Note: This story is sponsored by The Alliance for Lifetime Income.
What do you want to do in retirement? The list – of course – is likely as individual as you are, which is to say it may run the gamut from gardening to globetrotting, perfecting your sourdough recipe to perfecting your putt. But according to a recent survey, in addition to freedom from financial worries and the ability to spend time with family and others we love, what retirees want most is the flexibility to do what we want, whatever that happens to be.
Those things, even if they’re relatively simple, cost money when you’re talking about sustaining them over the two to three decades (sometimes longer) than retirement can last. Making sure you have enough income not only for your fixed expenses and needs, but for your discretionary ones and wants, has become more challenging over the last half century, explains Ben Harris, formerly the Chief Economic Advisor to Vice President Joe Biden, today a visiting associate professor at Northwestern and an Alliance for Lifetime Income Fellow. “What’s happened over the past 40 to 50 years is that we’ve had this sea change in how people save for retirement. We’ve gone from having a defined benefit plan or pension, where if you got a benefit from work it was for life, to 401(k)s where workers have to take on their own saving and investment decisions [in order to make their money last].”
The problem is if those workers don’t save enough, invest properly or figure out a strategy to make their money last as long as they do, that can take a tremendous toll on happiness in the last one-quarter to one-third of life. “When economists think about happiness over your entire life, what causes you to be unhappy is basically if you lived a certain lifestyle and you’re not able to afford it anymore,” explains Harris, also an educational fellow with the Alliance for Lifetime Income (as, full disclosure, am I). Being unable to predict how long you’re going to live – if you’re age 65, there’s a decent chance you’ll die in the next decade, but also a decent one you’ll live into your mid 90s – just exacerbates the situation.
So, how do you solve for it? Here’s a game plan.
- If you don’t know what you’ll need, how will you know how much money to save or count on? Focus your retirement plan on not just saving for retirement, but calculating the monthly income you’ll need and want in retirement. Ballpark the cost of your initial retirement lifestyle. Are you going to be able to put an exact number on what it’ll cost to live in retirement? Not necessarily, but you should be able to get close by looking your current costs of housing, transportation, healthcare, food, insurance, and entertainment. According to the Bureau of Labor Statistics, the average household run by a person age 65-plus spends about $3,800 a month (about $1,000 less than households overall). The biggest chunk of that (a little over $1,300) goes to housing, with transportation, healthcare and food following (at $500 – $600 each). But again, those are averages. If you’re going to retire the mortgage by the time you retire yourself, you may see a big drop in housing costs. If you refinanced recently, you may not. Similarly, if you had an expensive commute that you’ll no longer need to do, or spent a lot on workwear, those expenses may be reduced as well. On the flipside, the one thing you’ll have more of is time. If you plan to spend it traveling or embarking on another expensive endeavor, that may cost more. Bottom line: Take to the computer or a legal pad to look at what you’re spending now and how you estimate it might change. Then, with the help of a financial advisor or retirement calculator, make sure you’re saving enough to replace it.
- Consider your current saving rate. One thing that happens when you retire is that you go from being a saver to being a spender, practically overnight. For people who’ve been consistently putting a significant chunk of their income – whether it’s the 15% experts recommend, a little more or a little less – that can be a huge adjustment. In fact, the better a saver you’ve been, the less retirement spending is likely to be a problem for you not just because you’ve socked so much away, but because you’ve been living on less of your income for so long.
- Know that your spending will likely spike entering retirement, then slow with age. JP Morgan Asset Management recently analyzed the spending behaviors of more than 5,000 individuals who are already retired. What they saw is that during the two years before retirement and three years after, spending tended to rise. That makes sense. If you’re moving, you’ve got the costs associated with that. Even if you’re not, those first few retirement years are often big ones for travel and other active pursuits. After that, however, spending tailed off overall until retirees hit their 80s, when healthcare expenses started to nudge it back up. Interestingly, the decline over the years, particularly on transportation and food spending, was more than enough – on average – to account for the healthcare pop.
- Think about how you’ll create the income to cover these things. Once you’ve got a handle on what your spending will look like, it’s time to consider where the money will come from. Wade Pfau, Professor of Retirement Income at the American College as well as an Alliance Fellow, says there are essentially three ways you can think about funding retirement. You can buy a bond that matures every year to support your income needs. You can continue to invest the money in your portfolio and withdraw a small enough sum each year to give you good odds that it will go the distance, essentially following the 4% rule. (The downside of that is that you don’t know how the market will do, he notes. “A downturn early in retirement can impact your spending throughout.”) Or you can use a chunk of your nest egg to buy an annuity to generate income. Economists, he explains, like this last option because you’re pooling your risk with others – some who will not live as long as you do, others who will outlive you – you typically get a better return than by purchasing a bond without the market risk.
- Consider dividing to conquer. Pfau and other experts note that a combination of the solutions above is often best. “There will always be a role for investment assets,” he says. “An annuity won’t be good for liquidity, but it is good for spending. That leaves the remaining investment portfolio to provide liquidity and growth.”
Finally, although planning is a smart move, panicking is typically not necessary, Harris notes. “The academic evidence is pretty strong that people will be able to maintain standard of living; most people are able to do things,” he says. “We don’t see many situations where people have to sell their car and downgrade. People, on average, are pretty able to do what they were able to do before retirement.”
For more information, visit www.RetireYourRisk.org.
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