When we're young, many of us envision retirement as a time of freedom and relaxation after decades in the workforce, but this isn't always how it goes. Retirement means life on a fixed income: an income you essentially guess at based on your goals and estimates of inflation, life expectancy, and investment growth. Optimism is usually an admirable quality, but when it comes to retirement planning, it can set you up for hardship.

About one in three retirees spend more than they expected they would when they first retired, according to the Employee Benefit Research Institute (EBRI) 2020 Retirement Confidence Survey. One in 10 said they were spending much more than they'd anticipated. For these individuals, watching the savings meant to last them the rest of their lives dwindle year after year, retirement is anything but relaxing.

Worried senior couple looking at financial documents

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This doesn't happen to everyone, but you can't bank on good luck. You must plan carefully and be realistic about how much you believe you'll spend in retirement if you want your savings to last.

Underestimating retirement costs is a huge problem

We all know retirement is costly, but there are lots of opinions about exactly how costly it will be. The EBRI survey found that 26% of retirees planned for a retirement that cost $1 million or more. Another 24% believed they'd spend between $500,000 and $1 million. Another third believed they'd spend anywhere from $100,000 to $500,000, and the final 18% thought they'd spend less than $100,000.

It's not surprising that people have such different opinions about how much retirement will cost. It is different for everyone, and people have their own ideas about how they want to spend their time. For some, it might be traveling, while for others, it may involve a part-time job. Then there are individual health and life expectancy factors to include, not to mention personal debt and living expenses. And there will always be expenses you can't plan for, like injuries, broken appliances, or a homeowners insurance claim. There are no hard-and-fast rules about retirement costs.

But we do have data about the average retirement, thanks to the government. The Bureau of Labor Statistics' latest Consumer Expenditure Survey, based on 2018 data, found that the average household headed by an adult 65 or older spent $50,860 that year. This amount will climb over time as inflation drives up living costs. But this still doesn't tell us much without considering life expectancy.

The average 65-year-old man retiring today can expect to live until 84 while the average 65-year-old woman can expect to live to 86.5, according to the Social Security Administration. But it also predicts that one in three 65-year-olds today will live past 90 and one in seven will live past 95. This means it's possible to need retirement income for 30 years or more if you retire at 65.

If we use our estimate of $50,860 per year and adjust this 3% annually for inflation, a 30-year retirement would cost a little over $2.4 million. Even a 20-year retirement would still cost close to $1.4 million. Of course, you won't have to pay for all of this yourself because you'll have some money from Social Security and possibly a 401(k) match, but you'll still have to save diligently throughout your working life to reach that goal. The EBRI survey found that only four in 10 workers believe they'll need $1 million or more for retirement, and that means some of them are in danger of coming up short if they spend an average amount and live a longer-than-average life.

Budgeting for tomorrow's retirement

Planning for an expensive retirement can help you avoid saving too little. Expect to live a long life unless you have good reason to believe you won't be around for that long, like a serious health problem. You should also plan for higher living expenses (a 3% annual inflation rate, factored into most retirement calculators, should do the trick). Plan for slower investment growth, too, so your retirement plan isn't completely derailed if the stock market goes through a rough patch. Use a 5% or 6% annual investment rate of return when calculating how much your savings could grow over time.

You also need to make sure your plan includes all the key costs associated with your retirement. Healthcare can often get overlooked, either because people expect to remain healthy into their old age or because they think Medicare will take care of everything. But even the healthiest among us can get sidelined by an injury. And while Medicare will help some, it doesn't cover everything and it brings costs of its own. Expect your healthcare expenses to rise in retirement, regardless of your health now. You may also want to investigate supplemental healthcare insurance to cover the costs Medicare doesn't. Look into the average premiums for these policies and include them in your retirement budget.

It never hurts to have a backup plan, either. If you aren't able to save as much as you'd hoped during your working life or you have a major expense that wipes out a large chunk of your retirement savings early on, you should have a strategy to help you course-correct. This might include cutting unnecessary spending, like travel or big-ticket purchases, or taking a part-time job. You could also try delaying retirement a little longer to give yourself more time to save.

The most important thing you can do is check in with yourself often. Review your retirement plan at least once a year to see if it needs tweaking. If you're saving more or less than you anticipated or if your health or ideas about retirement have changed since you first made the plan, you will need to make adjustments. The sooner you do this, the smaller the changes you have to make will be.