Creating a budget or spending plan can sometimes get a bad
reputation for feeling too restrictive. Admittedly, budgets are not
one-size-fits-all and using the wrong method for your circumstances can result
in feeling exhausted and limited. However, there is a huge benefit to tracking
how much of your money gets spent — especially if you hope to retire by age 65
or sooner.
Tracking your expenses is one of the most important steps
for figuring out your “retirement number” (a.k.a., how much money you need to
have saved or invested before you can enter retirement). This is because once
you’re retired, you’ll need to know how much money you should be spending each
year to ensure that your savings and investments will keep you afloat for the
rest of your life.
Remember, the idea is that once you enter retirement, you
won’t be working so all the money you invested can be withdrawn each year and
used as “income.”
The amount of money you’ll withdraw each year will be
different for everyone, and will depend on a number of factors such as, where
you live, how much you’ll pay in rent or mortgage and the type of lifestyle you
want to have in retirement. Traveling several times a year will mean spending
more money compared to only spending time in your own backyard and taking up an
inexpensive hobby or volunteer work.
You can look to your current lifestyle and interests — and
thus, your current level of spending — for some clues as to about how much
money you’re likely to spend each year in retirement. For example, if you
travel a lot now and want to keep traveling around in retirement, this should
be taken into consideration.
Keep in mind that your current level of spending likely
won’t be an exact match for how much you’ll spend in your golden years, since
some costs are likely to be lower or higher in retirement. For instance, you
might spend more on healthcare later on than you do now. However, maybe your
housing costs will be lower in retirement than they’re now if you plan to pay
off your home by then. Still, though, your current expenses can be a solid
starting point.
If you’ve already been budgeting, simply refer back to each
month’s budget. Look at your total spend for each month and add up all the
numbers — you’ll then see exactly how much money you’ve spent in a year. But if
you haven’t already been budgeting or tracking your expenses, you’ll want to
comb through your bank statements and start adding up the numbers. This can
quite frankly be very time consuming and frustrating, so using a budgeting app
like Mint or software like YNAB (You Need A Budget) will streamline the
process. These apps connect to your bank account and/or credit card to track
and categorize every transaction, giving you a monthly total for exactly how
much you’ve spent.
Now that you know how much money you’re currently spending,
you might want to adjust the amount based on what you think you’ll spend in
retirement. Remember to account for traveling if you think you’ll be on the
road a lot, and other costly experiences or events if you think they’ll play a
big role in how you spend your time in the future.
Once you have a rough estimate of what you’ll spend each
year you should consider how much money you’ll receive in retirement benefits
like Social Security. For 2022, the average benefit amount for a retired worker
will be about $1,658 per month. That means retirees this year should receive an
average of nearly $20,000 in Social Security income — that’s about $20,000 less
that they’d have to withdraw from their own retirement savings.
After subtracting social security income from your total
spend, you’ll end up with the amount of money you’ll need to withdraw each year
from your own savings. Once you have this number, you can use the 4% rule to
calculate a grand total for how much you should save before you enter
retirement.
The 4% rule states that you should be able to comfortably
live off of 4% of your money in investments in your first year of retirement,
then slightly increase or decrease that amount to account for inflation each
subsequent year. Based on historical data, living off of just 4% will allow you
to use your retirement portfolio to cover expenses for 30 years.
If you plan to retire early, though, you might want to
adjust the percentage or pad your savings with extra money since you’ll need
more to last beyond just 30 years.
Let’s say you decide to work with 4% as the amount you’ll
withdraw in your first year of retirement. You’ll simply take the number you
calculated for your yearly retirement expenses and divide it by 0.04 (or
multiply it by 25) and the number you get is your retirement number. In other
words, this is how much money you’ll need to have before you can comfortably
and securely enter retirement.
Without tracking your expenses first, it’s difficult to get
an idea of how big (or small) of an end goal you’re looking at.
Apps like Personal Capital can help track and analyze your
spending, as well as help project how much money you’ll have in retirement with
its retirement planner tool. You can connect your bank account, credit cards
and investment accounts to the program to track your net worth, spending,
investments and more.
Bottom line
Tracking your expenses is such an important step when saving
for retirement because it’s difficult to create a goal for your retirement
number if you don’t even know where you’re currently at. Knowing how much you
spend right now can provide clues for how much money you’re likely going to
need each year in retirement — then, you can use this information to figure out
how much money you’ll need to save in total before you enter retirement.
This is especially important if you want to retire early
because you’ll need to make sure the money you save and invest will be enough
to last beyond 30 years.
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