Credit: People budgeting for retirement are in for a shock. What they will need is often more than they think. Higher-than-expected inflation and psychological barriers to cutting spending are the main culprits.
Budgets are tough things to do. There are fixed costs - things you have to have like utilities, food and even cable TV - and there are one-time expenses. The latter is usually bigger chunks, such as replacing cars, patching roofs and going on vacation. You can put off some one-time outlays, like a vacation, but not others: for instance, installing a new furnace in mid-winter after the old one died.
The federal government, which in October showed how difficult budgeting can be, at least knows that things get more expensive every year. As a result, without one vote being cast, our expenses rise each year, mainly due to automatically higher spending Social Security, Medicare and other entitlements serving an aging population. The Congressional Budget Office projects that over the next quarter-century, federal spending will increase to 26% of gross domestic product, 22% in 2012 and an average of 20.5% over the past 40 years.
Fortunately, a normal household doesn't have to deal with these large numbers, and you can vote to make changes when necessary if a shortfall looms. Your discussion with your spouse about what to cut likely won't result in a household shutdown based on the discussing. Yet as with Congress, outside forces complicate your planning.
Here are three factors to take into account when budgeting for retirement:
The 70% myth. Don't believe the old advice that you need just 70% of your working income when you retire. True, some expenses are gone or whittled down by then, like mortgage payments. Still, think about trips and other leisure pursuits you want to do as a retiree, when you will have the time. Those costs mount up. Plus, medical expenses expand; Medicare pays for only about half of your health-care tab.
Inflation Allowances. Certainly, the Consumer Price Index is tame nowadays, with inflation falling 0.2% in September. Inflation, though, is constant and relentless over the long-term, and this cannot be ignored. I caution you to use a 2.5% to 3.5% annual increase in most of your fixed expenses.
Making spending cutbacks. One major mistake we see pre-retirees make is that they say to themselves: "We will stop this expense or reduce that cost at retirement." Bad plan. This is not how you want to begin retirement, but it does provided confidence during the planning stages. But it is false confidence that makes you feel better today at the expense of reality.
If you go on a diet to achieve a goal weight - dieting is very similar to reducing expenses -you can give up chocolate or something else that you love in order to succeed. The discipline works and you hit the goal. Yet can you live without chocolate forever? That's not so easy.
People try to convince themselves that at retirement they will go from good wine to box wine, or buy used cars rather than new cars. My favorite is that they will give up cable TV or at least the movie packages upon leaving the work force. These may sound like plausible ideas and make the numbers work on paper, but they are simply not realistic for happy transitioning into the next phase of your life.
Creating an accurate budget is challenging and perhaps even as difficult as following one. To better understand your future, your chance of success, you need to know the numbers and be realistic in your assessment of what you want and need.
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Joseph "Big Joe" Clark, CFP, is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He teaches financial planning at Purdue University and is the host of Consider This with Big Joe Clark, found on WQME and iTunes. He is a Registered Principal offering Securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at bigjoe@yourlifeafterwork.com , or (765) 640-1524. Follow him on Twitter at @Big Joe_Clark and on Facebook athttp://www.facebook.com/FinancialEnhancementGroup.
Securities offered through and by World Equity Group Inc. Member FINRA/SIPC. Advisory services can be offered by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
