In this article, we discuss the Smiths’ and the Jones’ different lifestyle spending needs, and the annual savings necessary to maintain their lifestyle in retirement. Let’s walk through the steps these families should take each year to help them stay on track to achieve their goals.

1. Determine the cost of your annual lifestyle spending needs, and how much of that will continue into retirement.

  • Smiths – They currently earn $150,000 a year. After excluding retirement savings and expenses that wouldn’t continue into retirement, such as the cost of commuting to work, they determine that their annual spending is $90,000.
  • Joneses – They currently earn $500,000 a year. After backing out retirement savings and expenses that wouldn’t continue into retirement, this couple finds their annual spending is $250,000. This higher spending need is in part due to living in an expensive city and having a mortgage on their home and vacation property. About 10 years ago, this couple’s income was $175,000, with spending needs of $115,000.

Take-away: To determine your lifestyle spending needs, you need to exclude retirement savings and expenses that wouldn’t continue into retirement. Expenses that remain include utilities, taxes, food, entertainment, travel, etc. Many households carry a mortgage for the first 10-15 years into retirement. If you don’t think you’ll pay off your mortgage by the time you retire, make sure to include this housing cost in your spending estimate. You need to be aware of how much your lifestyle spending changes over time to make sure it’s sustainable in retirement. It’s far easier to spend more money than to cut back on your lifestyle.

2. Determine annual savings goals.

  • Smiths – To maintain their $90,000 spending level in retirement, the family has committed to maxing out their retirement accounts. The combination of Social Security benefits and withdrawals from their accounts in retirement will be enough to maintain their lifestyle without exhausting their resources.
  • Joneses – The family has been maxing out their retirement accounts, which was what they needed to do when their lifestyle spending was $115,000 a year. However, they haven’t increased savings since their income and lifestyle spending skyrocketed. If they plan on maintaining their $250,000 spending level in retirement, they need to save more money in coming years. This means that in addition to maxing out their retirement accounts, the Joneses need to put money into their taxable investment savings accounts and/or deferred compensation plan if available through their work.

Take-away: To maintain your lifestyle in retirement, you need to save annually to be on track for this important goal. The annual savings target can vary dramatically per family due to age, years until retirement and spending needs. You need to reevaluate your savings goal needs each time your lifestyle spending needs change to make sure you’re still on track. The good news is that once you’ve reached your annual savings goal, you can spend leftover dollars spent guilt-free!

We suggest working with an advisor to determine and reevaluate your annual savings targets to confirm whether you’re on track.

3. Prepare and follow a budget.

  • Smiths – In step 2, the Smiths determined that maxing out their retirement accounts is enough to achieve their goals as determined, so they can simply use a budget to track their spending. 
  • Joneses – It’s important for the Joneses to prepare a budget so they can see where they’re spending their money and determine where they can find the resources to make their additional annual savings. Since the Joneses are playing catch-up on their savings, they need to track their spending more closely and cut some unnecessary expenses so they can put away larger sums.

Take-away: No matter your income level, having a household budget is key to achieving your goals. It allows you to put all your income and expenses in one place to determine how much savings you can automate each month. The article Taking Control of Your Household Budget discusses a technique you can use as a budgeting template. It’s especially important to have a cash flow plan for families where cash bonuses and restricted stock make up a large part of their compensation.

4. Create and stick to a predetermined plan for unexpected income.

  • Smiths – Unless this family decides they want to spend more in retirement or retire earlier, they don’t need to save additional resources each year. Any excess resources can be spent or saved toward another goal, or on a trip!
  • Joneses – This family receives large annual bonuses. Some years are larger than others. In the past, the family spent the entire sum. Since they were already maxing out their retirement accounts during the year, they didn’t have any of their bonuses withheld for savings. Now that they know they need to play catch-up to achieve their goals, they’re open to saving a larger portion of them. This family could pre-allocate part of these bonuses to their employer’s deferred compensation plan and save a tremendous amount on taxes, or they could put it into a taxable investment account. This means that when they receive the bonus, the lesser of either 50% of the bonus or the amount they need to achieve their savings goal will be put toward savings. This still leaves a large portion of the bonus to spend on their lifestyle.

Take-away: If you’re behind on meeting your annual savings goals, you should have a predetermined savings allocation for windfalls. This means that of the bonus that you receive after-tax, possibly 25% is allocated to spending (i.e., the fun stuff), 25% to travel and short-term savings and 50% to long-term savings. That way, you get to spend and enjoy a large portion of your bonus while also saving a large sum towards the future. Too often, people receive a bonus and spend it quickly. It’s important to have a predetermined plan for how to allocate these excess dollars because your budget won’t account for this income.

We suggest reading Making Work Optional: Steps to Financial Freedom to learn how to best prioritize your savings to achieve your long-term goals. Make sure you read the section about “mistakes to avoid” on your path to financial freedom.

Please contact Merriman if you need help determining whether you’re on track for retirement, calculating annual savings targets and/or for any of your other financial planning needs.