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If you want to reach Financial Independence and be able to retire, you need to know how much you are going to spend while retired. If you are retiring next year, it is straightforward to know how much you are going to spend. However, if you are going to retire in a long time, it is not trivial to estimate how much you will spend in retirement.
I have already talked about the different ways tor each Financial Independence (FI). Regardless of which way you choose to reach FI, you will need an accurate estimation of your retirement expenses. Without this, you will not be able to know how much of the road remains.
You could think that you are going to spend precisely the same as you spend now. But this is wrong. You need to take into account many things. You will typically pay lower taxes. But your health expenses are likely to increase. And inflation will increase your costs significantly over the years.
In this post, I am going to cover the main points that will impact your retirement spending. It is not a surefire way to estimate how much you will spend in retirement. But it will help if you want an accurate estimation.
I think that taxes will be the item that will change the most after retirement. Taxes will highly depend based on where you live.
The income taxes will go down a lot since your main income will go to zero. If you have more income from a side hustle, you may still have to pay taxes on it. It will depend if you intend to continue on your side hustles.
If you have to pay net worth taxes, this will not change in retirement. So you need to take into account the full amount of your net worth taxes. But if you are retiring in a long time, you will have a higher net worth by the time you retire. And as such, your capital taxes will increase by the time of your retirement.
Now that you are in retirement, you will have to get money from your net worth. There are two means for that. Either you get dividends from your portfolio or your sell some shares. If you get dividends, you may have to pay taxes on dividends. If you rely on capital gains, you may have to pay taxes on capital gains.
On the other hand, there are many deductions that you do now that you will not be able to do later. For instance, when you retire, you cannot deduct your transportation or your contributions to the third pillar. This may make it increase. And you will still have to pay taxes on the first pillar pension.
As you can see, this is not a simple matter. It is difficult to estimate how much taxes you are going to pay after retirement. But this is important. For instance, in Switzerland, we pay both income taxes and capital taxes. And dividends are taxed as income here. However, we do not pay capital gain taxes. I expect my taxes to go down significantly when I retire. However, they will go up from now to the day I retire because of our increasing net worth. But I still expect fewer taxes than today when I retire. I would say that I will pay around 50% fewer taxes than now.
Once you retire, you may have opportunities for geo-arbitrage within Switzerland. Geo-Arbitrage could be a great way to reduce how much you spend in retirement.
Health costs are generally going up as you get older. Health expenses will drive up how much you will spend in retirement.
You are going to pay more for health insurance and more for doctors in general. Health expenses are something fundamental to consider. You do not want to go cheap on your health.
I expect at least a 50% increase in health costs by the time I retire. Moreover, since my current company pays my insurance, this is something more that I will have to pay by retirement if I am still with the same company.
If you want, I have an entire health insurance guide for you!
Housing expenses will likely change by the time you retire.
If you own your house, you may continue to amortize your house, and as such, your interests will go down every year. If your interest rate is fixed, you are safe from interest rate increases. But if your interest rate is variable, it is more difficult to estimate the interests on your mortgage. You should also consider fixed costs for your house and maintenance. These are likely to increase over time.
On the other hand, if you rent, it is more likely that the rent will go up. Generally, rent prices are increasing over time. You may be lucky, and your rent may go down. But you should not count on that. Finally, you need also to consider the case where you buy a house in the years between now and retirement. In that case, you have to change your estimate completely.
There is also one special case to consider. If you have kids now living in your home, you may not have kids at home anymore when you retire. That means that you probably do not need a big house or apartment anymore. So that means you can reduce your expenses. But most people do not move when their kids move out.
Generally, your food budget will not change in retirement. However, there is one thing you may want to consider. The number of people who eat your food may change. If you have children now, they may leave the house before you retire. But if you plan to have children, you may retire with children at home. In which case, your food budget will increase.
Some people are also going to eat out more after retirement. There are just more occasions to eat out. On the other hand, you will likely be at home for your lunches instead of being at work. That will make a difference as well. You need to consider both things in your estimations.
No more work
Not having to go to work every day may make some differences in your budget.
For instance, you will likely have to spend less on commuting. For some people, it also means you will not have to spend money on some nice work clothes.
On the other hand, you may lose some benefits from working at your current company. For instance, my company pays for my health insurance. Having topaz for my health insurance will make a huge difference once I retire. Moreover, I also have free coffee and some money for my lunches at work. These small benefits may not sound a lot, but this will impact your spending.
