Don’t Jeopardize Your Retirement Budget by Overspending
When it comes to a retirement budget, overspending is one of the most common retirement mistakes people make. There are two primary overspending traps to avoid falling into:
- Overspending based on your current income, preventing you from putting aside savings today to use tomorrow (in retirement).
- Underestimating what your expenses will be in retirement, causing you to spend more and save less than you should today.
Both of these traps can be circumvented by exercising spending discipline and engaging in retirement planning. The first step in controlling your spending and setting aside sufficient funds for retirement is to determine how much you need to save today to fund your desired retirement income of the future. To find an accurate number you can use, whether by yourself or in conjunction with a financial advisor, one of the many financial and retirement planning tools available to assist you in determining how much you should be saving out of your current income for this purpose. These planning tools typically feature the ability to choose from a variety of methods and formulas to determine how much you will need to save for retirement and how long your retirement savings are likely to last. One of the most important tasks these tools can help you with is estimating your retirement expenditures.
Avoiding the Trap of Underestimating Retirement Expenditures
As a general rule, a person’s expenses are expected to be lower in retirement than during their working career. This reflects factors such as not having to pay expenses associated with raising children, lower or no home mortgage expenses, lower wardrobe costs upon retiring from your job, downsizing living quarters, etc. However, despite these factors, people still often underestimate the expenses they will face in retirement, jeopardizing their ability to live the retirement lifestyle of their choice.
What are the factors that cause people to underestimate their retirement expenses? Some of these are as follows:
- Unanticipated medical expenses: Besides the deductible associated with Medicare, there are certain costs the program does not pay for at all, such as long-term assisted living care, or only partial coverage, such as prescription drugs. Many recipients of Medicare purchase Medigap insurance to extend their coverage.
- The rising cost of living: If you budget for retirement using current prices for items such as housing, transportation, food, etc. without taking into account the effects of inflation, you may find that the actual prices you pay in retirement are significantly higher than you planned for in your budget.
- Expenses related to adult children: Given the high cost of housing, college education, and healthcare in today’s world, many retirees find themselves spending significant sums helping their adult children financially.
- Property and other taxes: While many retirees downsize their residence or move to less expensive living quarters, they are still subject to property tax hikes, whether directly or indirectly in the form of rent increases.
How can you take these factors into account when planning for retirement, given that in many cases such expenses occur unexpectedly? One method of doing so is to build a buffer into your retirement income projections. Rather than planning to retire on savings adequate to generate just enough income to pay your expected retirement expenses, plan to amass savings sufficient to generate more income than you will need on a monthly or yearly basis, leaving excess funds to help pay for any unanticipated costs.
If you take this approach, you may have to save more today than you had originally anticipated, meaning that you may be overspending without knowing it. Hopefully, this isn’t the case and you will be able to build a retirement buffer without having to reduce your spending from current levels. But if it turns out that creating a buffer means that your current level of spending is excessive, cutting that spending is essential to improving your chances of being able to live the retirement lifestyle of your choice.
Whether this is the case, or you have simply gotten into the habit of spending more than you should be given your retirement savings goals and your current income, the key point is to find a way to rein in that spending so you can avoid jeopardizing your ability to retire comfortably.
Once you have settled on a retirement savings number, the next step is to adjust your spending in order to set aside the requisite amount to fund your retirement savings goal. To achieve this, it can be helpful to use a budgeting tool, whether a full-fledged financial planning application that comprehensively tracks your spending or a simple pen and paper list of your spending. The key is to know what you are spending your money on so that you have the necessary data to make informed decisions about your spending.
Overspending is often not simply a case of spending money lavishly, but of failing to adequately track what you are spending your money on. By using a budgeting tool to monitor your spending, you can see where your money is going. This will make it easier to make changes to your spending patterns as necessary to meet your retirement savings goals.
If you find that tracking your spending shows that an inordinately large chunk of your income is spent on certain non-essentials, this information can prove useful in reducing spending. For example, if you find that you are spending more money than you would like dining out, it might be possible to reduce this figure without giving up on eating outside the home altogether. To accomplish this, one solution might be to cut costs by reducing the amount of times you went out to eat each week.
Another example might be vacation spending. If you find this is your biggest nonessential budgetary expense you could take steps to reduce spending on this item without giving up the activity altogether. The same process could be used for almost any discretionary spending: clothes, treats, games, etc. The point here is not centered on cutting back spending on any particular item or activity, but on the importance of tracking what you spend your money on. Once you do this you give yourself the power to make spending cuts in the areas that will do the most good while having the least impact on your current lifestyle.
This is important because if you cut spending this way it is more likely to stick than if you simply try to restrict your spending to a certain amount without knowing exactly what it is you are spending your money on. Taking this latter approach can cause you to make cuts to your spending in areas that are vital to your current lifestyle, which can be counterproductive in the long run. For instance, if you cut spending on items you need to do business effectively, or to keep yourself healthy, happy and motivated at work and at home it can harm your ability to maximize your income from business activities – damaging your ability to set aside enough funds to meet your retirement income goals.
A Comprehensive Approach to Saving for Retirement
Preventing yourself from overspending is crucial to setting aside sufficient funds to enjoy the retirement lifestyle you deserve. To achieve this goal, be sure to take the time to estimate how much savings you will need to generate an acceptable level of retirement income. Once you have done so, adding in a buffer amount of income to deal with unanticipated expenses you encounter in retirement can help you avoid the trap of overspending today based on what your actual retirement expenses turn out to be. To adequately fund your retirement savings once you determine how much you need to set aside for this purpose, it is vital to closely examine your spending habits so you can cut back on nonessential expenditures when necessary. Whether you use an online app or pen and paper, tracking your spending can help you stay disciplined and avoid spending more than is prudent given your retirement savings goals.
Ron is co-founder and Chief Investment Officer for GlidePath Wealth Management an innovative money management firm that uses a patented process to deliver institutional-quality investment services to individual investors.