Choosing Not To Upgrade

I wanted an option to exist where my older fighters would not be upgraded unless I manually told them to be upgraded. Is this an option or are they upgraded automatically?

Do the fighters need to be located on a planet to be upgraded or can they be upgraded in the middle of space?

Is there a cost associated with upgrading ships and if so, will the expense pop up on my budget menu?
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Ships do not get upgraded automatically (you may be given the choice to upgrade them if you upgrade teh design, but upgrading the design alone will not affect them). If you want to upgrade your ships, all you need to do is select one on the map and hit the Upgrade button in the panel in the bottom part of the screen. Then choose what model to upgrade it to, whether you want to upgrade all of that ship or just the one, and how you want to pay (same options as if you purchased a new ship or planetary improvement).

It can be quite expensive to upgrade, but if you have very experienced ships it is worth it since you keep the experience bonus to HP. You can upgrade ships anywhere, and the time it takes will depend on how near it is to a planet/shipyard. Those very far away will take two or three turns, whereas those in orbit will be ready next turn. Those two or three turns can be very dangerous though as ships are rendered inoperative and left with only 1 HP during the upgrade process, so you should always upgrade in friendly space.