Tips for Making a Retirement Spending Plan
4 Min Read | Last updated: August 9, 2024
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Retirement spending plans tell you what portion of your retirement savings you can spend each year. Here’s how to start a retirement spending plan of your own.
At-A-Glance
- “Pay yourself first” is one of the core tenets of personal finance. But when you’re retired and ready to spend the retirement savings you’ve worked so hard for, you’ll need a plan.
- Retirement spending plans usually take into account factors like your age and Social Security eligibility, as well as the general direction of the overall economy.
Creating a retirement spending plan can be one of the most delicate financial decisions that one makes. If you end up spending too much, too soon, you could run the risk of running out of money in retirement – which is among the top fears of most Americans. In fact, in an Employee Benefit Research Institute (EBRI) survey, 70% of retirees wish they had saved more or earlier for retirement.1
Like most financial topics, retirement spending begins with asking yourself a few questions. These questions can help you set the foundation for a solid plan by tailoring the answers to your retirement budget and needs. To create a strong retirement spending plan, you may want to start with these two questions:
- How much should I withdraw from my retirement accounts?
- Which retirement account should I withdraw from, and in which order?
This article examines key elements and common questions on how to budget for retirement spending, as well as strategies that may help your money last longer.
How to Budget for Retirement
To create a solid retirement spending plan, it is important to have a good estimate for your retirement expenses. First, using an expense tracker or bank statement, gather all of your essential expenses. A typical retirement budget would generally include housing (if renting or owning and still carrying a mortgage), healthcare, food, utilities, and transportation. Remember that some of these expenses in retirement may be less than what they were during your working years.2 There are a few reasons for this. For example, transportation costs could be significantly less because you may not be commuting to work. The decrease in the amount of driving could also result in lower insurance rates.
According to an analysis of Bureau of Labor Statistics (BLS) data, Americans 65 years and older spend less than the average American As of September 2022 BLS Consumer Expenditure Surveys, the average American spent $66,928, which comes out to about $5,577 each month. In contrast, those who are 65 years and older spent an average of $52,141, or about $4,345 each month. These expenses drop even more at age 75, when the average is $45,820 or $3,818 per month.3
The next step is to estimate what your income will be in retirement. In most cases, your retirement income will be dependent on the amount that you have saved for retirement in accounts like an Individual Retirement Arrangement (IRA) or 401(k), but also include Social Security, any pension that you might qualify for, and income from any side projects, rental properties, or businesses that you may decide to run in retirement.
According to data from the Social Security Administration, for people over 65, Social Security benefits represent about 30% of their income.4 The amount received in Social Security income will vary depending on when you decide to draw on the funds. The longer you wait, the higher your Social Security income will be – especially if you wait to collect until you reach 70 years old.5 This is one reason why it is important to strategically withdraw funds from your retirement accounts, but how much should you withdraw and from which accounts?
The 4% Retirement Spending Rule
The 4% rule is one of the most common retirement withdrawal methods. It suggests that you withdraw 4% of your total retirement account balance each year and adjust that amount for inflation in subsequent years.2 For example, someone with a balance of $1,000,000 in their 401(k) account would withdraw $40,000 in their first year of retirement. Before accounting for taxes, this would mean that their retirement income before Social Security and other factors will be about $3,333 per month.
With this number in hand, you should have a better idea of what you can afford to spend in retirement. If there is a shortfall, and your expenses exceed your annual income from 4% of your retirement account, that is where Social Security or a part-time job enter the picture.
Keep in mind that the 4% rule is not perfect – it does not take into account the potential impact of rising interest rates or market volatility. Consider meeting with a financial planner to decide if the 4% rule is right for you or if there is another strategy that may work better.
Which Account(s) Should You Withdraw from First?
As you spend money in retirement, you will have to choose which account to withdraw from and in what order. The order of withdrawals matters, as it could have an impact on your tax situation and the longevity of your retirement savings. A common method here is to begin spending from your taxable investing accounts first, followed by any tax-deferred retirement (traditional IRA, 401(k), etc.) accounts.6 However, your choice should be tailored to your specific situation with the help of a financial planning and tax professional.
Putting it All Together
Let’s say you decide to retire at age 65. After adding up all your expenses, you determine that you need $3,500 per month to pay your expenses, which works out to $42,000 in your first year of retirement. If you decide to take Social Security benefits now, you will receive $1,400 each month (or $16,800, annualized). By contributing to your 401(k) over your career, you have saved $800,000. Using the 4% rule, you could withdraw $32,000 of that $800,000 in your first year of retirement, or $2,666 per month. That amount, plus your Social Security benefit, equals $4,066 each month (before factoring in taxes), or $48,800 for the full year. In this simplified scenario, your retirement income exceeds your expenses and you’re good to go.
If you run into a scenario in which your annual expenses in retirement are higher than your retirement income, then you may have to consider other options, such as working longer or taking a part-time job to offset the deficit.
The Takeaway
Creating a retirement spending plan can be broken down into three major parts. The first is understanding and gathering all your expenses. Next is finding your sources of income in retirement. Last is deciding how much of that income you will use each year.
1 “Retiree Reflections,” Employee Benefit Research Institute
2 “How Much Will You Spend in Retirement?,” Experian
3 “Consumer Expenditure Surveys,” United States Bureau of Labor Statistics
4 “Fact Sheet Social Security,” Social Security Administration
5 “You Can Receive Benefits Before Your Full Retirement Age,” Social Security Administration
6 “In What Order Should You Tap Your Retirement Funds?,” Kiplinger
Kevin L. Matthews II is a #1 bestselling author and former financial advisor. During his advisory career he managed more than $140 million and ranked among the top 100 most influential financial advisors.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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