Calculating expenses is key to retirement financial planning

In planning for retirement, the basic question for most people is how to replace your working paycheck so you can maintain your desired lifestyle in a retirement period that may be 20 or 30 years. As a financial advisor I find people often want to first focus on how they will generate income during retirement, concentrating on how much they can earn from sources such as Social Security, pension payouts, distributions from investment retirement accounts, and perhaps continuing to work to some degree.

This is understandable as cash flow calculations from these sources tend to be pretty straight forward. The issues that from a financial planning perspective it is a little like putting the cart before the horse. The question is how can you determine how much income you will need if you don’t know how much your retirement will cost? Accurately estimating your expected expenses therefore is key to your retirement planning because it will likely dictate many of the financial decisions you will have to make.

For example, your projected expenses may determine when you can stop working, when you should begin claiming your Social Security benefits, how you should design your retirement accounts withdrawal strategy so you don’t run out of money in your lifetime, what type of investment strategy best suits your needs, or if you will need to work part-time to make ends meet.

Accurately planning for these future expenses is a challenge because they involve so many unknowns. Rising inflation, healthcare costs or long-term care needs, unexpected financial calamities, market volatility, even your life longevity all pose complications that, lacking a crystal ball, often cannot be fully foreseen. Also, please know that the old rule of thumb that you should expect retirement expenses to be around 80% of your working expenses often falls short these days. However, there are techniques that can help with your future expenses financial planning.

For example, I encourage my clients to consider their retirement expenses in different categories:

The first is essentials. These are the must-haves of life — your mortgage or rent payments, regular medical expenses such as insurance premiums, utilities, groceries, and other monthly expenses that keep your life running. These expenses tend to be less flexible and therefore should be covered by more dependable fixed income sources, such as Social Security, pension payouts or other annuity payouts, and then supplemented with other income such as from investment accounts distributions.

The second is lifestyle expenses. These are the nice-to-haves in life, such as travel, dining out, or maybe a weekend home. It’s about the activities you want to do and how you want to live. While not as vital as essential expenses, they are still important in determining the quality of life you wish to have. Having a good grasp of what these expenses will be enables you to adjust your variable income sources for them, such as determining the investment strategies that will generate sufficient distribution income from your retirement accounts but still remain within your risk tolerance levels.

A third is, well, other stuff. For example, I encourage clients to maintain a “safety net” equal to at least six months of essential expenses, even though building this resource may require cutting into your lifestyle costs. Also, clients who regard leaving a financial legacy as very important also need to incorporate this into their financial plan as a type of future “expense”.

Obviously, retirement financial planning can be complicated. A CERTIFIEDFINANCIAL PLANNER™ professional can help you to develop the financial goals that are most important to you and then help keep you on track to achieving these goals – and help you keep that horse firmly in front of the cart.