If you are surprised by this item, you may want to read about how much you are spending to work.
On the plus side, you may enjoy some retirement benefits in your country. These benefits could reduce how much you are going to spend in retirement.
In Switzerland, several things are cheaper once you reach retirement age. Moreover, you can also get the money from your three pillars once you retire. The money from your second and third pillar should already be accounted for in your net worth. However, the pension from your first pillar may help you with some nice passive income.
But something is essential. In most countries, you will not be able to get retirement benefits until you reach the official age. For instance, in Switzerland, that means you will not be able to get your benefits until the age of 65 for men and 64 for women.
So, if you are planning for early retirement, you will need to account different for the years between your early retirement and the official one.
More time – New hobbies
There is one thing that people do not take into account for retirement. You will have plenty of time on your hand. That means you are going to do something during that time.
Some people are going to travel more and go more outside. That means they will have to pay extra money for their time. Having more time is not a bad thing, of course. But this is something you need to take into account. For most people, their entertainment budget will increase in retirement.
If you only have frugal hobbies, it should not be a big deal. You will be able to enjoy your hobbies with a lot more time and not spend a lot more money than now for these hobbies.
It may sound counter-intuitive to some, but having more time may end up costing you more. Most people will not think of this when estimating their retirement expenses. But this is important!
Something vital you need to take into account is inflation.
Every year, the average price for consumers is increasing. Inflation is the rate at which the prices are rising. It can be negative in which cases the prices are decreasing. But over the long-term, it is going up. Even though you may spend 20’000 dollars per year today, it could significantly increase due to inflation.
Now, nobody can predict inflation over a long period in the future. So you need to estimate the inflation per year. You can take the average inflation over the last ten years as a benchmark. For instance, this would give you around 1.6% per year for the United States. For Switzerland, it was negative in the last ten years, with an average of -0.38% per year.
You should be a bit conservative with your estimates. Inflation may go up in the future. In which case, it is better to count on a bit more inflation than average. For the United States, I would account for at least 2% inflation per year. And for Switzerland, I would account for at least 1% per year.
And do not forget that inflation also compounds! Ten years at 2% is not a 20% increase! It is 21.89%. You need to take the inflation rate at the power of the number of years of retirement. Let’s take a few examples with 20’000 dollars of base expenses:
- In 10 years at 1% inflation per year, you will spend 22092 dollars.
- In 20 years at 1% inflation per year, you will spend 24403 dollars.
- In 10 years at 2% inflation, you will spend 24379 dollars.
- In 20 years at 2% inflation, you will spend 29718 dollars.
As you can see, the impact of inflation on your retirement expenses is far from being negligible. It is something you need to take into account!
Margin of safety
Until now, we have seen it is difficult to estimate what you will spend in retirement. Therefore, I think it would be wise for most people to have a margin of safety.
For instance, if you estimate your retirement expenses at 100’000 CHF per year, you may want to account for 110’000 CHF. That way, your retirement plan will be able to handle a 10% increase in expenses.
It will also mean that you will increase your chances of a successful retirement.
How much margin of safety you use will depend on your capacity to take risks. For some people, 1 or 2% will be enough. But most people will need at least 5%.
For us, I am probably going to take about a 5% margin of safety before I retire.
How much will we spend in retirement?
We are very far from retirement and Financial Independence. So for now, we only have a vague idea of what we are going to spend in retirement.
As an estimate, we are taking our current expenses. But we already know that many things will change since we are planning on having a house and children.
We are currently spending about 70’000 CHF per year. I would think that we are going to spend 80’000 CHF per year in retirement. Of course, this is a very rough estimate of what we are going to spend in retirement. It will depend if we retire with young children, for instance.
The closer you are to retire, the easier it will get to estimate your expenses.
Estimating how much you will spend in retirement is something essential if you want to retire early. You need to know how much you are going to spend if you want to have enough money to cover your expenses. Whether you are going to cover your expenses by passive income or by capital gains, you need to know when you are financially Independent.
However, estimating your retirement expenses is not straightforward. You need to take many things into account. You need to update your estimate every year. Your estimation will become more and more accurate as you are getting close to retirement.
If you want to be safe, you may want to increase a bit your estimated retirement expenses. It will depend on your risk aversion and your confidence in your estimation. A margin of safety will make your retirement safer.
Now that you know how much you will spend in retirement, you can easily calculate your Financial Independence (FI) Number.
How do you estimate you will spend in retirement? Have you ever done this exercise?