Congratulations on making it to retirement! Now you have the time you always wanted to do whatever you choose and focus on what brings you happiness.

But the way your retirement looks to you at the beginning is not how it will look over time. The fact is that your retirement will evolve in phases as your priorities change. So one of the most important things you can do right now is to understand how your retirement will change and budget for those different phases.

The three phases of retirement spending.

We typically break retirement down into three distinct phases, each with its own distinct priorities and financial considerations. But it’s certainly not a straight line for spending or budgeting.

Early retirement. These are the go-go years when you’re free of the responsibilities of work and child-rearing to do what you want. Many clients tend to spend more on travel and other activities in this early phase.

Mid retirement. This phase marks a transition from the “go-go” years to the “go slow” years. Here, your priorities may be dictated by your health, mobility, legacy and overall goals. At this phase, travel, for instance may not be as important as it once was.

Late retirement. This could be called the “no go” years, when health and other issues take center stage.

Sources of retirement income.

If you’re like most people, once you stop working, you’ll be on a fixed income with three potential sources to draw on: savings, investments and Social Security. If you’re one of the 21% of people in the U.S. to have a pension, that’s even better. But no matter how many income sources you have, you should stick to a financial plan and budget right from the start.

Because now we have to convert all those savings and investments into a replacement for your paycheck. So, one of the first decisions you’ll make is how and when to withdraw from your retirement accounts. While most clients take monthly distributions, you can also choose to take your money annually, quarterly, semi-annually, or just about any time you want.

Creating a retirement budget before you retire.

While a solid budget will be fluid, it should be built into your financial plan. Well before our clients are ready to retire, we like to work with them to create a budget. Because the last thing anyone wants is to run out of money in retirement.

There are also a number of expenses that every budget should include, yet many people forget. Most of us will naturally budget for basics like housing, transportation and food. And many people will also want to set aside money for fun stuff like travel, after all you now have unlimited vacation time. But you also have to consider and plan for unexpected retirement expenses that could quickly drain your savings and may even affect your financial legacy.

A few of these often-overlooked expenses could include:

Taxes in retirement. Typically, you will pay taxes on retirement account withdrawals. We know this sounds basic, but many clients forget this and it’s big. Our rule of thumb is to withhold at least 20%-25% of your withdrawal. If you need $10,000 a month, for instance, we tend to add an additional 2,000 for taxes so $10,000 in expenses means $12,000 withdrawal. If you’re lucky enough to have a Roth IRA, withdrawals are tax-free. However, we tend to put off Roth withdrawals as long as possible so it has as much time as possible to grow. Of course, such decisions are different for every client and are based on your circumstances and personal preferences. We recommend that you always check with your tax professional to see what’s right for you.

One question we hear often is, “Will my Social Security be taxed?” Some retirees do owe federal taxes on their Social Security. And while most states don’t touch your Social Security benefits, there are some that do. Even if you live in a state that doesn’t tax your benefits, the federal government still might; more than 40% of beneficiaries pay income taxes on a portion of their benefits. The amount you’ll pay in taxes typically depends on how much you withdraw and your combined retirement income. A number of tax management strategies might help to mitigate your tax bill, so working with a tax professional can help ensure taxes don’t drain your retirement account.

Medical Expenses. By some estimates, you’ll need an average of $295,000 per person to cover medical expenses in retirement. Women often require more than men because they live longer. We have some clients who’ve set up a medical account or earmark some of their investments specifically for medical expenses.
It’s also important to know that Medicare won’t necessarily cover all your health care expenses in retirement. Fortunately, you have several options when dealing with health care retirement expenses. To help cover those additional costs you might consider additional insurance plans to bridge the gap, such as:

  • Medigap
  • Medicare prescription drug coverage
  • Health savings accounts (HSAs)
  • Long-term care

One of the most important and often-overlooked needs is preparing for long-term care as you age. The U.S. Department of Health and Human Services estimates that 70% of older Americans will need some kind of long-term care. This can include assistance attending to personal needs, such as bathing, dressing, eating, taking medications and more. Medicare usually doesn’t cover these expenses, and the government estimates the average duration of long-term care services is two years with an average total cost of $138,000. So it’s important to plan ahead.

Caring for adult children. Dubbed the “boomerang” or “sandwich” generation by some observers, young adults are staying in school longer and delaying marriage. Currently more than one in three of adults 18 to 34 is living in their parents’ home, according to U.S. Census Bureau data from 2017.

Certainly there are some benefits. After all, moving back in with mom and dad can provide millennials with an opportunity to start saving money toward their own financial independence.

But it’s not just adult children moving in with retirees. The Pew Research Center found that 14% of adults living in a shared household in 2018 were parents who moved back in with their adult children. From an elderly parent’s vantage, moving back in with family may be a preferred option if they didn’t plan adequately for long-term care.

Whether your children move back in with you or you move in with your children, it could still put a dent in your retirement spending, and it’s something to consider as you plan your budget.

Prepare for the unexpected. Even the best plans can change, and some events, like divorce or bringing grandkids into the house full time, could mean rethinking retirement completely. Divorce could mean a smaller pool of retirement funds, which means less money to invest and less time for it to grow. It could also mean a new budget for housing, food and health care expenses. And it happens more frequently than you might imagine. “Gray Divorce” is now the largest-growing segment for divorce attorneys.

Some of our clients also face the responsibility of raising a grandchild, which often adds a major financial stress. According to U.S. Department of Agriculture data from 2020, the cost for a middle-income family to raise a child until age 18 is $233,610 – and that doesn’t even include the cost of college.

Finishing the job you started.

If you’re like most of our clients, you’ve been working toward this moment for 30 or 40 years. But in many respects, saving and investing was the easy part. Now, creating a budget and transitioning to retirement may well be the most important part, since how you budget your income sources will determine the kind of retirement you’ll have.

That’s just one reason it’s so important to work with a CERTIFIED FINANCIAL PLANNER™ professional. There are few things more critical as you transition into retirement than to keep your retirement budget expectations and projections in line.

This is the time you have waited for, and getting this part right will allow you to truly enjoy the fruits of all your labor.

This commentary contained herein is intended for informational purposes only and should not be construed as tax, legal or investment advice. Past performance is not indicative of future results. Clients should obtain their own tax, legal or investment advice based on their circumstances. The material is based on sources deemed reliable but is not guaranteed.

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