Building a retirement budget: essentials, extras and the tax in between

Start from what you spend now

The most reliable starting point is your actual spending over the past year, taken from bank and credit card statements. Estimates from memory tend to miss irregular costs such as car repairs, gifts, annual insurance premiums and home maintenance.

Once you have a full year, convert everything to annual amounts in today's dollars. The planner works in today's dollars too, so your budget can go straight into it without adjusting for future inflation.

Some people find it easier to track three months in detail and multiply up, then add annual and irregular costs separately. Either way, the aim is a figure that reflects how you actually live.

Then go line by line and ask what changes when work stops. That's where a retirement budget starts to differ from a working budget.

Essentials versus flexible spending

Sorting each line into one of two groups makes the budget far more useful for planning:

• Essentials: housing (rent or mortgage, property tax, condo fees), utilities, groceries, insurance, transportation, phone and internet, prescriptions and basic health costs.
• Flexible: travel, dining out, hobbies, gifts and family support, entertainment, vehicle upgrades and home renovations.
• Irregular but predictable: a new roof, a replacement car or major dental work, which can be spread as an annual amount.
• One-time goals: helping a child with a home purchase or a milestone trip, which may be better planned as a lump sum than a yearly cost.

Costs that change in retirement

Some working costs often disappear: commuting, work clothing, professional fees, CPP contributions and retirement savings contributions. If part of each paycheque has been going into savings, that money no longer needs to be set aside.

Other costs can rise. Free time often means more travel, hobbies and dining out, especially in the early years. Health-related costs not covered by your provincial plan, such as dental care, vision and some prescriptions, may become a larger part of the budget once workplace benefits end.

Housing deserves its own look. A paid-off mortgage lowers spending considerably, while carrying debt into retirement keeps it high; the guide to retiring with debt or a mortgage covers that situation.

Taxes change shape too. Payroll deductions stop, but tax on CPP, OAS, pension and RRIF income may be withheld at source or paid through instalments, which is easy to miss in a budget built from bank statements.

Turning a budget into a gross income need

Suppose Tom and Aisha, both 61, live in Newfoundland and Labrador and plan to retire next year. Their budget comes to $40,000 a year of essentials and $16,000 of flexible spending, for $56,000 a year after tax.

Most of their retirement income will be taxable. At 65, the calculator has them receiving about $19,800 of combined CPP, $18,300 of combined OAS and about $25,867 from their RRSPs, for a household taxable income of roughly $64,000. The planner splits that evenly, so each spouse has roughly $32,000 of taxable income.

On $32,000 of income in Newfoundland and Labrador, the calculator estimates about $3,987 of combined federal and provincial tax per person, an average rate of about 12% and a marginal rate of about 23%. Their $56,000 budget therefore needs roughly $64,000 of gross income. The retirement tax calculator shows the same estimate for any income and province.

Testing the budget against savings

Tom and Aisha have $350,000 in RRSPs and $120,000 in TFSAs combined, and will add $15,000 and $14,000 before retiring. Their CPP estimates at 65 are $950 and $700 a month, and both expect full OAS. With an illustrative 6% return before retirement, 5% after and 2% inflation, their savings reach about $518,569 at 62.

At the full $56,000 budget, the plan runs short at 86. By 90, their spending would fall about $18,581 below target each year, leaving them with roughly what CPP and OAS provide after tax.

The calculator estimates their highest steady spending to 95 at $52,700, so the full budget sits about $3,300 a year above what their savings can sustain under these assumptions.

Where the flexible line earns its keep

Because they separated essentials from extras, Tom and Aisha can see their options clearly. If they trimmed flexible spending from $16,000 to $8,000, for $48,000 a year in total, the plan would last to 95 with about $268,134 left after tax. Their RRSP draw at 65 would drop to about $15,518, and their household tax to about $5,618.

Spending doesn't have to be flat. Some households expect higher travel and activity costs in the first decade and lower ones later, with care costs possibly rising near the end. A budget that changes by phase can be more realistic than one steady number.

The flexible line also matters in poor market years. Cutting travel for a year or two can reduce how much has to be sold at low prices, which the sequence of returns guide explains.

The split also shows the floor. Tom and Aisha's $40,000 of essentials is the amount their income has to cover in almost any scenario, and comparing it with their combined CPP and OAS shows how much of that floor public pensions alone would carry.

Keeping the budget current

A retirement budget is a working document. Comparing it with actual spending once a year shows where estimates were off, and gives early warning if spending is drifting above what savings can support.

Keeping a short note of why each figure was chosen helps future reviews tell a deliberate change from gradual drift.

Benefits change over time too. OAS is adjusted quarterly for inflation, and the key figures page lists the current CPP, OAS and tax amounts with their dates. For couples, pension income splitting can change the tax line in the budget.

If you live in Quebec, note that the tax estimates here don't include Quebec provincial income tax, and your public pension comes from QPP through Retraite Québec. To turn your own budget into a savings target, try the How much do I need calculator.