Now is the time to be as specific and realistic as possible about your expected retirement spending. Don’t be tempted to estimate your retirement needs based on a percentage of current expenses — that is a poor rule of thumb when planning for retirement.

While some of your current expenses may decrease, others may increase. Of course, your estimates will not be exact. Think of this planning estimate as a blueprint for your retirement planning, subject to revisions as your needs change.

Understanding Today’s Spending

A good starting point for serious retirement financial planning is to understand your current expenses. Where does your money go now?

If you don’t currently track expenses, keep track over the next few weeks of everything you spend. Then, classify these expenses into major categories such as food, entertainment, and utilities. You may be surprised where you’re spending your money!

Forecasting Future Spending

Once you understand what your current monthly spending is, you’ll have the basis for predicting which expenses may change when you retire.

A significant number of retirees spend at least what they did before retirement, with many spending more - at least those who are not restricted by income.

Although detailed budgeting can help, what is most critical is a thoughtful comparison of today’s major expense categories with costs expected during retirement. Here are some expense categories and how they may change.

Some retirement expenses usually go down:

• Taxes. If there is no earned income after retirement, payroll taxes for Social Security and Medicare disappear. For example, someone earning $50,000 annually, paid $3,825 in 2006 for Social Security and Medicare taxes, but will pay nothing in retirement if there is no earned income. (Some public sector employees have not paid Social Security.) Some states have reduced property taxes and income taxes for retirees.
• Retirement contributions. For those who are saving aggressively - as they should be just before retirement - this change can be significant.
• Life insurance. This type of insurance may not be needed after retirement, or at least not as large a policy as during the working years, since survivor pension benefits and retirement savings should take care of dependents.

Some expenses may be replaced by other costs:

• Everyday expenses. It is usually assumed that during retirement there will be lower costs for basic living expenses such as clothing, utilities, food, and commuting. Retirees may find that they can reduce these costs by using coupons and discounts.

Retirement generally doesn’t affect utility costs; however, it may even increase heating and air conditioning costs if more time is spent in the house. Food costs may change depending on how many meals are prepared at home. The clothing budget may increase for a time as the work wardrobe is replaced by casual clothes. Commuting cost savings may be more than offset by leisure travel or the costs of going to volunteer work.

Some big future expenses are determined by today’s decisions:

• Mortgage payment. A mortgage payment is often a family’s single largest monthly expense, especially during younger years. Retirement spending rules of thumb assume that the mortgage will be paid by retirement age, but that is not always the case.
• Other debt payments. Many retirees must make debt payments out of limited retirement income. Poor debt management can devastate the retirement years.

Some expenses are likely to increase:

• Health care cost. In retirement, the days of getting a generous employer contribution to our health care costs are over. Only a lucky few retirees will enjoy significant employer health care contributions.

For a couple who retire before Medicare eligibility at age 65, monthly health insurance premiums can easily exceed $1,000. Even after age 65, costs associated with a Medicare supplement frequently exceed $500 a month for a couple.

Some costs will be high:

• Paying for your dream. Whatever money is not needed for required expenses is your retirement dream money. The better job you do with managing expenses for necessary things, especially by eliminating debt and managing day-to-day costs, the more money you will have to spend as you want.
The better job you do with managing expenses for necessary things, especially by eliminating debt and managing day-to-day costs, the more money you will have to spend as you want.
• Giving. Many retirees who have been financially successful want to share their good fortune with others. Many wish to contribute to their grandchildren’s education or to make gifts to adult children or a favorite charity. Giving to church, charity, or family during his or her lifetime can be a tremendously satisfying capstone to the life’s dreams of a retiree.
• Travel and leisure costs. Retirement travel is an expense that can grow to be greater than expected. The cost of extensive travel is a new expense in retirement that needs to be realistically estimated.

Plan for the inevitable:

• Survivor costs. For couples, however emotionally difficult, financial planning for survivorship is a necessary part of retirement planning. Understanding how the death of one partner will impact expenses and income can lead to better decisions that will reduce money worries for a survivor.

Matching Expenses To Income Sources

Now look at your retirement spending plan to see what is required and what is desired. By distinguishing between needs and wants, you can see how much flexibility you have in your budget and determine which expenses can be reduced, if necessary.

If your lifetime income sources, such as defined benefit pension payments and Social Security, will cover your required budget and if they will continue to meet your basic needs as your costs change, you have a high degree of retirement security. If not, you may need to consider supplementing these secure income sources with systematic withdrawals from conservatively invested retirement accounts or perhaps even an immediate payment annuity. Before purchasing an annuity, investigate how to purchase service credits from your pension system, if that option is open to you.

The difference between required and desired spending is flexible spending - extras such as eating out, travel, and entertainment. These expenses may be best covered as needed by flexible, occasional withdrawals from invested retirement accounts.