No. of Recommendations: 6
But what are my monthly expenses? The $5K I spent last month? Or the $15K I spent during the same month a year ago when my A/C finally died and I had to get a new one?`

Quite possibly neither.

First off, you can't deal with a single total. You need to dig down a bit into some of the details. And you certainly can't look at one month. I'd look at yearly figures, then divide by 12 to get an estimate of average monthly expenses if you prefer to think that way.

Start with the easy stuff - housing, utilities, food, clothing, routine medical care (including health insurance), household supplies. Get the basics covered. What are your annual costs for these items.

Then go on to things like communications (TV, cell phone, internet - unless you want to include those in utilities, which is perfectly fine). Gasoline and maintenance for cars. (Personally, I'd toss a bit in for repairs as well, unless you are the type to swap out cars when the warranty expires.) Car payments, if that is part of your plan. Entertainment and dining out (if you haven't included the dining in food above). Travel and vacations. I'm sure you can add in a few categories of your own - things you spend money on regularly, although perhaps not evenly each month.

Don't forget to plan for income taxes.

Lastly, there's the big lumpy expenses. Things that are significant (say $3-4k or more), that you know will happen, but you might not know exactly when. Home heater and A/C. Washer and dryer. Refrigerator. Roof. New cars (if you prefer to pay cash). Major medical expenses. Home painting. These require some serious thought.

If you know some of these are coming in the first couple years of your retirement, I'd mentally pull their cost out of your total investments and base your regular withdrawals on the reduced amount. Basically, treat it as if you spent the money already and it wasn't available for long-term retirement withdrawals.

For anything else, I'd make an educated guess as to how long it will be until each of these items will be needed. Maybe your roof is 10 years old and it should have a 25 year life. So your guess might be that you'll need to replace it in 15 years. Figure up what a roof might cost today. Precision is not important, but being in the right ballpark is. Picking $15k or $16k won't make any significant difference. But picking $10k instead of $20k (or the other way around) will. When you've got that number, divide it by the estimated remaining life. That much of your 4% annual withdrawal really needs to be set aside for this expense. Let's say you think you'll need to replace your furnace in 5 years, and you estimate that will cost $5k. So $1000 of your annual withdrawal really needs to be set aside for this longer term expense. It's not available for current spending.

Naturally, you probably don't want to actually put that money into a savings account. You probably want to leave it invested. (Although I'm not going to fault anyone who does choose to stick that money aside into a separate account, if that helps you.) You could instead reduce your annual withdrawal by $1000 (in my furnace example above) and leave that wherever it is currently invested.

In short, you can't actually spend the whole 4% SWR. Some of that SWR needs to be earmarked for long-term, lumpy spending.

After all of this is done, add up your annual totals for each of these kinds of payments and give it a sanity check. Does the total make sense compared to what you are spending currently? If all this adds up to $4k a month, but you are currently spending $6k a month, something may be wrong. What are you forgetting? Or is there some expense you currently have that will go away in retirement? Is the retirement total $10k a month when you're currently spending $7k? Again, look for something wrong. Keeping track of your current spending will help tremendously with this whole process.

Yes, this gets a bit involved. But you really only get one shot at retirement. If you are at all close on your numbers, it makes sense to me to run through the details. You might only need to do this level of planning once or twice. And a second run through should be quicker, particularly if you keep track of the first go around.

--Peter
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