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7 Steps to Building a Retirement Budget

Retirement Planning
older couple doing paperwork and planning their retirement budget

While entering retirement is certainly an exciting, celebratory time, it also involves a host of financial considerations. As you make this major transition, it's important to evaluate your financial situation and make the proper adjustments. A retirement budget may help you stay more financially stable. Here are some steps to consider as you get started.

1. Examine Your Expenses

When devising a retirement budget, it's good to be realistic about how much you may need for your day-to-day life. You might be most active during the first few years of retirement. Consider setting aside some money to cover the costs of travel, new hobbies and social activities.

Health care and medical bills tend to be big expenses after retirement. A recent report found that retirees in the U.S. spent an average of $122,000 on medical costs between the time they turned 70 and when they passed — most of which was paid out of pocket. Try to account for these potential changes in your expenses when devising a new spending plan.

2. Find Small Ways to Save

Since retirees generally live on a fixed income, consider reducing your cost of living as much as you can without radically diminishing your quality of life.

The areas where you choose to cut back largely depend on your personal needs and preferences. If your kids are grown and have left the nest, you might want to downsize. When you no longer work, you may choose to have one car for the household instead of two. You could also save on food by eating out less, or you could reduce monthly bills by canceling subscriptions you no longer use.

3. Create a Retirement Paycheck

Giving yourself a "retirement paycheck" simply means allotting yourself a regular amount of money each month. Factors that could affect your retirement paycheck include any continuing work, Social Security, mortgage payments and other bills, debt, retirement accounts, savings and investments, and insurance.

To supplement your retirement paycheck, you could purchase an annuity, which provides regular payments on a fixed schedule. An annuity has an accumulation phase as well as a payout phase. The type of annuity — fixed, variable, deferred or immediate — that might work for you depends on whether you're saving for retirement or already retired. As you determine which type is best, you may want to be mindful of any potential surrender charges. Immediate annuities and annuities that have been annuitized generally don't come with surrender charges, but funds are often not accessible outside of the guaranteed income stream.

4. Bucket Your Savings

When planning your retirement budget, you'll generally also need to determine how long you'll accumulate assets and when you'll start taking money out of each of these funds. To help make this determination, consider the "three-bucket approach" to savings. This approach separates your money into three different pools, or "buckets," to help provide income from different sources at different points during your retirement.

The first bucket contains cash reserves that you may need to tap into in the next few years. Generally, it consists of guaranteed, liquid income as well as Social Security and pension funds. The second bucket is for money you may need within the next 10 years.

Finally, your third financial bucket is for the distant future. This may contain longer-term investments. By keeping these higher-risk investments in the third bucket, you'll allow them more time to potentially net a higher return. Just keep in mind that these investments do not guarantee growth and have the potential for both gains and losses.

5. Earn Some Side Income

Could you use extra cash to boost your retirement income? If so, you might want to take on some side jobs. Or you could capitalize on your experience as a seasoned pro in your field and offer consulting services. By working, you could boost your retirement income and also create an avenue to explore your passions and meet new people.

6. Assess Your Tax Strategy

How and when you'll be taxed affects your retirement budget. Traditional IRAs are tax-deferred. However, you'll be taxed when you start withdrawing funds. Roth IRAs are taxed the year you make contributions, so you can enjoy tax-free distributions on earnings as long as certain requirements are met. Pension payments are taxable. Examine your accounts and consider speaking with a tax professional to understand your tax obligations.

7. Review Your Spending Plan Regularly

A good budget reflects changes in needs and lifestyle. Consider sitting down, reviewing your spending plan, and making adjustments as needed on a regular basis. With so many moving parts and considerations, it might be useful to meet with a financial professional to discuss your concerns, assess your needs and develop a budget.

A retirement budget could help you live more comfortably in your non-working years. Use these tips to get started and keep in mind that the budgetary choices you make today will likely affect your financial future.

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To qualify for tax-free, penalty-free distributions on Roth IRA earnings, the account must in place for at least five years and the account owner must be over age 59 ½, using the distributions for a first-time home purchase, or due to death or disability.

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