Developing A Retirement Budget
The path to retiring early is straightforward. Accumulate enough assets to fund all your expenses for the rest of your life. Figuring out what is “enough” and then saving that amount can be challenging.
Today I want to limit the discussion to expenses and budgets. In order to answer the question “how much do I need to save for early retirement?“, you have to determine what you plan on spending in early retirement. Everyone has unique interests and desires and can expect to spend different amounts while working and during retirement. I can’t tell you whether spending $30,000 per year is right for you or if you will be happier spending $50,000 or $100,000. It all depends on what kind of lifestyle makes you content and how long you want to work in order to gather enough assets to fund your desired lifestyle.
I’ll be the first to admit that budgeting can be boring. I never put together a budget while working. We were naturally frugal and always managed to save half our paychecks or more. Decent incomes helped fuel the high savings rate.
I didn’t budget, but I did track expenses very closely. I started out using an excel spreadsheet. It was somewhat complicated and took about an hour per month to update. This is a good method as long as you are diligent in keeping the spreadsheet up to date.
I recently switched to Personal Capital to track all of our expenses (review). Personal Capital also tracks all our income (including dividends and interest), and summarizes a couple dozen investment accounts into one screen. It is completely free to use Personal Capital whether you have $1,000 or $1,000,000 or more. If you don’t already track expenses, try Personal Capital, since it only takes 10 minutes to sign up and link all your accounts.
In a recent article on the Root of Good household’s annual expenses, I showed how our core annual expenses add up to around $24,000 per year. This amount is an average of our actual spending over the three year period of 2010, 2011, and 2012. Some of these core expenses will continue unchanged into retirement, while others will increase or decrease depending on our planned retirement activities and lifestyle.
I also added a line item to explicitly account for income taxes, since these are no longer a “cost of working” but are now an expense associated with our spending. The more we spend, the more we have to withdraw from our investment portfolio, the higher our income tax will be each year.
Here is a chart showing our historical average spending, projected changes in spending due to retirement, and our retirement budget:
I’ll start with the home repairs and maintenance addition. I added $1,500 per year to my repairs/maintenance category to cover things that eventually need replacing, upgrading, or may require major fixes:
- HVAC system
- hot water heater
- plumbing or electrical,
- doors and windows
- carpet or other flooring
- interior and exterior paint
For each system or item on the list, I took the rough cost to replace or upgrade the system and divided by the years the system typically lasts to get an annual cost. For example, I expect to get around 10 years of service out of the HVAC before needing major service or total replacement. I figure $4,500 should cover the replacement. That amounts to $450 per year. I repeat this exercise for the roof ($4,000 to replace every 20 years), appliances (~$350 to replace various units at 8 to 20 years), and all the other items on the list.
Luck being what it is, I will probably have to replace my hot water heater, HVAC and an appliance or two in the same year. But then I might go five years without spending anything on the items on this list. That is why I use an average cost per year of $1,500 that should cover all the items over the long term. I can do some of this work myself (with youtube’s help) or spend time finding a good inexpensive contractor, so that will save me some money as well.
Other house expenses like utilities, taxes, and insurance should remain relatively constant. We might see a slight increase in energy and water consumption due to being home more during retirement. For now, I am not adding anything extra into the retirement budget to account for slightly increased consumption.
Some might wonder where our mortgage payments are on the budget. Although we still have a mortgage right now, it only has a little over three years remaining. Instead of accounting for the monthly payments as an expense, it makes more sense to mentally set aside enough to pay off the mortgage in full (around $50,000) and not include that amount in our investment portfolio total that will be used to fund our retirement expenses.
Our already low auto expenses should drop when Mrs. RootofGood gives herself a pink slip soon. Right now, we spend about half our auto budget on gas for Mrs. RootofGood’s commute. I subtracted $1,500 from the “auto – gas” category to account for no more commuting costs.
The plan is to cut back to one car once Mrs. RootofGood isn’t working, which will save on insurance, maintenance, registration, and taxes for the second car. I don’t really drive more than two or three times per week now that I’m retired, and it is mostly with the rest of the family. Cutting back to one car should be fairly easy given our access to transit and walkable destinations around the neighborhood.
Since I am using our historical spending from 2010 to 2012 as the basis for our retirement budget, there are no “car replacement” costs recorded in the historical results. We didn’t buy any new cars during that period. To account for the cost of buying a new(er) car occasionally, I added $1,000 to the “auto maintenance” category. However, cutting from two cars to one car should reduce our maintenance, insurance, and taxes by at least $500. The net result (+$1,000 – $500) is a $500 addition to the “auto maintenance” category.
After the $1,500 savings from getting rid of the commuting costs, we should end up with a $1,000 reduction in annual auto costs in retirement.
Medical and Dental
Medical and dental expenses are a little tricky. While working, Mrs. RootofGood had excellent nearly free medical insurance and well subsidized dental insurance. These insurance expenses came out of her paycheck and are not something we expected to carry into retirement, so we never tracked the expenses.
In retirement, we will get a health insurance plan from the new healthcare.gov exchange. Since our taxable income is so low, we will qualify for a very significant subsidy that will help keep premiums down. I expect the health insurance premiums to be around $1,100 per year. Check out why our premiums will be so low in this article on Obamacare and early retirement. Our premiums might be even lower (closer to $500) if our state doesn’t expand Medicaid (the subsidy kicks in at a lower income level). But I’m planning on $1,100 per year for budget purposes.
