for family expenses might shrink, for example, once your children are out of the house and financially independent.

Three women out for a walk in the park.

On the other hand, you might see health care expenses increase as you get older. According to the Bureau of Labor Statistics, a person 65 years or older spends around $6,668 per year on healthcare, not including the cost of long-term care. Learning how to make a retirement budget that accounts for those expenses while you’re still young and healthy can keep you from coming up short later.

Be realistic about retirement income

Once you’re done estimating retirement expenses, think about the sources of your retirement income. The list might include your 401(k), Individual Retirement Account (IRA), an employer pension plan, Social Security or business income if you own a business or have a side hustle.

The Social Security Administration offers a calculator that can help you determine your estimated benefits and make a retirement budget. You can also use an online retirement income calculator to estimate how much income your savings will generate once you retire. From there, you can create a plan for drawing down assets from different savings vehicles.

“In many cases, simply taking a proportionate amount of income from each type of account you own gets the job done,” says Byron W. Ellis, CFP®.

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Let’s say you hold 60 percent of your savings in an IRA and the remaining 40 percent in high-yield savings vehicles. Ellis says you could plan to follow that same 60/40 split for income as you make a retirement budget. Sixty percent of the income you need to meet your retirement expenses would come from your IRA, in this scenario, while the rest would come from those high-yield savings accounts.

Remember that with a traditional 401(k) or IRA, Required Minimum Distributions (RMDs) are required to start by age 70½ if you were 70½ by 12/31/2019. Distributions are required to start by age 72 if you turned 72 from 1/1/2020 to 12/31/2022. If you turned 73 in 2023 or years following, distributions will not be required until you are age 73. That can affect your yearly retirement income total. Visit the IRS website for additional details.

“The amount required is based on how much is in the IRA and how old you are, so the larger the account balance and the older you get, the more you have to distribute,” Ellis says.

“Creating a budget is important since most people have two income sources for retirement: Social Security and whatever they have saved. Projecting how much you’ll spend is critically important to know if you have enough money saved and if it will last long enough.”

Derek Mazzarella, financial advisor

Consider your lifestyle goals and plan for emergencies

As you learn how to estimate your retirement expenses, consider what kind of lifestyle you plan to enjoy when you retire.

“It’s common for new retirees to spend more earlier on in retirement” since they tend to be the most active, says Mazzarella, the financial advisor. That can be especially true during the first two years of retirement.

Health care has already been mentioned as a budget buster, but spending more time traveling, taking up a new hobby or buying a vacation home should also be top-of-mind when determining how to estimate your retirement expenses.

While new experiences and adventures should be considered when estimating retirement expenses, you’ll also need to factor in unexpected expenses. Having an emergency fund of easily accessible cash can keep you from having to tap your retirement accounts to pay for something like a home repair or a medical bill. Mazzarella says to keep three to six months’ worth of expenses in emergency savings for retirement.

Time is on your side

Learning how to estimate your retirement expenses can help you figure out what you’ll need income-wise, but that will only get you so far. You still need to act to ensure you’re saving enough. Thanks to compound interest—when your interest starts earning interest of its own—the sooner you can start saving for retirement, the better.

If you’re not putting money into an employer-provided 401(k) plan or an IRA, make enrolling and setting up contributions your top priority. If you are enrolled in a company-provided plan, check your current contribution rate to see if you’re saving at least enough to get the company match.

Consider signing up for an automatic annual contribution rate increase if your plan offers that feature. Bumping up your savings by even 1 percent annually could make a significant difference in how much you’re able to save over the long run.

Finally, consider your various options when it comes to IRA accounts. For example, the Discover® IRA CD offers guaranteed returns at fixed terms. The Discover IRA Savings Account allows for flexible contributions and withdrawals, and it provides a place for you to transfer your maturing IRA CD without locking in a fixed term. Keep in mind that there may be an IRS early withdrawal penalty depending on your plan type and the age at which you withdraw your funds. Consider consulting a tax advisor to discuss your specific situation.

Both of these accounts can help you add even more money to your retirement savings by locking in a competitive interest rate and allowing you to enjoy tax benefits along the way.

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