Spokane Journal of Business

Set goals when mulling spending in retirement

Ask yourself some delving questions to begin process

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Retirement, per se, is still a relatively new phenomenon. Not all that long ago, people pretty much worked until they died. Retirement, as a definite period of your lifetime, is something that only really came into being starting in the 1970s in the U.S.

Whether already retired or on the path to being so, you likely have a pretty good idea about your fixed monthly expenses. However, the great unknowns of how future markets will perform, your health care costs, and the ever-popular “unplanned expenses” all have to be factored into deciding how much you’ll need to allow you to do those things.

The great market sage, Mr. Lawrence “Yogi” Berra, offered this tidbit. “If you don’t know where you’re going, you’ll likely wind up someplace else.”

In other words, retiring is not just like going to work each day. Just as you’ve planned your daily work schedules, you should discipline yourself to be strategizing about what it is you want to do, or get out of, this retired time. And again, this exercise can be done whether you’re already there or on the way.

What do I actually want to do with my money in retirement? Going through this process can give you the opportunity to help clear up misconceptions and set realistic expectations about everyday life in retirement. The way we think about and describe our work, relationships, social life, finances, and health all play an important role. 

Here are some questions to consider as you work to figure it all out. How much, if any, debt and of what type will I be carrying at retirement? What assumptions am I using for market returns, tax rates, and the rate of inflation? How expensive is the cost of living and are tax rates different where I plan to live? How will my spending change as I age? What are my other sources of income in retirement—pensions, Social Security, part-time work, etc.?

Look at your current cash flows. Identify those expenses you feel are essential or necessary. Now, from the income side, add your guaranteed income sources, i.e., Social Security, pension, vet benefits, etc. Then, look to see if you’ve got a surplus of cash – or of expenses. If the latter, identify what can you change in order to make you cash flow positive.

Along with these pretty much fact-based questions, here’s a few more values-based questions to help spark your thinking. There are no wrong answers; only what’s applicable to your situation.

For instance, “To me, retirement is like (fill in the blank).” Or, “My social life will consist of (blank).” Or, “My physical life is (blank).” Open-ended thoughts like these can help you to focus on what’s important to you about your money.

Here are four catch-all goal categories to help you focus on better managing your retirement assets and prioritizing how to use them. 

•Longevity goals. These center on your ability to cover your essential expenses over your retirement. These include things such as housing, health care, living expenses, and being able to maintain your independence, without having to rely on others.

•Lifestyle goals. These relate to how you want to go about your life, as well as maintaining your desired standard of living. These are mostly discretionary things like travel, leisure-time activities, and social interactions.

•Legacy goals. These are for any gifts, bequests, or donations you may want your family or the community to enjoy. Many of these can be met while you’re still around, by the way.

•Liquidity goals. The amount of assets you’d like to have available quickly—within 30 days—for unexpected expenses, such as home or car repairs. Don’t use assets that are set aside for some other need. 

Meir Statman is a professor of finance at Santa Clara University. The professor brought up the term “the dividend puzzle” in his book, “Finance For Normal People,” when talking about the significant hesitation on behalf of many retirees to tap into their principal. Their attitude is that income from the assets is great, but under no circumstances do I want to use principal to live on.

Think of all your retirement assets as a well providing you water to live on. A water well is refilled, in our part of the world anyway, with a combination of rain and snow melt. When you draw upon that well, the water looks the same. The source doesn’t matter.

Mentally splitting your assets into just income or principal is, in behavioral finance, termed as “the mental accounting rule.” Basically, that means many investors think of money as being simply either income capital/principal. That’s great for your working years. The problem is that once people retire and they’re actually spending from their portfolio, rather than only saving, that rule tends to get in their way—cutting off their water supply, in a manner of speaking.

Here’s a couple reasons why I believe that you should definitely consider using your principal to help you meet your retirement needs.

First, the taxation of your withdrawals is usually different when you use principal instead of dividends as the source. While a blend of those sources usually is what many people use, when you withdraw your principal, it’s either going to be considered a return of capital—so no tax due—or capital gains. 

The tax on long-term capital gains—a capital asset held for, at least, 366 days qualifies—is the lowest you can have. In addition, you can also get the money whenever you wish, as opposed to waiting for the quarterly dividend distribution. 

For instance, because they can be desperate with interest rates so low, income-only folks might invest in either high-yield or longer-term bonds. That can set them up for risks that they might not understand or want. They’ve also been buying high-dividend stocks, concentrating their portfolios in telecommunications and utilities, sectors that are already highly overvalued due to yield chasing.

What’s needed is to help these investors to find ways to control their consumption but not restrict it so much as to where they live like misers, even though they have ample portfolios.

How can someone give himself or herself permission to tap periodically the things that have performed really well in their portfolio, even if it means principal? How do people get over that mental threshold?

Think, for example, of using your mutual funds with an automatic withdrawal program. You decide, either by a dollar amount or a percentage of the fund assets, to get your distribution, in whatever frequency you wish. The fund will actually likely pay you a combination of both income and capital gains, while leaving the rest of the money to grow. People tend to see the distribution as income, so it becomes okay to spend. Now, you do spend, but you don’t spend too much or too fast.

Another is to think of your RMD, the annual required minimum distribution, as a guide. The percentage of RMD goes up with age as your life expectancy goes down. Many people in retirement hate the idea of RMD because now they have to pay taxes on the withdrawals, since all retirement plans except the Roth are tax deferred, not tax free.

Once a withdrawal is made, and you’ve paid taxes on it, go ahead and put it in your money market fund or spend it. That’s also a pretty good rule to overcome the reluctance to dip into capital.

If you have a really long life expectancy, you may want to instead reinvest through your traditional accounts for further potential growth. 

You can create all the spreadsheets you want but life inevitably will throw you a curveball, and some of your assumptions will prove to be untrue. That’s an unfortunate side effect of trying to plan in the face of uncertainty. 

And that’s why having a financial strategy is a process and not an event. You don’t simply set a course of action and follow that exact one for your remaining days. Financial strategies should be open ended because there always will be corrective actions, or difficult decisions that have to be made along the way.

It’s like the old saying, “Plans are useless but planning is indispensable.”

Michael Maehl is a financial adviser and Spokane-based senior vice president of Opus 111 Group LLC, a Seattle-based financial services company. He can be reached at 509.747.3323.

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