We plan to self insure for dental expenses during retirement unless a great dental insurance plan comes along. Most dental insurance plans seem to be fairly expensive for the coverage you get. We have a great solo practitioner dentist that is also very affordable and doesn’t recommend unnecessary treatments (to his own financial detriment!).
Historically, we spent $1,425 annually on medical and dental expenses (in addition to med/dental insurance premiums we didn’t track). These costs included some pretty serious stuff including the delivery of our son and tons of precautionary tests during the pregnancy (everything turned out perfectly, by the way).
I am budgeting $2,000 extra for medical and dental expenses, and most of that is for the health insurance premium. Additional dental expenses make up the rest of the increase.
Our tax bill during retirement will be very low due to our low incomes and our three dependent children. Federal taxes will be close to zero, and state taxes won’t be much higher. At some point in the next 10 to 20 years as the kids leave the house (and their dependent status), our taxes will go up as our kid related expenses go down.
For budget purposes, I’m planning on $1,000 per year to cover our federal and state income tax burdens. I have been pretty good at managing my tax liability while working, so I think I can keep it up in retirement (when our taxable income stream will be more malleable).
We are looking forward to more vacations. And longer vacations. We average around $1,300 per year on vacations and have managed to get in quite a bit of traveling in the last three years (given that we have three kids):
- long weekend in Washington, D.C.
- 2 weeks at the beach in an oceanfront house
- 7 night cruise in the Caribbean
- shorter beach trips and day trips
I’m a big fan of “travel hacking”. I get a lot of free airline miles and hotel points from credit card bonus offers and using the right cards to maximize rewards and cash back. In the list of our recent vacations, I didn’t include our nine day trip to Argentina and Uruguay where we spent about $500 total including hotels, flights, local transportation, and meals. In addition, we recently spent 4 days in Chicago for about $250 total (free flights and hotels for the four of us – we left the one year old with grandma).
Travel hacking makes our vacations incredibly affordable. Or viewed a different way, we can stretch a $1,300 vacation budget pretty far when we can get free or cheap flights and hotels.
Where are we headed next? I honestly don’t have a clue! But we would like to travel all over the world. Various destinations in Central and South America, Europe, and Asia make the list. We also plan on taking cruises occasionally to more “mundane” destinations like the Caribbean.
Having lots of free time in retirement gives us more flexibility to pick travel dates that save us money or stretch our airline miles further. We can travel during an off-peak season or on any day of the week if the cheap flights are only available during certain times or days. We are also able to partake of steep discounts for last minute travel. For example, we scored a nice mountain cabin rental on the lake this past summer for more than 50% off the going rate. The owners were running a last minute special to fill up their cabin for the following weekend.
To fund our additional vacations, I have added $4,000 to the “vacation” category which brings our total vacation budget to just over $5,000. This may not seem like a lot, however throw in a set or two of free flights for the family and a week or two of free hotels, and we can get pretty far on that sum of money.
I subtracted $150 from the “education, training, and professional fees” category. I paid for some professional licenses while working. I won’t have those expenses during retirement, since I went “inactive”. Unless I get bored and reactivate a license or two to have some fun and make a buck.
I bumped up our “miscellaneous” spending category by $956 as a fudge factor to allow a little extra spending here and there. It also makes our total retirement expenses an even number, so that alone is worth $956 per year.
The Bottom Line
To recap, I took my average historical spending from the last three years and then projected how our expenses will change in retirement. Then I added the historical expenses and the projected changes to arrive at my retirement budget. I started with around $24,000 in historical expenses (during my working years) to which I added around $8,000 in increased spending during retirement. The bottom line retirement budget comes to $32,000.
There is a little fluff in our budget, so we could always trim back on spending in some areas if our investment portfolio performed really poorly or we had an unexpected expense in one category. Since our budget is so low, even a tiny bit of supplemental income can keep us living our planned retirement lifestyle.
Our year to year spending will never hit $32,000 exactly. One year we might spend $5,000 more than budgeted if we replace a car or do a major home improvement project. Other years our spending might run a few thousand under the $32,000 budget.
They key to a successful early retirement is knowing what you want to spend, and saving enough to be able to fund your desired lifestyle.
Want to retire early?
Here are your action items:
- Start tracking your expenses now. Personal Capital is the easiest way to start tracking expenses in only 10 minutes. You have to know what you are spending before you can plan your retirement budget. No excuses!
- Think about what you want to do in retirement and what it might cost. Take your time on this. This is probably the hardest part of budgeting for retirement expenses, as it can be difficult to think of what you want to do for fun for the rest of your life. But you are responsible for your own entertainment.
- Figure out areas where your spending in retirement might differ from your spending while working. You will spend less in some categories like commuting and will probably spend more in other categories like entertainment, recreation, and travel.
- Take your current expenses and add or subtract as necessary in areas of spending that will change in retirement. Don’t forget categories like “income tax” that you may not keep track of right now.
Update as of 3/1/2015: For 2015, I’m giving us a 1.3% raise over 2014 and plan on spending $32,400. I hope to publish an updated overview of our early retirement budget soon.