Some people may have preconceived ideas about how their spending will change when they retire. You may think that you will spend less and save money in some categories, only for the opposite to be true. However, it is not always easy to know.
For a realistic picture of your financial situation, you should estimate how your annual spending and income will change after you retire. Depending on your retirement plan, your spending may change in a different way than another retiree. Everyone has different financial needs and expenses.
How will retiring affect your expenses? Although some aspects of retirement expenses may be difficult to predict, others may be easier to take into account. It’s a good idea to evaluate your non-discretionary and discretionary expenses to get an idea of where you might find savings, and where you might find some unexpected increases in spending.
Non-discretionary expenditures are required for daily life and generally can’t be avoided. You don’t have much control over them. These costs include:
Discretionary expenditures are nonessential costs, but may be an important part of enjoying your retirement. These costs include:
Your spending and saving may also be affected by inflation and your investment time horizon. Inflation can reduce your purchasing power over time. Although inflation rates can vary year over year, inflation has averaged approximately 3% per year since 1925.[ii] It may not initially sound like much. But if that inflation rate continues and you need $50,000 now to cover annual living expenses, you’ll need about $90,000 in 20 years and about $120,000 in 30 years. It is important to be aware of how much your living expenses may increase in the future because of inflation.
Investment time horizon also plays a role in your total retirement costs. In addition to your own life expectancy, consider your partner’s life expectancy. Many people are living longer because of medical advances. To be on the safe side, prepare to live a long time and make sure you have planned to meet your financial needs.
You may believe you will spend significantly less in retirement across many categories. It is worth keeping in mind that costs of spending categories fluctuate. Exhibit 1 shows price changes in various categories from December 1989 to December 2017. You can see that clothing costs fell in that period, whereas health care, energy prices and food costs rose.
How will your spending and saving change in these categories? This will vary from retiree to retiree. Carefully evaluate how your choices in each category will affect what you may actually spend.
Source: FactSet, as of 01/09/2018. Consumer Price Index data from 12/31/1990 - 12/31/2017.
Now that you’ve thought about how you much you may spend in retirement, how will you provide that income? Begin by considering all your current sources of investment and non-investment retirement income.
Do you have a sufficient nest egg to enjoy a comfortable retirement? When evaluating your retirement planning, make sure to estimate your retirement spending carefully. If you need help assessing your cash flow, income and retirement expenses, contact us today or download one of our educational guides to learn more.
[i] Source: FactSet, as of 01/09/2018. Consumer Price Index data from 12/31/1990-12/31/2017.
[ii] Source: FactSet, as of 2/12/2018. Based on US BLS consumer Price Index from 12/31/1925 to 12/31/2017.