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How to Estimate Your Retirement Expenses

Estimate How Much You Will Spend Each Year In Retirement

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To determine how much money you will need to retire, you must estimate your retirement expenses, or how much you expect to spend each year in retirement.

1. Start with how much you spend now.

A good way to begin to estimate retirement expenses is to use your current monthly take home pay as a starting place, and then ask a few additional questions. Answer the following questions when going through this process:

  • What is your monthly take home pay?
  • What expenses come out of your paycheck that you will have to pay out of pocket once you are retired?
  • What extra expenses do you want to budget for during retirement? This would include things like travel, or extra money for medical expenses.
  • Be sure to build in monthly savings for items that will eventually need to be replaced such as major home repairs or automobile purchases.
  • Do you have expenses that will decrease in retirement? For example, if you have a long commute to work, your transportation costs may decrease after retirement.
  • Don't forget to estimate taxes you will pay in retirement.

Example:
  • Current monthly take home pay: $4,300 per month ($51,600 per year).
  • Expenses covered by employer that will come out of pocket once retired: currently your employer pays for your health insurance premiums. You learn that once retired you will have to pay $350 per month ($4,200 per year) for this coverage.
  • Extra expenses: You plan on traveling in retirement, so you budget an extra $500 per month ($6,000 per year) for travel.

After totaling those expenses, you estimate that your total monthly expenses in retirement will be $5,150 ($61,800 per year).

Caution: Take your time with this step, as you have to know about how much you will spend to determine how much you will need to retire. One of the biggest mistakes I see retirees make is inaccurately estimating how much they will need to spend in retirement to have a comfortable lifestyle. They end up overspending because they missed items in their initial list of retirement expenses. The most common items that are missed are annually occurring items like real estate taxes, or insurance premiums, medical expenses such as dental, eye care, and hearing and periodic expenses like needed home and auto repairs.

To get a more detailed picture than using monthly take home pay, print out and complete this retirement expense worksheet. I also provide additional tips in How to Make a Retirement Budget.

2. Once you have an accurate estimate of your retirement expenses, estimate the amount of income tax you will pay on your retirement income.

To come up with an accurate estimate of the amount of taxes you will pay in retirement you will need to run a tax projection. You can learn how in 3 Ways To Do Your Tax Planning.

Why is tax planning so important?

If you have mortgage interest, rental properties and/or the majority of your retirement income will come from investments that are not inside of a retirement plan, you may pay very little in taxes once retired. If you have pension income, the majority of your retirement income will come from qualified retirement plans like IRAs or 401ks, and/or your home is paid off, your tax rate in retirement may be higher than you might think.

Learn more in Frequently Asked Questions About Retirement Taxes

To continue the example above, assume this person will pay 15% for federal taxes.

Calculation:
$61,800 / (1-.15) = $72,705

(In the calculation above, by dividing your net income by 1 minus your expected tax bracket, that will tell you the amount of gross income you will need to pay your taxes and meet your expenses.)

This particular upcoming retiree has calculated that they will need about $73,000 of gross income per year to retire comfortably. For clarification, here is the breakdown of gross income, taxes, and expenses in the example:
$72,705 x .15 = $10,905 (estimated taxes)
$61,800 (living expenses) + $10,905 = $72,705

Many of the detailed online retirement income calculators will provide a retirement income tax estimate for you.

Next: Figure Out Sources Of Guaranteed Retirement Income

Back to: 4 Steps To Determine How Much Money You Need To Retire

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