Reverse Budgeting

How Much Do I Spend in Retirement?  Does it Really Matter?  What if I could budget without…budgeting?

At CapSouth, it is our mission to help clients define and live their One Best Financial Life™.  We challenge clients to consider their values and what is important to them, and then to develop actionable goals that we endeavor to help them achieve.  This leads to the need to have a sound financial plan in place that considers a client’s assets and resources, and projects their probability of meeting those stated goals.  We want clients to live with confidence in peace of mind, knowing that they are on track to live the life they want to live.  Sometimes the focus of planning needs to be encouraging a client to scale back and pace their spending to allow for a more secure retirement.  Other times that planning focus should be to urge a client to spend more, to travel, to take the family with them on vacations and make memories…to live their life more fully.  In all cases, we are looking for the client’s confidence zone in their plan to serve as guard rails, so that they are not worried about running out of money, and on the other end, they are not leaving significant assets behind that are unplanned for.

More often than not, it seems, we meet with clients who do not have a clear idea of how much they spend.  Particularly when a couple nearing retirement comes to us as a new prospect, a common answer is that they have just always lived within their means, or spent less than they made.  How much you spend in retirement is very important in planning.  Depending on your age at retirement and your assets, a seemingly small change in your annual spending can make a significant difference in the success of your plan.  Many people plan for thirty years or more in retirement – a long time for inflation and market fluctuations to catch up with you and to affect your probability of meeting all your goals and objectives.  We have invested in sophisticated software to factor in these variables for you, to allow you to simply think of how much you will need for retirement in today’s dollars.  That does require us, though, to have an accurate number for that element.  Whether we are planning for annual living expenses of $50,000 or $500,000, we need some assurance that this number is reliable.

But who wants to budget?  You should see some of the facial expressions we get when we mention that “B word”!  And if you are newly in, or approaching, retirement, how do you really know what your retirement lifestyle will be and what it will cost you?  Further, trying to look at past or future spending can be even more difficult when you have varying sources of income throughout the year.  Fear not, we have a solution.  Reverse Budgeting.  I believe in giving credit where it is due, so I will tell you this is not my concept; I learned it from CapSouth’s founder, Donald Bolden, years ago, and I have been recommending it to clients in retirement ever since. 

Here’s how it works:

1. As best you can, come up with an idea of what you expect your basic living expenses to be in retirement.  This should not include other specified goals in your plan such as travel, new cars, etc., but your basic living expenses of utilities, groceries, fuel, clothing, dining out, and the like.  For illustration purposes, let’s say that number comes out to $5,000 per month.
2. Now, figure up what regular income sources you have such as Social Security, pensions, rental income, etc.  For this number, let’s assume $3,000 per month.
3. Set up an “operating account” for your household and start it with a cushion balance of your comfort level.  Let’s use $25,000. (Note:  You and your spouse may decide to have two operating accounts; the concept still works.)
4. We would then work with you to establish a conservative Cash Management Account (CMA) among your accounts at Schwab, from which we would establish a recurring monthly transfer of the $2,000 per month to supplement your income and meet your expected expenses of $5,000 per month.  We typically recommend this transfer being set up to occur on the 5^th of each month rather than the 1^st, to help track which deposit was for which month and to not allow weekends or holidays to confuse things.
5. What about those random sources of income throughout the year?  Still employed and have a varying income?  Receive additional bonuses?  It is so easy to allow yourself to quickly spend that seemingly “extra” income without realizing it, giving yourself (and us) an inaccurate picture of the cost of your lifestyle.  Under the Reverse Budgeting model, all variable income is deposited into the cash management account at Schwab, adding to the funds available to provide for your monthly transfers to your operating account.
6. It is likely no surprise to you that some months will cost more than others.  You may have family visiting and spend more on groceries.  You might have an anniversary and treat yourself to a nice dinner and some gifts to celebrate.  Your refrigerator might need to be repaired or replaced.  However, if we look back at this operating account in six months, a year, or more, we can get an idea of what you were really spending. 

If that $25,000 cushion is down to $5,000, then we have a problem and need to make adjustments.  We would review to see if there were a number of non-recurring, unexpected expenses during that period, or if life just cost more than you thought.  We could increase the goal for living expenses in the plan to see if the new amount is still successful or what trade-offs need to be considered.  If your regular monthly expenses are $6,000 or $7,000, then maybe you need to consider reducing those big trips each year from three down to two. 

If that cushion is up to $50,000, we also have an inaccurate plan and need to make adjustments.  We might encourage you to consider what goals you had for retirement spending that you haven’t been doing and challenge you to do what you said that you valued.  It could also open the door for more travel, giving to charity or your family, upgrading your vehicle, buying a second home…whatever that looks like for you.  If you are doing everything you want to, then we need to acknowledge that you are going to likely leave more behind than you might have thought, and we may need to review your estate plan to make sure it aligns with your wishes.

This is a simplified example, and we recognize that yours may be more complex.  Life certainly will happen, and circumstances will change.  Planning is never complete, and we continue to monitor, review, and update assumptions over time.  Reverse Budgeting is a tool that can help to provide more confidence and reliability to your financial planning process, without having to focus on the “B word” of budgeting.  We may not be able to tell where the money is going, but we (and you) can tell how much is needed to maintain your lifestyle.

To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

By: Scott McDowall, CFP®

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.