Table of Contents
Table of Contents
When planning for your retirement spending needs, a good place to begin is with understanding the average retirement budget. From this foundation, you can build in some key assumptions, such as life expectancy, health care needs, inflation and investment return rates.
A good place to begin is examining your current cash flow and itemizing your regular spending. This can help you understand the costs you may encounter in retirement and form budgeting goals to work toward in the meantime.
Once you've calculated your personal spending baseline, you can factor in other financial assumptions. Some of the key things to think about are how to anticipate your saving and spending needs and the external forces and situational factors that can affect them. Here are some details on each of those to consider:
Retirement Budget Guidelines for Saving & Spending
It's difficult to know exactly what assumptions to make about your retirement — how much income you'll need or what a good withdrawal pace is so you don't deplete your assets. But some general rules can help you sketch out your retirement budget:
The 80% Rule for How Much Money You'll Need
Financial planners commonly forecast retirement spending by assuming you'll need 80% of your pre-retirement income. For example, if your total annual household income is $100,000 the year before you retire, you could probably expect to need at least $80,000 in income in your first year of retirement.1 It's important to realize this is just a general rule. Your spending could be higher or lower depending upon other factors, such as your health status, travel plans and personalized lifestyle costs.
To get a more individualized estimate, you can use our retirement calculator with your exact numbers and assumptions to see how long your retirement savings will last.
The 4% Rule for How Much to Withdraw
The 4% rule for retirement withdrawals can help you estimate how much income to take from your retirement savings each year so that it lasts.2 It's based on historic average rates of return and calculates what annual withdrawals you could make, including adjustments for inflation, for 30 years without running out of money. While its effectiveness has been debated in recent years — and numbers may need to be adjusted on individual situations — the rule provides a good strategy to abide by.
Let's say you expect to have $1 million in your retirement accounts by the time you decide to stop working. Based on the 4% rule, you might withdraw $40,000 (4% of $1 million) in your first year of retirement.
The next year, you might again take out 4% but also factor in a small increase for annual inflation. If you were to take out $40,000 again plus an additional 3% of that $40,000 for inflation ($1,200), your total withdrawal would be $41,200 in year two.
The idea is that you can continue to take out a 4% withdrawal amount plus a bit extra for inflation every year. Based on historic averages, the money should last at least 30 years using this rule. You may need to set your sights on a different number, based on your personal preferences and individual situation, so give this rule ample thought before implementing.
The Rule of 72 for Forecasting Investment Growth
The sooner you start saving for retirement, the more your investments have time to compound and reach their growth potential. A simple rule for envisioning what this investment growth will be is the Rule of 72 for compound interest. It can give you an estimate of the number of years it will take to double your original investment.3
To find that number of years easily, divide 72 by the expected annual rate of return on your investment. If that rate were 8%, then it would take about nine years (72 divided by 8) before the original investment amount would double. Using a $10,000 investment as an example, the rule would predict an 8% compound interest rate and bring that account to about $20,000 in nine years (the actual figure is about $19,990, so it's a pretty close estimate).
You can also use this rule another way — to calculate the rate of return needed to double your investment over a specified number of years. For this, divide 72 by the number of years in which you want the investment to double. So if you wanted to double your money in 10 years, you'd need an annual rate of return of 7.2%.
One note: Calculating with the Rule of 72 does not include any additional contributions you might make to the account over time. To get a closer estimate using periodic deposits, try our compound interest calculator.
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External Forces on Your Retirement Spending
Unfortunately, you can't control every aspect of retirement planning with simple accounting formulas. The costs of things can change, and you can't know how long you'll live. But if you keep external factors like these at the top of your mind, you can build some flexibility into your retirement plan:
A reasonable average long-term rate of inflation to plan for is between 3% and 3.5%. While the annual inflation rate has recently turned higher, it's important to look at a longer range of time for retirement calculations. Retirement can last several years, if not decades. Historically, the rise and fall in the costs of goods and services smooth out in the long run. For example, the U.S. annual inflation rate was 7% in 2021, but the average long-term inflation rate was 3.25%.4
If you are years or decades away from retirement, you'll want to adjust your retirement income needs to reflect the long-term inflation rate. With an average rate of 3.25% inflation, for example, your income need would double in 22 years. So, if you're about 40 years old now and your annual income is $50,000, you would want to have $100,000 to maintain the lifestyle you have now in your 60s.
Affordability & Location
Knowing the best and worst states for retirement is useful for planning.5 A significant factor that can place your retirement spending above or below the average retirement budget is the state you plan to live in after you've retired. Some states have a higher cost of living — the cost of housing, food and health care — as well as higher income and property taxes than other states.
