A Bank Statement Approach to Budgeting – but NOT used like you’d think!

Please note: The purpose of this simple exercise is to get the BIG PICTURE about your lifestyle and the total amount you spend … in the first place! Go from general impressions of your lifestyle to informed insights via the easy exercise explained below.

This exercise simply keeps you from getting lost or confused by laborious methods or details. Did I mention simple?

This simple method helps you better see what your spending actually is, including the oft forgot taxes. It’s the big picture! You don’t need details, unless you wish to dive deeper later, to get the bigger picture. This simple exercise, what I call homework, allows you to have a better sense about retirement feasibility (discussed later). Retirement transition can be worrisome, even scary for some. This simple exercise may remove much of that anxiety about making that transition.

When preparing budgets, people tend to think about their typical spending patterns—failing to account for big-ticket items, or other less than monthly expenses. When it comes to thinking about your upcoming retirement, the single largest budget item is often forgotten – income taxes! Why? Because that’s taken out, before you even see your money.

The old fashion way of “budgeting,” a term I dislike using, is laborious and I submit tends to focus on the wrong thing when it comes to the bigger picture about why are you going through the exercise in the first place? Most people do this to better understand where their money goes. But, for retirement planning, most people simply want to keep their lifestyle the same as it is now as opposed to having to tighten the belt once retired.

That implies that money once retired will go to the same lifestyle expenses, in general, as how that money is spent now while working. There are some substitutions of expense categories, but the objective is to spend the same amount, maybe on slightly different things, in retirement as you do now.

So, what’s a simple and painless way to get a handle on your ANNUAL expenditures now while you’re working? How does this give you a better understanding of your spending needs once your retire that keeps your lifestyle similar?

The benchmark to make a retirement readiness decision is what I call Standard of Individual Living (SOIL). I usually get an estimate of lifestyle from the tax return’s front page and the W-2. However, the next level down for even more insight is through the following exercise.

This exercise is much easier than budgeting for each and every expense … and in reality, how you spend money over time has, and will, change. So it’s the big picture we’re after first.

If you have budget data, the above exercise serves to capture the difference between what you think you spend and what you’ve actually spent (since it comes from actual bank outflows, it went somewhere) … is there a difference? Why? Note: I’m not suggesting doing a budgeting exercise yet if you haven’t done so. The first objective is to get a baseline picture and that comes from below.

The big picture purpose of this exercise is to get insights into your broad annual lifestyle expenditures. Since everyone is unique with their own unique lifestyle, rules of thumbs (for example: the 80% rule) should NOT be used to get a handle and sense of what income you’ll need annually (so that those non-routine expenses are also accounted for) to sustain your desired lifestyle. Why not use a rule of thumb? Simply as I stated, your expenses are different based on your unique lifestyle compared to others and their unique lifestyle.

By using your bank account statement(s) to determine how much you spend each year, you automatically exclude items like Social Security and Medicare (payroll taxes) and other items related to work. Your employer retirement plan contributions that you also won’t have once retired are also excluded.

There may be other work related expenditures that ARE in your bank statements, however, rather than exclude those expenditures too, I suggest keeping them in the below exercise so that you have the funds available in retirement to substitute those work expenses with retirement related expenses once you retire. In other words, you’ll simple use that “extra” money for something else once retired.

Once you know how much you spend now while working to support your present lifestyle, the exercise below will help you target how much you’ll spend to support that same lifestyle once retired.

Here’s the easy way:

Time to roll up your sleeves and take out your bank statements. Don’t worry, you’re NOT going to go through each detail in those statements. In fact, the big picture has already been done for you on each bank statement!

Take out your last bank statement. Typically people pay for their monthly expenditures out of their checking account(s), so that is the bank statement you’ll use for this exercise. If monthly expenses are paid out of more than one bank account, do this for each one.

In excel, enter the total expenses for that statement (all the minus signs). Most bank statements show a summary of money in, and money out (minus signs). Ignore where the money came from. The objective is to capture all monthly expenditures (your lifestyle), i.e., the minus signs.

Repeat for each month of the year.

Sum the total expenses for the year.

ADD the TOTAL income tax for both Federal and State (from your tax returns). NOT the total withheld or refunded, or tax due. This is the TOTAL tax calculated only on the return, because that’s the actual amount of tax you paid.

Subtract contributions to IRAs/Roths for the year, if any – because those contributions go towards future lifestyle expenses (aka, retirement), not today’s lifestyle expenses. In other words, you didn’t spend it, so it doesn’t count as lifestyle spending.

Now, there may be times where you may have made transfers of sums out of checking into savings or other accounts too. Those are not “lifestyle” expenditures, but moving money from one “pocket” to another and not spent on something that supports your lifestyle as an expenditure. You’d want to remove those as a lifestyle expense as well.

If certain expenditures come directly out of savings, instead of going first through checking, over the course of the year, you would also want to add those savings outgoes to your lifestyle expenditures.

Resulting sum is your total annual SOIL for the year … in other words the numerical value for your lifestyle.

Repeat for 2 or 3 more years. Average the years if there’s variations in spending from one year to the next.

Result:

That final annual value is “the number” representing your annual lifestyle expense that I call your unique Standard of Individual Living (SOIL) … divide by 12 if you want a monthly lifestyle number … again, it’s important to include taxes * .  It is useful to compare these lifestyle expenditure numbers to the total of all your estimated retirement annual sources of income such as Social Security, supplemental income from your retirement savings portfolio, and/or a pension for those who have them.

*Taxes are important to consider because you will still pay those in retirement from most of your income sources. You’ll be in the same tax brackets in retirement as you were while working when viewed through the lens of having the same, or similar, SOIL. If you reduce your lifestyle, maybe taxes would be lower – it depends on where you are in your tax bracket to begin with. Also tax brackets change often while working, and probably will also keep changing once retired; so don’t get all worked up about what tax brackets might be. Just like your working years, you adjusted when brackets adjusted – you’ll do the same once retired too!

Please see the post “What is a Retirement Feasibility Timeline?” to see how this exercise outcome may be used next in retirement planning.

Photo by Vendanti on Pixels

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