Budgeting in Retirement: The First 5 Years

Newly retired or about to be? First off, big kudos to you. While bidding adieu to your working years is quite a major life achievement, and there’s much to be excited about, it’s important to consider your finances during this huge transition.

Adjusting to your new income when you’re retired takes work. You’ll want to make sure you have enough to be happy. Here are some tips that folks who’ve recently retired should consider.

Get a Handle on Your Living Expenses

Because you’ll be living on a fixed income for the rest of your life, you’ll need to figure out what your expenses will look like when you retire. The general rule of thumb is to aim for your living expenses during your golden years to be 80% or less of those in your pre-retirement period.

It’s not until you enter retirement that you truly know what your expenses are, points out Mark Wilson, president of MILE Wealth Management.

While some expenses, such as your mortgage and bills, remain the same, others, like the costs of commuting and your wardrobe for work, may take a dip. And some might also go up, like those for travel, hobbies and entertainment. “Roughly tracking these in retirement will give some comfort as to where actual spending will end up,” Wilson said.

Adjust Your Expenses According to Your Values

Know what’s important to you, and create a spending plan around those values. If you’re married, have conversations with your spouse on how to spend in a way that’s in sync with your shared values, says Robinson Crawford, founder of Montebello Avenue.

Since you’ll most likely need to lower your expenses, cut back in areas that make sense to you. Let’s say maintaining your home is starting to be more trouble than it’s worth. In that case, consider downsizing. Or if you no longer need to commute to work, can you make do with one car for your household? On the flip side, if you and your spouse love fine dining, aim to spend more eating out.

At the end of the day, it’s about making realistic trade-offs so you can enhance your quality of life while not going over your new budget. “Taking ownership means being responsible for the transition to a fixed income, and failure to do so can jeopardize your retirement success,” Crawford said.

Look for Ways to Earn Extra Cash

You may find that going from working full time to not at all can be a hard adjustment, explains Jeffrey Burke, owner of 7th Street Financial – not to mention that you’re getting accustomed to a smaller budget. Consider finding part-time work or a side hustle; job websites geared toward the 50-and-older set include Senior Job Bank and Retirement Jobs. As a seasoned professional, you should also consider consulting in your field, or you can turn a long-harbored passion into a side business. Ideally, do something you really enjoy, recommends Burke. You’re retired, after all. This not only eases financial pressure, but can help you meet new people, stay social and stave off boredom.

Figure Out When You’ll File for Social Security

Although you can take your Social Security benefit when you’re 62, depending on your situation, you may want to wait a little longer. Each year you push back claiming Social Security means a boost in your monthly and lifetime benefits.

For instance, if you delay filing, you’ll receive 8% more in benefits until you hit age 70, explains Pat Logue of Prudent Financial Planning. When you reach your full retirement age, which is typically 66 or 67, you’ll receive 100% of your benefits. Hold off until you’re 70, and you’ll get 132% percent of your benefits. “Optimizing your Social Security filing strategy can result in your net worth increasing substantially over your lifetime,” Logue said.

Tax Advantage of Lower Tax Brackets

You’ll most likely be in your lowest tax brackets in your early retirement years, Wilson notes. That’s because you may be bolstering your Social Security with funds saved outside of your retirement plans.

“Once you hit age 70½, a portion of tax-deferred accounts must be used, and this leads to higher tax brackets from that age on,” Wilson said. “Making Roth conversions or taking capital gains can be an excellent strategy that will save you taxes.”

You’ll want to gauge whether you’re a good candidate for a Roth conversion. Also known as a “backdoor” Roth IRA, a Roth conversion means converting money from your Traditional IRA to your Roth IRA and paying taxes on the amount. “The goal here is to move funds from a tax-deferred account to a tax-free account, while paying a low tax rate to do so,” explained Danny G. Michael, a principal of Satori Wealth Management.

You’re a prime candidate for a Roth conversion if you’re in a lower income tax bracket but have the resources to pay any tax owed on the conversion, Wilson adds. This is usually the case when you can live off a single source of income – think Social Security, cash savings or investments in a taxable account – which can be cashed in at a preferred tax rate.

Mind the Required Minimum Distributions (RMD)

Let’s say you’ve created a pristine budget, Crawford says. It includes taxes, Medicare and Medigap insurance, and it even has a long-term care plan. One item that’s easy to overlook? Your required minimum distributions on your retirement plans and IRAs (except Roth IRAS). If you’re over 70½ and have assets in a pre-tax retirement account, such as a traditional IRA, you’ll be subject to taking out a minimum amount of these funds. See how this factors into your retirement paycheck or fixed monthly income.

Yes, creating a budget for your early retirement years is complex, but it’s also essential. It would be wise to take a close look at your budget right before you retire and in the first few years of retirement, making adjustments as needed. Chances are you’ll need to re-evaluate every few years thereafter to ensure that your lifestyle is a good match for your spending plan. By making money moves now, you’ll be that much better off in the years to come.

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