In the last post I wrote on how the present methods of estimating expenses at retirement were not the correct ones. Let us see here if we can arrive at a better and more accurate method of doing this. One important requirement for it is that you must have an idea of how you are spending your money today. You can go through the process in the following steps.
Step 1: Understand your current expense heads and the amounts you spend on these
- If you are already maintaining a budget then this will be relatively easy to do. If not then start recording all your expenses, do it for 3-4 months and come back to this after that.
- Ideally, use some online tool so that it will be easy to keep track of the expenses and the trends. I myself use My Money from ICICI but choose one that you will be comfortable with.
- Make sure it is linked to all your bank accounts so that all inflows and outflows are recorded completely.
- Categorize all your expenses at a logical level – Groceries, Non Veg items, Utilities, Insurance, Schooling, Expenses for children, Entertainment, Dining out, Vacations, Repairs, Car expenses, Transportation are some examples. A standard tool like My Money will give you some default categories and you can add to these based on your needs.
- Ideally, you should have the data for one whole year to capture expenses like Insurance, Vacations etc which are usually annual expenses. If you do not have this, use 3-4 months data and project accordingly.
Step 2: Take out the expenses that you will most likely not have in retirement
- Look at each expense head and decide whether it will be there for you at a retired state or not. Some things like Schooling for children will be obvious but there will be several others.
- At a retired state you do not really need Life insurance, so be sure to take this out.
- Do not take out expenses you are not sure about. For example, you may think today that you will not have any Non Veg food when in retirement, but if your retirement is some distance away do not make these decisions now.
- In general all children related expenses will be gone by the time you retire.
- If you are staying in a rented house and will move to your own in retirement, take out the rental expense.
- After this exercise you will be left with a number of expense heads with your current annual expenses in each of these. You will now have to think what kind of a retired life do you want and adjust these accordingly.
Step 3: Outline the kind of life you want to live in retirement
- Your expenses will always be a function of how you spend your time, so you need to understand it carefully.
- Decide on issues like where you would want to live, what activities will you engage in, is travel going to be a major part, will you have any old/new hobbies to cater to, how social you want to be, what kind of transportation you will need etc. Basically you need a picture of your retired state. Yes, this can change and, if it does, you will have to deal with it but you still need a starting point.
- One example for me is that we have decided to avoid long train journeys and want to do these by Air. You may have similar lifestyle choices in retirement think through these.
- The outcome of this exercise is an agreed version of your retirement life with your spouse and other members of your family, if they are going to stay with you.
Step 4: Adjust expenses arrived at in Step 2 with the changed life situation in Step 3
- Take each expense head in step 2 and examine it under your projected situation of retired life in step 3. For example you may have 4 people in your family today and currently spend 10000 Rs every month on food. In a retired state your 2 children would have left and only you and your spouse will be there.
- Adjust each expense head for current expenses for the projected future situation. Use common sense and not any formula – for example, in the above case you may decide your food expenses to be 6000 Rs per month.
- Not all expense heads will need to be adjusted, Insurance and utilities for example will largely be unchanged.
- It will be a good idea to increase the medical insurance coverage now, so you can adjust it upwards as per your need.
- Medicine and related expenses can also be increased as you will need more of these in retirement.
- The outcome of this exercise will be to have a set of expense heads along with current annual expenses, that reflects fairly accurately your ideal retired state.
Step 5: Add new expense heads based on your projected retired state in step 3
- Based on your expectations of retired life you may need to add some new expense heads that are not there today. For example if you want to take up playing Golf you will need to add related expense heads.
- Estimate the expenses annually for each of these expense heads that you have added.
- Add these expenses heads and projected annual expenses to the ones that we arrived at in step 4.
Step 6: Project your expenses in the first year of retirement
- Take each major category of expenses and assume an appropriate inflation factor to it. Do not take an overall inflation factor as that will not be realistic.
- Project these expenses annually in the year of your retirement.
- Add up all of these to get an idea of what you will spend in the first year of retirement.
Step 7: Estimate expenses for assisted care and living
- If you think you are likely to live beyond 85 or so this will become important.
- Estimate current costs of a full time attendant and associated expenses by getting some real data.
- Project these expenses at 85 years of age as you will hopefully not need this earlier.
For all practical purposes, you will need to plan for step 6 but if you want peace of mind then step 7 is important. We will keep this in mind and see how it can be tackled from a planning point of view.
in the next post, I will give some actual data in order to demonstrate this process. Remember when you are doing this, you need to do it yourself from ground up without the use of any tools or calculators, except for projecting expenses. Doing this yourself along with your spouse will probably take half a day of effort but it will be priceless in terms of your financial future.
I look forward to getting feedback from all of you on this.
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