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Financial Advisors and Retirement Planners for Attorneys and Couples

How to forecast expenses in retirement

I’ve talked to a lot of retirees and people close to retirement. And I’ve run into some very smart people! Many retirees I talk to have done their own financial forecasting and modeling, trying to estimate what their expenses will be 5, 10, 15 years from now and if their portfolio will be able to sustain the spending.

So exactly do you forecast your expenses in retirement? This is tricky. Even the most avid budgeter is going to be off because there are a lot of unknowns. But there are ways to improve your accuracy. Let’s start with the worst method: cash flow.

The worst way to forecast your expenses is based on your current overall cash flow. The way this is done is like this: take your current take home pay, subtract taxes, subtract how much you are putting away in retirement accounts and other accounts and voila! There’s how much you’ll spend in retirement.

There are a few problems with this method. First, what you spend money on right now is not what you’ll necessarily spend money on in retirement. Unless of course you want to buy work clothes and drive to an office every day in retirement. But if you’re like me, you want to do different things—like travel, try new hobbies, maybe start a business just for fun, volunteer, dote on your grandkids, etc.

Secondly, your expenses will change over time. The amount you spend on healthcare will go up probably because you won’t have a generous employer health plan. Medicare isn’t free. And furthermore, healthcare costs will probably increase faster than other expenses like food and shelter. At a certain point in time, your home will be paid off and you’ll spend less because you won’t have a mortgage.

Okay, so what’s the better method? Goals-based budgeting. Create a separate budget for different categories: basic living expenses, healthcare, mortgage, travel, a home remodel, a new care, etc. Start with the basics—the bills and spending on everyday things like food. These are your basic living expenses. Make sure you adjust your budget for inflation—I estimate about a 2.5% increase each year. Add in the mortgage and note when it gets paid off, but make sure you keep the property taxes in your budget. Oh and these will inflate each year too. When it comes to healthcare expenses, I use a higher inflation rate: 6.5%. If you need help estimating these costs, AARP has a health care costs calculator on their website.

Sounding confusing and tricky? Maybe you need the help of someone who specializes in this stuff. Give us a call today!


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