Retirement planning is one of the most important financial exercises you’ll do with your spouse. Some aspects of your plan, such as saving and investments, have well-documented blueprints for success. However, there are some essential aspects of budgeting that you have to determine yourself. It’s important to have a conversation with your spouse to set lifestyle expectations so that you can create goals and track your progress along the way.

Determine how much cash flow you need in retirement

Retirement planning ultimately centers on replacing income so you can live comfortably without earned income. That number is different for everyone, based on a few key variables.

A functional retirement plan is like solving a cash flow puzzle, so you need to figure out the amount of cash that will flow out of your household on basic needs and lifestyle goals. Once you figure that out, the other puzzle pieces fall into place, dictating other pivotal decisions in your plan.

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Creating a budget is an important step in financial planning, regardless of your age, so hopefully it’s a fairly natural conversation as you approach retirement. However, the stakes can be a bit more dramatic in a fixed-income situation — there’s less margin for error when you don’t have any earned income.

Budget setting should reflect basic needs, but you can’t ignore lifestyle goals. Spouses need to be on the same page about several factors, such as:

• Where you want to live: Buying a new home, relocating, or spending time in an area with a significantly different cost of living plays a major role in your cash needs.
• How much you want to earmark for discretionary spending. This can include travel, dining out, home improvements, and entertainment. Some people are willing to make sacrifices today to maximize the fun and leisure of their golden years.
• How long you want to work: Many people dream about an early retirement, but sacrificing earned income can drastically alter your financial resources later.

A little research can give you a good idea of the income required to meet your needs for food, housing, transportation, and healthcare. Anything above and beyond that baseline is a personal choice. Don’t let confusion or miscommunication on discretionary spending disrupt an otherwise good plan.

Use the 4% rule to set preliminary goals

Estimating a budget is perhaps the most important variable in retirement planning. Once you plug that number in, you can calculate a handful of essential benchmarks for planning and goal setting.

Suppose you and your spouse agree on a budget that’s close to the national average, which is around $70,000 per year. Social Security covers a big chunk of that cash flow. The average Social Security benefit is just over $1,900 per month. With spousal benefits, the household can reasonably expect total benefits around $2,800, which is $34,200 per year. Everyone’s circumstances are different, but that’s a useful starting point.

In this example, the couple has to rely on their assets to cover $35,800 worth of annual expenses. The 4% rule helps people determine the assets required to generate a certain amount of cash. Years of data indicate that most households can spend 4% of their total retirement investments each year without running too much risk of running out of money.

According to the 4% rule, you’d need around $900,000 of invested assets to generate $35,800 of annual income. Your plan isn’t going to precisely match this hypothetical example, but it’s a useful template.

Most people need to attain even higher asset levels to accommodate taxes. At least some portion of your retirement income is likely subject to taxation. Distributions from a 401(k) or traditional IRA are treated as ordinary income. Social Security benefits are taxed in some states. Dividends and bond interest are often taxable for brokerage accounts, and capital gains can apply to brokerage investments as well.

Taxes can be mitigated with Roth IRAs, Treasury bonds, and municipal bonds, which all offer special tax treatment. However, it’s unlikely that you’ll be able to avoid the IRS altogether in retirement.

Your savings goal should dictate your planning decisions

Developing a target number of retirement savings is a helpful benchmark. If you’re a long way from retirement, numerous variables will impact your specific goals over time. However, the magic number gets clearer as you get closer to your retirement date. Importantly, you’ll have a better idea of the age at which it’s feasible to stop working.

If you’re like most Americans, falling substantially short of the minimum assets necessary to replace your income, then you need to keep working and saving. If you’re set on retiring before you reach your savings goal, you’ll have to adjust your expectations for retirement lifestyle. However, if you’re already past the minimum amount that can sustain your lifestyle goals, then you can seriously think about leaving the workforce without a disturbance.

Ultimately, you’ll struggle to make a reliable retirement plan unless you’re focused on cash flow. Building a budget is a core component of that exercise.

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