People save and invest money for decades leading up to their retirement. But when you finally walk away from your job, it can be difficult to determine exactly how much of that money you should spend.
Some people overspend, while others are afraid that they are spending too much and live excessively frugal lifestyles. Here’s how you can navigate the first year of retirement so you don’t fall into the first-year spending trap.
Why the first year of retirement can be financially disorienting
Many aspects of your life can change when you stop working. You no longer get a regular paycheck, which means you’re likely pulling from investment and savings accounts. You may be tapping Social Security, or strategizing how to put off receiving benefits so you can get a bigger check.
You’re spending your time differently, which can lead to added costs. Your first year of retirement may be filled with deferred costs for home repairs, appliances or a new car. You may need gear for new hobbies, or want to spend money on outings with children and grandchildren. You also need to factor in taxes you’ll pay on withdrawals from traditional retirement accounts. Many retirees also like to travel, which can be expensive.
While overspending is certainly a risk, financially disciplined households can also struggle to go from saving mode to spending mode. Even well-prepared households can feel uncomfortable about spending money they have put in their nest eggs despite planning for this exact scenario for many years.
How to stay on track
You don’t want to spend too much or too little in retirement. While your first year of retirement may look different than the ones that follow, it can be a good test period to get your financial systems in order.
Tracking your monthly spending and categorizing each purchase as recurring, temporary or one-off will give you a better picture of your normal expenses. You can also establish a “retirement transition” budget for the first 12-18 months that accounts for extra spending, and then tighten it afterward. You can then revisit withdrawal rates after the initial spending settles down. Keep in mind, you should adjust any strategies so that they align with your specific goals and financial situation.
Regularly revisit your budget and monitor your spending so that you understand how much you’re spending relative to what you have saved. Remember that you’re not just looking at whether you’ve spent too much money; you also want to get a sense of whether you’re limiting yourself.
Planning ahead helps. Before retiring, assess all your finances and make a plan for how much you can spend. That way, you won’t get caught up in the emotions of being free from your job, and you can create a strategic plan that takes into account your income, budget, taxes and dream retirement.
