Retirement Budget: Can you skip the spreadsheet for a better way?

Time to Read: 6 Minutes

Creating a sizeable nest egg is just the start of successful retirement planning. Ensuring that an investment portfolio will be able to provide a desired level of income for several decades requires a careful ongoing strategy, and making realistic predictions about long-term expenses is a critical step. It doesn’t have to be a complex, tedious process though. There’s a simple technique we’ve used to create accurate estimates of spending for families preparing to retire.    

How do I estimate my retirement expenses?  Why a typical bottom-up retirement budget doesn’t work 

Underestimating living expenses can lead to an unrealistically rosy retirement plan picture. This false sense of financial security often results in a rude awakening later in retirement, as the true extent of spending becomes clear.  Additional spending – even if it’s not a huge amount – will have a long-term impact and may require you to make unexpected and uncomfortable changes to lifestyle.   

To estimate retirement expenses, investors are often advised to complete a spending or budgeting spreadsheet with detailed categories of expenses.  This traditional “bottom up” approach to budgeting rarely works well. The process is time-consuming and tedious, and the result is often inaccurate.  

While it might be easy to know your annual expense for many regular recurring expenses, it’s quite difficult to accurately reflect larger, irregular, or unplanned expenses in a spreadsheet.  For example, a monthly cable/internet bill fits nicely in a spreadsheet. The purchase of new home appliances or a large bill at the veterinarian for a sick pet is another matter. Not including these expenses can result in a meaningful underestimation of total retirement spending needs.   

Further, detailed expense categories don’t add much value to a retirement plan.  Successful retirement income planning rests on accurate estimates of a family’s living expenses over time.  It’s the money needed from an investment portfolio each year which matters.  Whether money is being spent at a restaurant or Whole Foods rarely comes into play.   

The good news is there is a simpler, easier, more accurate way families can plan for real retirement expenses.  

Top Down – No retirement spending calculator required 

The first step in our preferred method for estimating retirement expenses is to determine your total current spending.   

Most families use one primary checking account.  Paychecks and other earnings are deposited to the account, and expenses come out on a regular basis.  For example, mortgage payments might come directly from the checking account. Expenses charged to credit cards are indirectly paid from checking when the monthly credit card bill is paid.   

To determine exactly how much you spent in a calendar year, just compare the balance in your checking account at the beginning of the year to the balance at the end of the year.  Then total up the direct deposits from earnings (salary, bonus, etc.) throughout the year.  This can easily be done online with most banks in just a few minutes.    

In this simple example, the total spending for the year would be the direct deposits, adjusted for any change in the value of the account between January 1st and December 31st.  If the value of the bank account declined during the year, add that decline in value to the direct deposits.  If the value of the bank account increased during the year, subtract that from the total direct deposits to know how much was spent.  This total spending amount is accurate, quick, and reliable. 

Example: 

January 1st checking account balance: $135,000 

Sum of direct deposits throughout the year: $395,000 

December 31st checking account balance: $120,000 

Implied total annual spending for the year: $395,000 (direct deposits) + $15,000 (difference in checking account value from January 1st to December 31st) = $410,000 total spending for the year. 

At BWM Financial we recommend clients perform the same exercise for several of the previous calendar years, and then compare the totals to see if they are consistent.  One year of spending may be unique and not representative of a normal year.  If spending is consistent for several years in a row, we generally feel more confident using the spending as a predictor of future costs of living.  Large variations in spending from year to year warrant a closer look to determine the reason for the variability. (Footnote #1 – Families with highly variable spending may need to plan more conservatively with their wealth manager, consider adaptive spending approaches to retirement, create backup spending plans, etc.  They may want to work with their wealth manager to include a modest expense buffer in their retirement plan.  They could also consider slowly backing away from working for a paycheck over time. Or they may need a longer track record of annual expense data to predict their cost of living in retirement.)  

 Adjusting the data for today 

Once you’ve determined your total current annual spending, we recommend identifying any large income or expenses over the past several years which should be removed altogether.  These should only include income or expenses which are not representative of a typical year.  Be careful to do this only when there is a strong case for removal.   

The purchase of a second home, a large inheritance from a relative, or an extraordinary income tax bill due to the sale of a business are great examples of amounts that may need to be removed. (Footnote #2 – We estimate income taxes in client plans and ask clients to only provide after-tax spending estimates.)   

It’s important to resist the urge to remove smaller unplanned or irregular expenses.  Home maintenance or larger medical bills, for example, may not happen each year.  Because of this, it’s tempting to remove them from the total expenses.  However, other unexpected expenses will generally pop up in future years.  The best predictor of overall irregular unplanned costs in the future is previous costs. One year, you might spend money on a new water heater, the next you might have a large dental bill.  Fight the temptation to remove these from your annual expenses. 

Total annual expenses may need to be adjusted for some business owners who run expenses through their business accounts.  For example, the cost of a car lease might not be reflected in a personal bank account if it is paid by your company.  However, costs like these will need to be added to overall personal expenses starting in retirement.   

Striking the right balance can be difficult.  We advise removing income and expenses sparingly.  We have extensive experience and can help you determine what to keep and what to remove, if you have questions.   

 Adjusting the data for retirement 

Today’s expenses must be adjusted to account for changes in retirement.  Certain large costs have special tax treatment, deductibility, inflation characteristics, and other considerations which should be reflected in any good financial plan.    

Mortgage payments are a good example of an expense that should have special consideration.  Principal and interest payments on mortgages may be substantial and they generally do not increase with inflation over time.  They also have an end date and interest may be tax-deductible.  For these reasons, we like to separate a mortgage payment from other “forever” expenses such as a utility bill in a client’s retirement plan.  In other words, an accurate financial plan would not assume one’s mortgage payment lasts forever and increases with inflation.  This sort of unrealistic assumption would overestimate long-term retirement expenses and paint an overly pessimistic retirement spending picture.  

Major expected future expenses should also be included in a retirement plan.  Common items are college costs for kids, healthcare expenses, the purchase of a second home, etc.  These costs will also change over time. Healthcare provides a good illustration. If retirement occurs before Medicare eligibility at age 65, it may be necessary to purchase private medical insurance during the gap years. This is an additional cost not included in today’s spending, but it will likely decrease once Medicare enrollment is possible.   

The complete picture 

Making realistic initial retirement expense estimates is just the first step.  At BWM we help clients throughout retirement with a wide range of related items: 

• Accounting for chronic medical care costs later in retirement   
• Preparing for higher-than-expected inflation or taxes in retirement 
• Tracking spending plans to make sure reality matches the plan 
• Generating a monthly “paycheck” from a retirement portfolio 
• Tax-efficient portfolio withdrawal strategies with your CPA   
• Avoiding common spending pitfalls and blindspots 

Putting it all together 

Planning a retirement with confidence requires realistic projections of annual expenses.  Realistic does not mean detailed, exact, or inflexible.  It does, however, mean that expense assumptions approximate reality today, and they account for changes over time.  This doesn’t require intense effort, but it does help to have an experienced financial team and a reliable process to follow.    

If you’re unsure about when to retire, how to accurately estimate your long-term expenses, or how to turn your investments into a “paycheck”, please contact us to discuss your situation.    

Investment advice offered through Stratos Wealth Partners, Ltd., a Registered Investment Advisor DBA BWM Financial.  The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.