In essence, creating a retirement budget is about money in versus money out.
You figure out what kind of income you can reliably generate from your joint assets, and then compare it to your household’s expenses. If income exceeds expenses, you’re done. If not, you will need to make some adjustments.
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But within that simplicity are countless moving parts. Managing your income includes investments, risk analysis, longevity issues and much more. When managing your expenses, you make assumptions about housing, insurance, lifestyle, inflation and (again) much more.
To see how this works, imagine a hypothetical couple at age 60. They have a combined $1.3 million in their 401(k)s and can expect to receive $5,100 a month in combined Social Security benefits. This lends itself to a generous income, so expenses are less likely to be a problem, even with a reasonably comfortable lifestyle.
So here are some factors that will impact the income side of their budget.
Draw up an income plan
From an income perspective, our hypothetical couple is doing quite well.
At $2,550 per person, their final monthly Social Security benefits will be well above the average retirement benefit of $1,866 per month in April 2024.
So this household will start with a guaranteed $61,200 per year from benefits alone in retirement. But the real assets are this couple’s 401(k)s. Here we have two people with $1.3 million for their 401(k) plans. They are also only 60 years old. Assuming they wait until full retirement age to collect their benefits and retire, that gives their 401(k)s another seven years of investment and growth.
Of course, how much they will have in their 401(k)s at the end of those seven years will depend on their investment strategy and market performance. However, here’s how much money they could potentially have if their portfolio grew at rough historical averages:
Even using conservative assumptions, seven years from now our couple could potentially have a significant savings pool by the time they retire.
For example, take the middle-of-the-road approach of 8% with a potential of $2.2 million at retirement. An annual withdrawal rate of 4% would produce $88,000 in pre-tax income per year. With their Social Security benefits, that could total $149,200 in inflation-adjusted pre-tax income.
This number will vary widely depending on the couple’s actual investment choices and withdrawal strategies. In all cases, however, it’s likely they’ll be able to retire with a solid six-figure income.
Creating a sustainable income plan in retirement is important, but potentially complicated work. Fortunately, a financial advisor with expertise in retirement planning can help you with this.
Taxes and RMDs
Taxes are the next challenge to tackle when putting together a retirement income plan and budget.
While taxes are not unique to retirement, they are becoming more complicated. Most households spend their working lives with a single tax status. You earn W-2 income, pay income tax through withholding, then file a basic 1040 and get a refund.
When you retire, your tax status diversifies. Among other possible situations, you should anticipate income taxes on deferred portfolios, taxes on Social Security benefits, as well as capital gains and income taxes on any taxable portfolios you have. You’ll need to balance that with the tax-free income from any Roth portfolios, and plan for how you’ll pay all those taxes.
A financial advisor may be able to help with this, and management will matter.
Take our example above. The couple would be able to take $88,000 in pre-tax income from their 401(k)s. After income taxes, they would be left with about $81,200. Up to 85% of their Social Security benefits would also be taxable.
Taxes can also cross your budget in the form of RMDs. These are your required minimum distributions, the amount you must withdraw from your pre-tax portfolio each year starting at age 73 (age 75 if you turn 74 after December 31, 2032). Roth portfolios are exempt from this requirement.
Even if you don’t need all of your money—say your lifestyle is minimal and you have few needs—the IRS still requires you to take this withdrawal and pay taxes on it.
Lifespan, inflation and insurance
Then anticipate the long-term issues that could affect your income, including longevity, inflation and health.
You generally don’t have to budget for decades during your working life. Your family income will hopefully adapt to the needs of a particular era. That changes with retirement. You have to think in terms of twenty, thirty or even forty years.
This is a problem known as ‘longevity risk’. It’s the chance that you will outlive your retirement savings and rely on Social Security in your later years. Especially given the unpredictable advances in medicine and aging, the younger you are, the more you need to plan for this.
You may be able to limit this risk by planning for more years than you need. Take a realistic lifespan – mid-to-late 80s for an average retiree – and then budget for an even longer lifespan.
For example, instead of planning for a 25-year retirement by withdrawing $88,000 in the first year of retirement (and adjusting upward for inflation each year thereafter), our couple could expect to live with a lower initial recording would begin. This could help them stretch their money to 35 years. It will modestly limit their spending power, in return for the assurance that their 90th birthday will be something to celebrate.
If you’re not sure how long your retirement needs will be, or you simply need help creating an income plan, consider working with a financial advisor.
Thinking in decades also means planning for inflation.
Even at 2% inflation, prices double approximately every 35 years. For people living in cities, and especially those who rent out their homes, prices will rise even faster. The more fixed your income is, for example with low-yielding investments, pensions or annuity payments, the more these rising costs will affect your lifestyle. Plan with this in mind so that your budget doesn’t get tighter while your income remains the same.
Finally, prepare for new insurance needs. Retiring means having to plan for higher healthcare costs as life goes on. This may come as a surprise, especially for people who are used to spending their lives relatively young and healthy, i.e. most retirees. Structural costs like gap and long-term care insurance will reduce your disposable income, and you want to be prepared for that.
In short
Creating a retirement budget is a process of balancing your income with your spending needs. Even households that can expect a relatively generous income should make sure they take into account the many factors that can influence this, from investment returns to taxes, insurance and inflation.
Tips for Managing Inflation During Retirement
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The biggest problem with planning for inflation is that it is not one number. Although the government publishes its key figures every month, local inflation varies by community and lifestyle. Make sure you take this potential variance into account, otherwise prices can surprise even a well-planned retirement.
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A financial advisor can help you create a comprehensive retirement plan that aims to protect your income from inflation. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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The post We are 60, have $1.3 million in 401(k)s and will receive $5,100 monthly from Social Security. What is our pension budget? first appeared on SmartReads by SmartAsset.