The most affordable states for retirement in 2022 include Georgia, Oklahoma, Tennessee and Texas while the worst — strictly in terms of costs — include California, Connecticut, Massachusetts and New York.
According to the Social Security Administration's life expectancy calculator, the average number of additional years a 65-year-old male can expect to live is about 19 years; for a female of the same age, it's 21 years.6 This means the average life expectancy for people who are just reaching retirement age right now is roughly 85 years.
However, regardless of expectancy, there's no calculating if a person will live in retirement for five years or 40 years. Life expectancy averages don't account for a wide number of factors that influence longevity, such as your health, lifestyle and family history.
Situational Factors for Your Retirement Spending
Fortunately, some elements of retirement budgeting are personal factors that you may be able to control. It's crucial to consider the potential benefits and risks of these factors like these:
When adjusting the average retirement budget to meet your needs, your health status may factor into your best guesses about your life expectancy and living costs. This can be difficult to quantify, especially for younger people trying to plan for retirement decades ahead of time. Some key aspects that can help you plan, though, are your current lifestyle and family health history.
For example, if you're a smoker and your family has a history of heart disease, your life expectancy will probably fall below average. But if you're in good health and your parents and grandparents lived exceptionally long lives, you might count on the same for yourself.
To be conservative, financial planners often recommend assuming a longer life expectancy of 90 years. This precaution can help reduce the risk that you'll run out of money in retirement.
Living Expenses & Lifestyle
Lifestyle costs can greatly affect a retiree's bottom line. If you love to travel and dine out frequently, you can expect your retirement spending to be high. Or if you opt for a simple life in retirement, your income needs may be significantly lower.
On average, you can expect living costs in your 60s and beyond to be lower compared to your 50s. The Bureau of Labor Statistics reports that people in their 50s have living expenses of nearly $71,000. But that number is halved to about $35,200 for people age 65 and older.7
When anticipating your living costs in retirement, you'll want to factor in reductions in housing costs, such as downsizing or paying off a mortgage, and elimination of childcare costs, if applicable. Some expenses you can probably count on having are these:
- Property taxes
- Auto and travel
- Insurance premiums
Emergencies can still happen after you've retired, so it's important to continue to factor in unforeseen costs as a part of your retirement spending. Not factoring for surprise expenses has the potential to derail your plans.
Financial professionals generally advise setting aside three to six months of living expenses. If your basic monthly living expenses — food, housing, utilities and insurance premiums — are $5,000 per month in retirement, then it's a good idea to have $15,000 to $30,000 in emergency funds. Whether you're closer to three months or to six months of living expenses depends on multiple factors, such as your health or how dependable your income sources are.
While it can seem easy to project living expenses in retirement, there are often multiple factors to consider, including life expectancy, health care needs, inflation, living expenses and lifestyle. General guidelines, such as an average retirement budget, can be a good start for planning, but working with a financial professional can prove valuable, especially as you get closer to retirement.
- Hagen K. How much do I need to retire comfortably? The Motley Fool. https://www.fool.com/retirement/how-much-do-i-need/. Last updated December 8, 2021. Accessed March 7, 2022.
- Parrish S. The 4% rule faces new problems today. Kiplinger. https://www.kiplinger.com/retirement/retirement-planning/603831/the-4-rule-faces-new-problems-today. Published November 29, 2021. Accessed March 7, 2022.
- What is compound interest? U.S. Securities and Exchange Commission. https://www.investor.gov/additional-resources/information/youth/teachers-classroom-resources/what-compound-interest. Accessed March 7, 2022.
- United States inflation rate. Trading Economics. https://tradingeconomics.com/united-states/inflation-cpi#:. Last updated February 2022. Accessed March 7, 2022.
- Cohen M. The 10 best states in the U.S. to spend your retirement in 2022. CNBC. https://www.cnbc.com/2022/01/29/the-10-best-states-in-the-us-to-spend-your-retirement-in-2022.html. Published January 29, 2022. Accessed March 7, 2022.
- Retirement and survivors benefits: Life expectancy calculator. Social Security Administration. https://www.ssa.gov/oact/population/longevity.html. Accessed March 7, 2022.
- Consumer Expenditure Surveys, 2020. Table 4500: Selected age of reference person: Annual expenditure means, shares, standard errors, and coefficients of variation. Bureau of Labor Statistics. https://www.bls.gov/cex/tables/calendar-year/mean-item-share-average-standard-error/reference-person-age-splits-2020.pdf. Published September 2021. Accessed March 7, 2022.