How to Estimate Your Retirement Expenses

Estimate how much you will spend each year in retirement

Man in a suit with a calculator for a head.
In retirement some expenses go down and other will go up. Use a budget to include all your must-have's. Fanatic Studio / Getty Images

To determine how much money you will need to retire, you must estimate your retirement expenses. Here's how you come up with an estimate.

1. Start with how much you spend now

A good way to begin to estimate retirement expenses is to use your current monthly take-home pay as a starting place, and then ask a few additional questions. Use the following questions to guide you through this process:

  • What is your monthly take-home pay? (This is what gets deposited to you after all deductions for taxes, retirement plans, insurance, etc.)
  • What expenses come out of your paycheck that you will have to pay out-of-pocket once you are retired? (For example, health insurance.)
  • What extra expenses do you want to budget for during retirement? This would include things like travel, or extra money for health care expenses.
  • Be sure to build in monthly savings for items that will eventually need to be replaced such as major home repairs or automobile purchases.
  • Do you have expenses that will decrease in retirement? For example, if you have a long commute to work, your transportation costs may decrease after retirement. If you must dress for success at work, perhaps in retirement, your dry cleaning bill will decrease.

Example:

  • Current monthly take-home pay: $4,300 per month ($51,600 per year).
  • Expenses covered by employer that will come out-of-pocket once retired: currently your employer pays for your health insurance premiums. You learn that once retired you will have to pay $350 per month ($4,200 per year) for this coverage.
  • Extra expenses: You plan on traveling in retirement, so you budget an extra $500 per month ($6,000 per year) for travel.

After totaling those expenses, you estimate that your total expenses in retirement will be $5,150 per month, which is $61,800 per year.

Caution: Take your time with this step. You have to know about how much you will spend to determine how much you will need to retire.

One of the biggest mistakes I see retirees make is underestimating how much they will need to spend in retirement to have a comfortable lifestyle. They end up overspending because they missed items in their initial list of retirement expenses. The most common items that are missed are annually occurring items like real estate taxes and insurance premiums, medical expenses such as dental, eye care, and hearing, and periodic expenses like home upkeep and auto repairs.

2. Next, estimate the amount of tax you will pay on your retirement income

Unless your only source of funds is Social Security, it is likely you will pay taxes in retirement. You can use an estimated tax rate, such as 25%, which is better than not accounting for taxes at all. However to come up with an accurate dollar amount to budget for, and to set up your tax withholding or quarterly payments, you will need to do a tax projection. A tax projection is an estimate that you do before year-end that shows you what your tax return will likely look like.

 

Why is a tax projection so important?

  • If you have mortgage interest, rental properties and/or the majority of your retirement income will come from investments that are not inside of a retirement plan, you may pay very little in taxes once retired.
  • If you have pension income, and/or the majority of your retirement income will come from qualified retirement plans like IRAs or 401(k)s, and/or your home is paid off, your tax rate in retirement may be higher than you might think.

For the sake of simplicity, and to continue the example started above, we will use an estimated tax rate. Let's assume the  person in our example will be in the 15% marginal tax bracket, and that most of their income will come from retirement account withdrawals (which means it is all taxable).

Calculation:

  • $61,800 / (1-.15) = $72,705

In the calculation above, dividing your net income by 1 minus your expected tax bracket will tell you the amount of gross income you will need to pay your taxes and meet your other expenses.

This particular upcoming retiree has calculated that they will need about $73,000 of gross income per year to retire comfortably. For clarification, here is the breakdown of gross income, taxes, and expenses in the example:

  • $72,705 x .15 = $10,905 (estimated taxes)
  • $61,800 (living expenses) + $10,905 = $72,705

Once you have an estimate of how much you'll need to spend each year, move to the next step in the planning process, and begin adding up your guaranteed sources of income

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