Learn How to Make a Retirement Budget

Woman planning a retirement budget
••• Budgeting can be fun. Here's how to get it done. kupicoo/Getty Images

Believe it or not, a retirement budget can lead to more fun in retirement. By having a plan, you'll have less stress. In addition, making a retirement budget helps you avoid one of the biggest retirement mistakes people make – which is spending too much too soon.

Why a Retirement Budget Is so Important

Of all the many factors that affect your retirement income (inflation, your rate of return on savings and investments, your retirement date, taxes, spending, part-time earnings, Social Security, pensions, etc.) there is ONE that you have the most control over.

It’s your spending. In retirement, over-spending is dangerous.

Getting a handle on your upcoming retirement budget puts you in a place where you’ll be able to make smart choices about the retirement lifestyle you want. You may find there are trade-offs you are willing to make that might enable you to do things like retire earlier, travel more in retirement, or have more money for fun and hobbies.

How to Create Your Retirement Budget

Start by gathering information. Below is a list of items you may need.

  • Your last 6 to 12 months worth of bank account statements
  • Your last 6 to 12 months worth of credit card statements
  • Last two pay stubs for you (and your spouse if you are married)
  • 10-12 colored highlighters
  • Last year’s tax return

Use the information on the items above to see where your money has been going, and use the highlighters to group expenses into categories by following the five steps below.

STEP 1 – List Fixed Expenses

Your budget starts by listing all of your recurring monthly, quarterly or annual payments. To make a super effective retirement budget, break this list down into three parts:

  • Essentials: This includes food, clothing, housing, transportation and health care.
  • Non-essential monthly obligations: Although we all may think of cable TV as an essential, it is not. Non-essentials are things like cable, gym memberships, subscriptions, and other items you receive bills for.
  • Required non-monthly expenses: Items like property taxes, insurance premiums, auto registration and home warranties may come up once a year. Be sure to take these periodic expenses and calculate their cost on a monthly basis and include it in your retirement budget.

To account for the timing of expenses, make a budget spreadsheet with the months January - December going horizontally. Down the vertical side list each expense. If it is your utility bill that runs on average $200 a month, put $200 going across for each month. If it is Christmas gifts and you spend about $500 a year, but $500 in the month of November and December. Do this for each item. Make a total for each month.

STEP 2 – Account for Changing Health Care Costs

If your employer has been paying premiums, once retired you may have to pick up the tab. If you are retiring prior to reaching age 65, health premiums will be expensive. Between the ages of 60 and 65, health insurance premiums can run $1,000 a month per person. You should shop for plans now so you can add an estimate of that monthly expense into your budget. 

And what about dental, eye care, and hearing? Add those expenses to your budget too! You must add in estimates for health care costs in retirement in order to develop a realistic expectation of how much you'll need to live on each year.

Getting this item wrong is one of the seven deadly retirement budget killers that can wreak havoc on your retirement plan.

STEP 3 – Add In Optional Items

This all the fun stuff, like travel, hobbies, sports, and entertainment.

STEP 4 – Determine How Your Time Will Be Spent

Next, consider how your hobbies and lifestyle may change. This may change the way you spend. If married, ask your spouse to do this also. Think about the things you want to be able to spend money on in retirement. If you have expensive hobbies, you'll need to budget more for those. Begin to think about changes you may be willing to make that would reallocate money from items that are less important to items that are more important. For example, if you want to travel more, would you be willing to downsize and live in a smaller house?

STEP 5 - Calculate Fixed Versus Flex

  • Total all your expenses.
  • Total all your fixed expenses separately.
  • Divide your fixed expenses into your total expenses.

How much of your retirement income will go toward fixed expenses? Does this align with your thoughts in Step 4 on how you want to spend your time in retirement? If you have large monthly obligations for house and car payments you can consider a lifestyle change to free up funds for travel or hobbies.

As a general rule of thumb, if you want more fun in retirement, find ways to lower fixed expenses so you can have more flex funds available to spend on the interests you most enjoy.