By Sam Dixon

Retirement planning is the responsibility of individuals now more than ever.

Defined-contribution plans such as the 401(k), where you, not the company, manage your investments, are in vogue. Defined-benefit pensions in the private sector are virtually extinct.

Sam Dixon

Sam Dixon

So, it’s up to you to plan the kind of post-working life you want whether or not you work with a financial advisor, and that strategizing need not be overwhelming. In fact, the big picture becomes much clearer if you begin your planning well in advance and with this basic framework: estimate what your expenses will be in retirement, develop a future budget accordingly, and build your investments and savings toward covering all of it.

You should update your plan annually to make sure you’re on track. Having an accurate estimate of your retirement expenses will affect how much you withdraw each year in retirement. But if you underestimate your expenses, you will outlive your portfolio. Remember: with people living longer on average, a future retiree must start retirement with a larger nest egg than most people did in previous generations.

These are some key points to keep in mind regarding retirement expenses and crafting a budget and a portfolio around them:

Be realistic. The problem for some retirees is they are unrealistic about their spending habits. For example, they splurge on travel despite having not paid off their mortgage, and then they have unforeseen medical expenses. In the planning stages, it’s imperative to be as specific as possible about the kind of retirement you desire and what those lifestyle expenses will be. When you have the freedom of time that you’ve long been working toward, you’ll want to have the freedom of doing what you want with that time – within reason, given the plan you can construct based on your projected earning levels.

Many people inaccurately predict that their annual retirement spending will be sizably less than during their working years. But for some, the early transition years of retirement do entail an increase in spending.

Prepare for health care and medical costs. Many retirees don’t adequately plan for health issues. While some think they’ll cruise through retirement and not encounter big medical problems, the data shows it’s a mistake to ignore the possibility and not save sufficiently for it. According to Fidelity Investments’ Retiree Health Care Cost Estimate, an average 65-year-old couple may need approximately $300,000 saved to cover health care and medical expenses. And that report did not include long-term care costs, which can be enormous. Not everyone needs long-term care insurance, but it’s worth investigating and putting money aside just in case.

Make a complete list of essentials vs. extras. Devise a T-chart with the essential expenses on one side and the extras on the other. Typically, retirees spend a higher percentage on extras or discretionary expenses – travel, dining outs, gifts, hobbies, and charity, for starters – in their first few retirement years than they do later. Granted, when planning retirement years in advance, it’s hard to get a complete grasp on what your discretionary spending could be. But having an idea of the fun things you’ll want to do in retirement will help you estimate what it might cost per year and how much you need to save. At the same time, consider what you could cut from the extras list – TV or magazine subscriptions, too much dining out, etc.

Essential expenses are mortgage or rent, groceries, taxes, utility bills, insurance, car payments, etc. – but they also include the hidden or unexpected costs such as home repairs, a sudden or lingering illness, and providing additional family support. Aside from the unexpected bills, the essentials are largely fixed expenses, and your Social Security should be used toward those costs. Ideally, pay off the mortgage and other large debts before retirement. Clearing these monthly bills, especially the mortgage, makes it much easier to handle the rest of your living expenses, save, and free up cash flow.

Devise an income distribution plan. Social Security for most people will not be enough to cover all their expense needs, and this is where another important aspect of retirement planning comes in. Determine what the gap will be, look at your investments, and create a distribution plan that will provide efficient cash flow in retirement.

Don’t forget about the inflation factor. Plan on increasing your retirement income by at least 3% each year so that you have consistent purchasing power. And as you plan, it’s important to remember that the reason some retirees suffer money shortfalls is because they’re invested in a way where their investments do not meet their risk tolerance. There are multiple ways to set up income distribution plans through market-based strategies or insurance products. Each strategy has advantages and disadvantages, and a duly licensed advisor – who is not biased one way or the other – can help walk you through the pros and cons of all the different strategies.

Don’t underestimate taxes. Taxes aren’t always less in retirement just because you are not working; withdrawals from tax-deferred accounts such as 401(k)s can complicate your financial picture, and an advisor can help you strategize before retirement about how to lessen the blow. While we don’t know what future tax rates will be, a solid retirement plan incorporates money that can be withdrawn tax-free, such as from a Roth IRA or a cash-value life insurance policy.

An advisor can help you project your after-tax real rate of investment returns. This is done to assess whether the portfolio is producing the necessary retirement income. The after-tax real rate of return is the actual financial benefit of an investment after accounting for the effects of inflation and taxes. It’s a more accurate measure of an investor’s net earnings after income taxes have been paid and the rate of return has been adjusted for. As one ages, this return threshold goes down as low-risk retirement portfolios are often mainly composed of low-yielding fixed-income securities. One crucial point to remember is determining your tax status when you begin to withdraw funds in retirement.

It can seem overwhelming to estimate your retirement expenses well before you are retired. Of course, no one can predict the future. But the best chance of achieving the confidence you want in retirement starts with an honest analysis of your expenses and a strategy designed to meet them.

About the author: Samuel J. Dixon, RFC

Samuel J. Dixon, RFC, is a managing partner at Oxford Advisory Group. A graduate of the College of Business at Florida State University, he specializes in retirement planning, estate planning, and investments for retirees, executives, and small business owners. He lectures on risk aversion in retirement and developing a predictable retirement plan. 


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