Here’s Why Budgeting Before Retirement Is So Important

09.21.23 | Personal Finance

When you imagine your retirement, you might picture traveling to sandy beaches, enjoying hobbies, and spending more time with family. Budgeting seems the opposite of fun, but some thoughtful planning can help you understand how income and spending change in retirement.

Income and Spending Change During Retirement

Do you know how much income you’ll need to maintain your pre-retirement lifestyle? Will you have enough to pursue your hobbies or take the Alaskan cruise you’ve always dreamed of? Understanding how your income and spending may change during retirement allows you to plan for the things that matter most without worrying if you’ll have enough money.

Income Plan

Your retirement income will probably include a mix of cash savings, 401(k), IRA/Roth IRA, Social Security, and/or pension. Your Social Security benefits will depend on your earnings history and retirement age. It may help to look at your first five years of retirement and where your income will come from. This gives a good understanding of your baseline and what supplemental income might come from your investments.

Spending Plan

Your retirement income determines how much you can spend. We usually advise our clients to plan for 70-80% of their pre-retirement income as a starting point for building out their retirement budget. Once you retire, you won’t be setting aside a percentage of your income for investments and savings. Other expenses like taxes and transportation might also go down. However, if you have a very active lifestyle, you may need to plan for 100% or more of your pre-retirement income. Everyone is different and your planning/budgeting should reflect the retirement you envision.

Income Planning May Help Minimize Potential Tax Liabilities and Medicare Premium Adjustments

Taxes may change during retirement, but they don’t disappear. Your retirement income will be taxed in a variety of ways:

  • 0-85% of your Social Security will be taxable (depending on your income)
  • Withdrawals from traditional IRAs and 401(k) accounts are taxable at ordinary income rates
  • Pension payments from private or government pensions are taxable
  • If you decide to continue working past retirement age, your wages are taxable
  • Capital gains and qualified dividends are taxed at preferential rates.

Tax-efficient income planning can help manage your tax burden and Medicare premiums, which are directly related to your income. The higher your income, the higher your Medicare premiums will be once you surpass a certain income level. The extra charges are called Income-Related Monthly Adjustment Amounts (IRMAA) and are based on your modified adjustment gross income (MAGI) from two years prior. So, your 2023 tax return is used to calculate IRMAA and Medicare premiums in 2025.

Planning around IRMAA isn’t easy since it requires thinking two years in advance. But a little careful planning can go a long way.

Filing For Social Security At The Right Time Maximizes Benefits

The “right time” to file for Social Security is different for everyone. It depends on a variety of factors like health, life expectancy, income need, balance of retirement savings and investment accounts, current economic landscape, interest rates, and more.

The earliest you can file is at 62 and the latest at 70. The decision of “when” broadly comes down to this:

  • Filing earlier means a smaller payment for a longer period
  • Filing later means a larger payment for a shorter period.

Each year you delay past full retirement age your benefit increases 8%. If you file before full retirement age there is a reduction between 5-6%. However, it may not make sense to delay if you do not have enough savings to live on until your full retirement age. The goal should be to file at the right time to maximize benefits and minimize taxes. Planning for this window is much easier if you already have an idea of your retirement income and spending plan.

Budget for the Retirement You’ve Always Wanted

Retirement income planning and budgeting isn’t everyone’s idea of fun, but a little bit of work upfront can avoid future headaches. We can take the frustration out of retirement budgeting and help you make informed financial decisions so you can have the retirement you’ve always wanted. Contact us any time to plan for a more confident financial future.

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