Why you may need LESS in retirement than you think

No payroll deductions and contributions

During your working years, you're typically dividing your paycheck and sending your money off in different directions. For one thing, it’s likely that you're allocating a big chunk of your pay toward employer-sponsored health insurance. Even though employers often provide a generous subsidy for this expense, the employee-paid portion has been growing steadily over the years.

Once you qualify for Medicare, as well as a Medicare supplement, there’s an excellent chance that your monthly cost for health insurance will decline. This will be even more true since you won’t have dependents included in your plan. (And let's face it: Family plans can be very expensive!)

An even bigger chunk of your check almost certainly is going into your employer-sponsored retirement plan. If you’ve been contributing 10%, 15% or 20% or more of your pay into a 401(k) or 403(b) plan, that’s an “expense” that will disappear in retirement. At that point, you’ll go from being a net contributor to your retirement plan, to a net user of the funds.

Still another major payroll tax-related cost is federal and state withholding tax. If you drop into a lower tax bracket, this will decline. This will be especially pronounced if your marginal federal tax bracket drops from something like 25% down to 15%, or even 10%.

Other miscellaneous payroll costs may also disappear. These can include deductions for life insurance, short-term disability, and charitable contributions. As they all disappear, you’ll have more control over the income that you do have.

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No FICA tax

This is a tax that most of us get used to paying from the first time we land a job. It’s not a dramatic amount, which is why we might underestimate how important it is in retirement. But it does take 7.65% of your income each year — and upwards of 15.3% if you’re self-employed. And perhaps just as significant, there are no deductions against your FICA tax. Not itemized tax deductions or even health insurance or retirement plan contributions. It’s essentially a flat tax that’s charged straight up against your entire income.

You will still have to pay the FICA tax on any earned income that you have. But the tax is assessed only on that: earned income. Once you retire, you'll be relying primarily on non-earned income. This includes interest, dividends and capital gains income from taxable investments, distributions from retirement plans, pensions, and even Social Security income. None are considered earned income and therefore not subject to the FICA tax.

No job-related expenses

Few people realize just how many expenses they incur just as a result of their jobs. But there’s actually a long list, and while no single expense may be alarmingly large, the combination of several can take a big chunk out of your income.

For starters, there are computer-related costs. This includes gasoline, tolls, and parking. If your car gets an average of 25 miles per gallon and you commute 40 miles round-trip each day, that means that you are traveling about 10,000 miles per year for work. That also means that you are burning about 400 gallons of gas doing it. If gas averages $2.50 a gallon, that means that you’re spending $1,000 per year on commuting — just for gas.

This doesn’t include other secondary expenses that are the result of commuting. That means the additional cost of repairs and maintenance on your car, and even the depreciation in its value, as a result of all of the commuting mileage. This can total several thousand dollars per year, depending upon the type of vehicle that you drive and how much it cost for tolls and parking where you work.

Apart from commuting expenses, there’s also weekday lunches. If you buy lunch out three times per week, at an average of $10 per meal, that’s $30 per week or about $1,500 per year.

Then there's the cost of clothing. Depending on the type of occupation you have, you may have to purchase clothing related to your job. There may also be dry-cleaning costs attached to that.

Although it’s impossible to generalize, it’s very likely that you spend several thousand dollars per year just related to doing your job. Once you retire, those expenses are gone.

To get an idea of how much money you're spending — and how much you can cut back — personal finance app YNAB offers an easy way to keep track of your budget.

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Less frequent need to spend money decompressing

Jobs create stress, and stress creates the need to decompress. From an expense standpoint, decompressing can get expensive. For example, jobs often result in tight schedules. That can make it difficult to cook your meals at home, causing you to eat dinner out more frequently. If you eat out twice a week, at an average of $50 for a couple, you’ll be spending about $100 per week or $5,000 per year.

Once you retire, you’ll still go out to eat, but there’s a good chance that you’ll do it less frequently. After all, once you’re retired, you’ll have more time to cook at home — and that can save you a lot of money.

And although you may travel when you retire, you may find it less necessary to take those tightly packed vacations, during which you try to pack several months worth of living into a single week. Those kind of vacations can cost thousands of dollars, while lower-pressure vacations taken in retirement can be done for a lot less.

Your mortgage and other debts may be paid off

Simply paying off your home mortgage greatly reduces the amount of money that you'll need in retirement. If your mortgage payment is $1,000 per month and you pay off it off, you will need $1,000 per month less when you retire.

The same will be true of other debts, such as car loans and credit cards. Let's say you have a $400-per-month car payment during your working years and another $200 per month in credit card payments. Paying those debts off will reduce your living expenses by $600 per month.

It’s also important to realize that it’s not just the fact that you will be lowering your cost of living. A lower cost of living means that less income is needed, and that also means that your income taxes will be lower.

For example, it’s possible that for every $100 you reduce a fixed expense or other cost of living, you'll reduce the need for $125 and income. If you reduce your fixed expenses by $1,000 per month, you’ll need $1,250 less income, or $15,000 per year.

You’re free to move to where the cost of living is less

From a financial standpoint, this could be one of the biggest changes. When you're tied to a job, you have to live where that job is. Not coincidentally, those are usually the places where the cost of living is highest. But when you retire, you’re no longer dependent upon geography. You can quite literally live anywhere you want, and you will almost certainly favor low-cost areas.

This can result in a major reduction in living expenses. For example, you can move to a state that doesn’t have an income tax. Florida, Texas and Tennessee are examples. If your state currently has a 6% state income tax, you will automatically reduce your cost of living by that much.

But many states have dramatic differences in real estate taxes as well. For example, the average real estate tax in California is $4,783 per year, but in South Carolina it's just $1,294. That’s a difference of $3,500 per year, just for property taxes.

But taxes aside, the other major component related to your cost of living is housing. There is a dramatic difference in housing costs from one area of the country to another. For example, the median house price in the San Francisco Bay area was $837,500 at the end of 2016. But the median house price for the Tampa Bay area was just $205,000, or more than 75% less.

Lower house prices have important implications for retirement savings

Money that is not invested in a house can be better invested in income-generating assets, like your retirement investment portfolio.

For example, continuing the San Francisco-versus-Tampa Bay comparison, since you'd need more than $600,000 less to purchase a home in the Tampa Bay area, that’s $600,000 more that you can have in your investment portfolio, generating income. At an annual rate of return of just 5% per year, that would result in $30,000 in extra income.

It’s OK to use rules of thumb to estimate how much money you'll need in retirement. And there are a lot of invaluable tools to help you along the way. But in addition, pay close attention to your actual living expenses. Any that you won’t have — or won’t have as much of — in retirement is that much less that you'll need to live on. And my guess is that it will be a lot lower than you think.