How to create a budget for retirement: A financial plan for your newfound freedom

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A retirement budget can help you better enjoy life after work.

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You’ve finally set a date for your retirement. Congratulations! All those years of long-term planning and saving have paid off. You’ve cleared the retirement homestretch. Now it’s time to relax and put your money worries behind you. Right?

Not quite. A solid next step is creating a retirement budget that considers potential changes to your income and expenses, including basic needs and long-awaited indulgences.

The first step is to define your lifestyle and its price tag. Many people need about 70% to 80% of their pre-retirement income to cover expenses in retirement. But no two households are the same. One couple may be planning to travel eight months out of the year and downsize to a smaller home, while another is content to putter around in the garden and catch up on some reading. Consider where you fall in that spectrum, and plan your spending accordingly.

Even if you have a relatively clear vision for retirement life, plotting out your anticipated expenses can be challenging, especially if you’ve never tracked them before.

Medicare, the government’s health insurance program that kicks in when you turn 65, covers many health care costs as long as retirees opt into Part B and Part D supplemental plans. Even with those plans, a 65-year-old single retiree can expect to shell out $157,500 to cover out-of-pocket health expenses in retirement, while a 65-year-old couple can anticipate paying about $315,000, according to a 2023 study by Fidelity Investments.

Furthermore, the average retiree can expect to spend some time in a long-term care facility. Many consumers mistakenly think that Medicare covers long-term care costs. The program does provide some coverage for short-term stays, but after 100 days, you’re mostly on your own.

By 2031, costs for long-term care could range from $6,048 to $12,141 monthly, depending on where you live and what level of care you need, according to projections by Genworth Financial. That kind of cash outlay is out of reach for many retirees, so coming up with a plan to cover such costs should be addressed in your budget.

If you plan to move closer to your children so they can assist in your care as you age, it’s important to consider whether your costs of living will rise or fall. Housing is typically the largest expense for most consumers, but other factors, such as real estate taxes, could also impact your budget one way or the other. Also, although most states don’t tax Social Security income, 11 do, and some tax other forms of retirement income. Be sure to research your state’s tax rules.

Occasional, unanticipated expenses are commonly overlooked when creating a budget, which is all the more reason to plan for them. If your retirement spans 30 years, for example, you may need to replace your home’s heating and/or air conditioning system along the way and buy a new mattress every so often. You might need a new car at some point. If you don’t have a comfortable amount of cash set aside, it might be wise to budget a monthly contribution to a savings account.

If you have a significant other, does your budget address what may happen to your finances if they die? The spouse or partner left behind, especially women, can often expect a significant drop in income, so proper estate planning should be part of the retirement budget process.

Say goodbye to your regular paycheck and hello to Social Security benefits—and possibly pension distributions, annuities, and money from more pursuits such as part-time jobs, rental properties, and even hobbies.

For those lucky enough to have socked away money in retirement accounts like 401(k) and individual retirement accounts, you’ll be able to draw down from these accounts to supplement your regular retirement income, but how much can you withdraw annually without running out of money? Financial advisors often rely on the 4% rule, which calls for withdrawing 4% of your savings each year (adjusted for inflation) to help keep you in the black for the rest of your days.

But don’t think you can avoid taxes by sitting indefinitely on the hard-earned money you’ve stashed away in a 401(k) or IRA. The IRS requires that you begin withdrawing some of your money each year beginning at age 72 or 73, depending on the year you were born. Known as required minimum distributions (RMDs), the amount is calculated by your account custodian, or you can use an IRS worksheet. (The idea is straightforward, but the RMD rules can get complex.)

Now it’s time to put the pieces of the puzzle together. Does your projected income, including that 4% withdrawal, exceed your projected expenses? If so, congratulations! You might consider planning to withdraw less than 4%, especially if leaving a financial legacy is important to you.

If your expenses exceed your income, you may find that you’ll have to play golf only twice a week to stay within your means. If paring down luxuries doesn’t do the trick, it may be time to think about a part-time job, renting out a room, downsizing, or a reverse mortgage.

Be cautious with your retirement accounts. It can be tempting to take out more than you’d planned to cover these shortfalls, but then you run the risk of running out of money. Slight modifications to your withdrawal plan may be possible, especially if it’s for the short term or your investments have outperformed your expectations.

For nearly half of workers over age 50, their biggest fear is outliving their savings and investments, according to a Transamerica Center for Retirement Studies survey released in September 2023. Although there are no guarantees, one of the best ways to ensure you don’t run out of money is to create—and stick to—a realistic retirement budget.