Many people have dreams of traveling, giving back, and spoiling grandchildren as they look forward to retirement. Whatever your retirement dream may be, you need to plan accordingly. Someone who intends to volunteer and complete puzzles in their free time will have lower expenses than someone who wants to travel the world, and you need to plan for those expenses no matter what your ideal retirement may look like.
Your retirement goals will dictate how much you should save and what kind of planning you need to do. While many people consider the bare essentials when thinking about costs in retirement, they sometimes overlook the discretionary spending that they might want to do. However, discretionary spending can have a huge impact on your retirement savings plan.
Broadly speaking, discretionary spending is any expense that is not required to cover basic, essential needs. It can be contrasted with mandatory spending, which is required to ensure that you live a healthy and safe lifestyle.
At its very basic level, discretionary spending includes “wants,” but mandatory spending items are “needs.” Potential examples of discretionary spending that you might see in retirement include things like:
Generally, anything that requires “fun money” is likely considered a discretionary expense.
Mandatory spending is sometimes referred to as “essential spending.” It includes any item or service that you must pay for to survive. Expenses related to your “four walls” are included in mandatory spending. These include things like:
You also need to consider necessary payments that you may not have had before retirement, such as increased tax obligations (in some cases). If you have any debt by the time you retire, you will need to account for those expenses in retirement as well.
In 2019, Forbes reported on a study that examined the true costs of retirement. Their study found that those planning for retirement are poor estimators when it comes to predicting what kinds of costs they may incur. For example, 46% of respondents estimated that their housing costs would go down in retirement. In reality, only about 30% of retirees will spend less on housing in retirement compared to when they were working full time.
Unfortunately, discretionary spending is sometimes forgotten or severely underestimated in retirement planning calculations. Failing to account for discretionary spending can leave your retirement savings severely underfunded if you expect to live the same type of lifestyle as before retirement.
For some, discretionary spending may stay relatively stable. However, for those who want to carry out big plans of travel or charitable giving in retirement, for example, their discretionary spending may go up. This spending increase may not last for your entire retirement period, but it might be a big part of it.
Discretionary spending may spike just before or just after retirement. After all, you have worked hard for your retirement, and spending money for house upgrades, gift-giving, and trips, are all very new and exciting. Many retirees will spend significant amounts of money on whatever they think is appropriate during this active stage.
As the “newness” of retirement wears off and retirees become less active, they are less likely to spend as much money. In the later years of retirement, funds often need to focus on medical needs, so discretionary spending slows significantly.
You should be able to review your current expenses to have a good idea of your continued essential budget items in retirement. However, your discretionary spending could change dramatically after you retire—often because you now have the time to take up the expensive hobbies that you have always wanted to do.
The first step in creating a budget that considers discretionary spending is to decide what discretionary spending categories you may have. Think through how often you will want to travel and where you will go, for example. Consider what kind of gifting you want to do on a regular basis. What kind of funds will you need to pursue hobbies?
Once you have this basic information, you can start making cost estimates for these goals. These estimates will become part of your regular budget in retirement (yes, you should still budget in retirement).
Consider an example. Imagine that you want to take at least one relatively lavish trip each year in retirement. You would also like to take several shorter trips throughout the year as well. Based on what you have in mind, the cost of the big trip will likely be around $5,000. The shorter trips will be $1,000 each. Based on this retirement goal, you will need an extra $7,000 every year in retirement.
While making accurate estimates is important, there is no way that you can realistically plan discretionary expenses to the penny. The critical aspect of this type of planning is that you pick a number that makes sense for you and your situation, and you stick to it during retirement.
Simply understanding how much you need in retirement is a good start, but you also have a lot of work to do to plan and put that plan into action—and the sooner you start, the better.
Dechtman Wealth Management wants to help you start the retirement planning process with their free e-book resource, “Plan Your Retirement Income in 5 Steps.” This resource takes the daunting task of planning for retirement. It breaks it down into manageable action steps that you can work through, including a review of discretionary vs. non-discretionary spending. This resource covers mandatory spending, discretionary retirement spending, and creating a discretionary spending personal budget. Download this free resource here.