Strategizing for retirement as lifespans grow longer
Rules of thumb are helpful, but only provide a baseline
Michael MaehlApril 27th, 2017
Making the transition from earning money to spending money when you first stop working is tricky, especially if you’re healthy and eager to enjoy all that new free time. The nice thing about work is that it keeps you from spending money. Remember, retirement is still a relatively new phenomenon. In the past, people pretty much worked until they died.
In 1889, Chancellor Otto von Bismarck’s German government introduced the first old age pension plan to provide retirement benefits to people over 70 … later reduced to 65. The aim of this wasn’t to provide a deserved holiday for old folks at the end of their lives but to ensure a safety net for those made incapable of working by the disabilities of extreme age. It was a pretty good bet for the government as, at the time, the average Prussian only lived to 45.
Social Security began in the U.S. in 1935, using the Chancellor’s arbitrary 65 age point. At the time, Social Security says that men had an average life expectancy of about 59; for women, it was 63. It wasn’t until about 1950 that the average U.S. life expectancies for both hit 65. Today, it’s 78 … and still the retirement age hasn’t changed.
UBS Wealth Management Americas discovered that most investors today don’t feel old until they turn 80. That’s a gigantic change from their parents’ generation, when old was regarded to be about 60.
Those short life expectancies of the past led to a practice that worked its way into many people’s planning for retirement, and continues even today. That’s the thought that, as you get closer to, and enter into, retirement, your assets should be invested into “safe” things. These safe things usually are bonds, certificates of deposit, and income annuities. The cash flow is fixed and you can count on it. That’s fine for what had been a retirement of just a few years.
However, retirements of multiple years in length are now the norm. Placing all, or the majority of, your assets into these types of investments can subject you to significant buying-power risk, due to inflation, along with reinvestment risk (the risk of lower returns when those issues mature). And, with the current returns on these items keeping you only just about even with inflation, any increase in your expenses could be a major problem.
So, how much do you need to retire?
This is the first question everyone wants to have answered. I submit there are others of equal importance for you to include with that as you try to figure it all out. For instance:
•What range of things do I actually want to do with my money in retirement; socially, physically, etc.?
•What are or will be my sources of income in retirement (retirement plans, pensions, Social Security, part-time work, etc.)?
•How much, if any, debt will I be carrying?
•What assumptions am I using for market returns, as well as the rate of inflation?
•How expensive is the cost of living and tax rates where I plan to live?
•How might my spending change as I age?
A recent poll conducted by BlackRock and Boston Research Group found that current workers who are planning for retirement often see their retirement as something very different from what current retirees are actually experiencing. Those include retirement age, life expectancy, savings, relationships, health, or part-time employment.
The way in which new and soon-to-be retirees describe the mental, social, physical and financial aspects of retirement can either limit or unleash their retirement journey.
There are all sorts of rules of thumb about saving for retirement. There’s the 4 percent withdrawal rule, raising the question of whether an annual withdrawal of 4 percent of your total retirement asset base, less taxes, is enough for you to live on.
Another rule says you’ll need to replace 80 percent of your current income with income from your portfolio in retirement. Further, having assets in nonretirement accounts also will help you to have the flexibility you need as you make withdrawals.
Rules of thumb can be helpful as a baseline for something as complex as creating a retirement strategy. But, importantly, they require context. It can be quite an involved process when you consider all of the variables involved.
As overwhelming as the entire process of strategizing for your retirement can be, you still should create such a strategy and, equally important, monitor your progress as you age. As Yogi Berra once said, “If you don’t know where you’re going, you’re going to wind up someplace else.”
A lot of folks transition to retirement with some preconceived idea that one source of funds from their retirement assets is “good,” while another is “bad.” For example, interest income and dividend income are good, but they never want to touch the principal. In fact, they’re all good and can help you at different times in the market cycles. You need to stop thinking that there’s a type of investment that is risk-free.
Try thinking of your combined retirement assets as a well. Wells get replenished from rain and snow melt. When you take out the water to live, it doesn’t matter what the source was.
Imagine that, when you’re retired, your retirement fund money well is being replenished by bond interest, dividend income, capital gains and your principal. They’ll fill your well at different times. The more sources (think asset allocation) you’ve got filling that well, the less likely it will be to run dry. That’s why being overly anchored on a single source of cash flow for your retirement can be a major problem, due to the different types of risk markets are subject to.
Diversifying across the spectrum of market risks, particularly having investments that respond differently to various conditions, is widely considered a great way to build a portfolio that can be depended on over time. This is because it ensures that no one risk will turn into the problem that kills your portfolio.
One of the key reasons for having a retirement investment strategy to manage your funds is so you’ll know what to do in different market situations. I believe your strategy should be to plan to draw on all sources of cash flows available to you. The big question is, how do you identify where to go for cash flow on a year-to-year basis? It depends.
A strategy that’s fairly straightforward can be that, if the markets are up, you take some interest and dividends and supplement those with capital gains. Or, if the markets are down, you use cash, let the portfolio recover, and dip into your principal to provide for your needs.
The issue of outliving your money is a real concern. To avoid having that happen, try not to make these classic mistakes.
First, be careful not to overspend on pent-up desires early on. Work your trips, etc., into your spending plans so you don’t kill your budget.
Next, wanting to be debt-free is a good goal and one that’s important for many retirees. However, if you haven’t paid off the mortgage yet, rushing to do so might not be your best move. The key is, as long as you have the cash flow to comfortably make the payments, don’t sacrifice your long-term retirement savings by using a big chunk to pay off your mortgage. Instead, keep that money invested where it should continue to grow for you ... plus, having a mortgage offers tax benefits you can still claim as a retiree.
Finally, be sure to allow for health-care costs in your later retirement years. According to Fidelity’s Retiree Health Care Cost Estimate for last year, a hypothetical 65-year-old heterosexual couple retiring in 2016, with life expectancies of 87 for the woman and 85 for the man, will need an estimated $260,000 to cover health care costs in retirement, though costs could be more or less depending on actual health status, area of residence, and longevity.
Create your strategy and stay with it … no matter the headlines of the day.
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. Securities and investment advisory services offered through KMS Financial Services Inc.