Building Your Retirement Budget

One quick comment before I cause any of my other readers to have a near heart attack.  In all these discussions about how much money you need to accumulate to cover your retirement years, we are talking about covering the expense needs that are not already being met by your other income sources such as Social Security or pensions.  Your annual “withdrawal” would only be the shortfall, or difference between your other retirement income and your expenses.

So let’s talk expenses.  I just saw this morning that CanadianMDinvestor has a great series about building your own retirement spreadsheets.  I like that he is actually starting at the beginning:  the budget.  As commenter, deegee, pointed out, this is really the foundation around which the whole process revolves. 

As I've said before, I don’t believe in short-cutting this process by assuming your budget will be 70% (or some other random percent) of your current income or current spending level.  I believe you have to go line by line and look at exactly what you are spending now, and then project the expenses that will increase, like health insurance, and those that will decrease like commuting costs. 

Once you’ve captured every single expense, break it down into two categories, non-discretionary and discretionary (or as CanadianMDInvestor calls it, needs versus wants.)  I’m not going to get all judgy about what is a want versus a need, for example, I view a housecleaner as discretionary, but I know for many of you that is a non-negotiable need.  This is your budget.  You get to decide.

Our breakdown landed at 70% non-discretionary:  Auto (repairs, fuel, insurance), computer and computer supplies, groceries, home maintenance and repairs, property taxes, mortgage payments, homeowners insurance, medical insurance and expenses--and 30% discretionary:  charitable donations, clothing, dining out, education, entertainment, gifts, recreation, subscriptions and vacations. 

When I originally went through this exercise, I included every want.  But I couldn’t make the retirement spreadsheet work with that budget.  And I really, really wanted to retire.  I wanted retirement more than I wanted to have someone else clean my toilets.  I wanted retirement more than I wanted to have someone clear my weeds.  I wanted retirement more than I wanted to work out at a fancy gym or stay in fancy hotels. So I cut those expenses and eventually trimmed enough fat to make it all work.

The reason I think it’s important to know how much of your budget is discretionary, is in the case that you feel you need to go to Plan B.  There are any number of factors that would require you to tap into Plan B, an unexpected medical expense, a dead car, or as in my situation, a 50% market decline.  The more cushion you have built in on your discretionary budget, the more flexibility you have to respond appropriately.

So maybe instead of calling it the discretionary portion, we should call it the peace of mind portion.

 

Some great related posts from Tamara at Early Retirement Journey:

            Budget Allocation in Early Retirement

            Retirement Budget Tracking

            Establishing Priorities to Achieve Early Retirement

 

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Comments

[Steve]

Excellent post. The discretionary and non-discretionary budget distinction is critical for peace of mind and flexibility. To me, "rules of thumb" are a waste of time. Everyone should analyze and understand their unique circumstances, including their personal inflation rate as the aggregate economic number most likely isn't representative of what each person is experiencing. For forecasting, planning, tracking, adjusting and staying on top of actual events, the spreadsheet is invaluable.

[deegee]

The "cushion" part is IMHO the most important part of one's ER budget. This enables you to be able to withstand at least some small, unforeseen expenses which may arise.

In my own case, I had to buy a new PC back in January. It cost me about $430 which was not a problem because the cushion I had couls already cover such expenses.

I did not, however, split my budget into discretionary versus non-discretionary expenses. I don't lead a very extravagant lifestyle (most months I do not even use my credit card) so there really isn't much I could cut. My monthly expenses are rather low anyway.

I do split my budget into medical versus non-medical for the purpose of assigning inflation rates, as my individual health insurance premiums are the ones which could cause me the most trouble long-term. I did switch to more of a bare-bones policy a year ago which has helped a lot.

[Robin Kirk]

You're right, classifying the expenses if it's discretionary or not can differ in every individual, depending on his/her needs. For example, optional expenses for me would be my relaxation costs (movies, gym, gadgets) while non-optional ones include my basic needs like food and rent. Although it's not mandatory to classify them, it helped me to track down further where I spend my income.

[Carlos Silva]

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