The Difference Between Discretionary and Non-Discretionary Spending

When planning for retirement, one of the most important steps to take is to clearly identify your financial and lifestyle goals for this stage of your life. Another critical step is to determine how much money your retirement lifestyle goals might cost. How much will you likely spend once you retire?

Spending Comes in Two Forms

In order to successfully plan for both your short-term and long-term retirement, you should understand that spending generally falls into two categories: non-discretionary and discretionary.

Simply put, non-discretionary spending represents expenditures for needs, while discretionary spending represents desires. Many people are familiar with this basic principle. However, the challenge comes in using the knowledge in a multi-year retirement strategy that extends far beyond your first year (or first few years) as a retiree by creating a detailed financial plan.

Saving for your nest egg now while trying to anticipate how you might spend later after you retire can be tricky. Taking the time to evaluate this is where some pre-retirees tend to fall short, which can have serious consequences for your finances during retirement.

Why is it Important to Know the Difference?

If you can’t anticipate how much you may need to spend in your retirement—whether you are maintaining or enhancing your lifestyle—then you may have difficulty accurately planning to meet your income needs. And if you can’t accurately plan your retirement saving and income needs, you may risk running out of money in retirement, in addition to falling short of your retirement goals. Here we will explore the potential costs of your retirement, starting with your non-discretionary expenses.

Non-Discretionary Spending

Certain expenditures are essential to your daily living.  You probably already encounter these costs now as a working individual, and will likely continue to encounter them as a retiree. Non-discretionary expenses include living expenses, debt, taxes, insurance and healthcare.

Living Expenses: At the most basic level, you will need to pay for housing, utilities, groceries and transportation for essential activities. Even if you own your residence outright, you may incur costs for necessary housing repairs or improvements.

Debt: You may be paying down a mortgage and continue to have credit card debt or a car loan. For every debt you owe, bear in mind the effect of interest that compounds over time on top of the principal you are obligated to repay.

Taxes: As a retiree, your taxes may be lower than when you were working as your tax rate shifts from income to capital gains. Nevertheless, the government still wants its cut, so you should plan to set aside enough money to settle your estimated tax bill.

Insurance/Healthcare: Healthcare costs have historically risen faster than the rate of inflation.[i] Healthcare may take up a larger portion of your budget as you grow older.

These are all necessary expenses that may change over the course of your retirement. But depending on your goals, there may be more to retirement spending than just the basic necessities. In other words, you should take some time to consider your discretionary expenditures as well.

Discretionary Spending

Discretionary expenses are optional and subject to your personal situation. They can include anything from the simplest of luxuries, such as a cable TV subscription, to large long-term goals, such as leaving a sizeable legacy to your children, grandchildren or charity.

Although these expenses may not be considered essential to your retirement, they are far from insignificant when it comes to enjoying your life or fulfilling your goals. While they may likely change throughout your retirement, maintaining control over this nonessential spending is important to fulfill those goals.

Travel: Some retirees plan to spend time traveling. This can mean visiting family, trekking across the country or taking trips overseas. If you plan to travel during retirement, don’t forget to account for the expenses involved.

Hobbies: Retirement is a perfect time to rekindle old hobbies or to spend time acquiring new ones. Whether you plan to put together an in-depth compilation of your family history, go fly-fishing or play golf on a regular basis, hobbies can incur costs.

Luxuries: What is considered a luxury varies from one person to the next. It can be simple, like having coffee out every morning, or more complex, like joining a country club. Whatever you decide, you will have to consider these costs in your budget.

Children and Grandchildren: Perhaps you plan to spend more on your children or grandchildren through travel costs for frequent visits, more gifts or by passing on a legacy.

In each discretionary spending case, you need to think about how much growth, income or cash flow these goals will require from your investments and accounts.

Beginning the Planning Process

Your spending habits throughout your retirement may change as your financial needs and goals change. Although your non-discretionary expenses may not offer much flexibility, your discretionary expenses can always be altered and adjusted. If you simply cannot live without one of your discretionary expenses, consider including that expense in with your non-discretionary, essential spending category instead.

So how can you begin planning now? Review your current savings and assets. And don’t forget to review your overall asset allocation. Does your current allocation account for an appropriate amount of growth to support your spending needs and goals? Does it account for inflation? Does it account for the length of your entire investment time horizon?

Planning for a successful retirement means taking a critical look at how discretionary and non-discretionary needs may change over time. Your spending needs may change when you retire, over time due to the effect of inflation, or due to unexpected circumstances.  Appropriately planning for what you can predict, and building in a safety net for the unpredictable, may help you on your path to a successful, enjoyable retirement.

What happens if you fall short of your target before you retire? You may not know whether your saving or investing efforts were adequate to provide enough for both types of spending. To prevent this from happening, your retirement portfolio should account for all the growth, income and cash flow you may need as a retiree in order to achieve the lifestyle you envision.

Do You Need Help with Your Retirement Planning?

Retirement planning requires a holistic view of your anticipated spending needs and financial goals. Weighing all the aspects of retirement planning, saving and spending is not always easy. You may want or need assistance from a trusted advisor to help you achieve your retirement goals.

Fisher Investments may be able to help. Contact us today to learn more about how to plan for your retirement spending.

[i] Source: FactSet, as of 01/09/2018. Consumer Price Index data from 12/31/1990-12/31/2017.

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