Step 4: Retirement Cash Flow
Crucial to retirement planning, this step is about developing a plan to manage the dollars flowing in and the dollars flowing out, and how this flow of dollars ultimately impacts your retirement savings.
Dollars flowing in can come from numerous sources – wages, distributions from retirement and other investment accounts, Social Security, pensions, interest, dividends, real estate, and more. Dollars flowing out are for covering living expenses and activities related to discretionary activities and choices around your desired lifestyle. Essentially, this is about cash flow projections, and how your cash flow ultimately impacts your overall savings and investments, or more aptly, your Net Worth.
There are two essential spending categories:
- Living Expenses
- Discretionary Expenses
About Your Living Expenses
Living expenses include:
- Housing or shelter (mortgage or rent, utilities, property taxes & insurance, upkeep, etc.)
- Groceries, household, and personal care items
- Healthcare (insurance, co-pays, deductibles, other out-of-pocket medical costs)
- Transportation (car purchase/payments, gas, upkeep, public transportation, etc.)
Expenses in each of these categories are essential and, for the most part, unavoidable. You will incur these expenses at every stage of life, and you must have a cash flow or spending plan to account for these expenses regardless of circumstances.
About Your Discretionary Expenses
Discretionary expenses are exactly that – subject to your discretion and voluntary. If “living expenses” are the things you must spend money on, “discretionary expenses” are those things you want to spend money on. So, how do you want to spend your money (after you have finished paying your living expenses, of course)? This is up to you to contemplate, except to say that these are typically the items you have on your “bucket list.”
During retirement, it is important to understand that living and discretionary expenses will trend in different directions over the course of many years.
Living expenses will trend up. Part of this will be the result of increases in the costs of many, if not most, items needed to maintain your standard of living, referred to as inflation, but the largest and most unpredictable increase in living expenses will be related to healthcare. Costs for healthcare will rise due to annual increases in insurance premiums and the overall costs of receiving healthcare, both preventative and needs-based. Healthcare inflation has been and is projected to continue to escalate at rates much higher than regular inflation. According to the federal government’s Bureau of Labor & Statistics, healthcare inflation has been trending in the 4%+ range, but according to other private research organizations, healthcare costs are escalating at 6%-8% annually. Regardless of which sources you choose to believe, retirees will see costs double or triple over a 20-30+ years retirement time frame. This trend is further exacerbated by the fact that, as people age, they require more healthcare. In fact, the most expensive years of retirement are the last 1-5 years because this is typically when the most healthcare will be needed.
Conversely, discretionary expenses will trend down. I am going to borrow a phrase from Tom Hegna, a retirement planning professional and author on the subject. He talks about the years of retirement segmented into the “go-go” years, “slow-go” years, and “no-go” years. During the initial “go-go” years of retirement, people are typically on the go – traveling, working, hobbies, volunteering, and a range of personal interests. During the middle “slow-go” retirement years, people tend to scale back on some of their activities as they mark things off their bucket list and slow down due to age and sometimes health. During the final “no-go” years of retirement, age- and health-related issues tend to cause people to moderate or halt retirement activities, reducing related expenses. This trend from “go-go” to “no-go” means less will be spent on discretionary expenses over time.
Cash Flow Projection
Monitoring cash flow and tracking spending is an unavoidable task, but it does not have to be overly complex or difficult. We offer tools to help categorize and track spending over time. This will help you develop a good idea of where your money is going and how to properly manage spending.
If you are in or near Walpole, MA, contact ProIncome Plan for help answering that all-important question, “How much should I save for retirement?” We will help you with all your retirement planning needs. Contact us today.