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The secret that will make -- or break -- your retirement

(MoneyWatch) When it comes to making retirement work, managing living expenses is the most common financial technique, according to the 2011 Retirement Risk Survey from the Society of Actuaries. For example, 83 percent of retirees say they want to eliminate all consumer debt, 75 percent want to pay off their mortgage before retirement, and 76 percent say they plan to cut back on spending.

Cutting back is one of the smartest moves you can make when you're planning for retirement. By paring down your expenses, you'll make your retirement savings last longer. But just how much should you consider trimming? If you budget for your anticipated living expenses you'll face when you retire, you can arrive at the right figure. Welcome to Week 11 of my series, 16 Weeks to Plan Your Retirement. Here we'll look at the second part of the magic formula for retirement security:

         I > E


Income > Expenses

Conventional wisdom from financial planners says you need a retirement income that's equal to anywhere from 70 to 100 percent of your pay just before retirement. The idea here is to have the same, or nearly the same, amount of spendable income in retirement that you had while you were working (after taking into account post-employment reductions in income taxes, savings and certain work-related expenses).

However, the fact is, your expenses may be substantially lower in retirement. And the higher your discretionary income while still employed, the more likely a larger disparity between your pre-retirement and post-retirement living expenses.

Another problem with the conventional wisdom is that when you do the math, it becomes clear that you need a gazillion dollars to retire. So it's a good idea to take a long, hard look at your living expenses and determine how much money you really need to cover basic living expenses and to afford only what truly makes you happy.

There's evidence that retirees' spending habits change during their retirement and that they may reduce their spending as they age. But it's not clear whether this reduction is voluntary or forced as financial resources dwindle.

Some people may want to organize their living expenses using software such as Quicken or retirement planning software such as Fidelity's Retirement Income Planner. These programs can help you estimate how your costs may change in retirement. You can determine your anticipated costs for basic fixed living expenses, such as housing, food, utilities and insurance, as well as discretionary expenses for entertainment, hobbies, vacations and gifts. This can help you with a strategy to generate retirement income in which you cover your basic living expenses with guaranteed sources of income such as Social Security, pensions and annuities, as well as discretionary expenses with invested assets.

It might take some time for you to finish this week's exercise, since I'll cover important parts of your retirement living expenses -- housing, insurance, medical bills and long-term-care expenses -- in future posts of this 16-week series.

Arriving at a retirement budget will also help you think about the tradeoffs you may make to retire when you are ready. It might also inspire you to see how you can reduce your retirement living expenses so that you can stretch your retirement savings. What is "just enough" to meet your needs and make you happy? Would you be willing to move out of the suburbs? Share housing to drastically cut your living costs? Become a dropout retiree?

How much is your retirement freedom really worth to you? The answer is different for everybody, but it's well worth your time to find the answer that works best for you.

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