The Basics Of Retirement PlanningForget the idea that you need millions to retire comfortably, as some would have you believe. One expert says you'll need less money than you thought.
What if you could bail out of your job years earlier than you thought? Or spend thousands of dollars more in retirement than you'd planned?
What if you're actually saving too much for retirement, instead of not enough?
A financial planner who has studied retirees' spending patterns insists all these things are possible because one of the most commonly accepted tenets of retirement planning is, well, wrong.
You'll spend less, not more
Traditional retirement planning, says planner Ty Bernicke of Eau Claire, Wis., assumes retirees' income needs will increase as they age, thanks to inflation. Most financial advisers and retirement calculators bump up the amount retirees are expected to withdraw from their savings by at least 3% a year to reflect rising prices.
Bernicke believes most people actually spend less as they age. He says that has been true of his own clients and is borne out by the U.S. Department of Labor's Consumer Expenditure Surveys, which show significant spending declines in every major category except health care as people age.
Bernicke's review of the survey data, contained in a recent Journal of Financial Planning article, indicates that the decline in spending appears to be voluntary, since household wealth continues to climb with a age.
A radically different approach
The idea that people don't have to plan for ever-increasing income needs could have profound effects on their retirement plans.
Bernicke uses the example of a couple who wants to retire at age 55 with an $800,000 nest egg earning an average of 8% a year, with $60,000 of after-tax spending money the first year. Traditional retirement planning dictates that their spending needs would escalate to more than $145,000 a year by the time they died at age 85. Except that they wouldn't make it that far, since their ever-increasing withdrawals would almost certainly deplete their savings by age 81. To avoid running out of money, they either would have to retire seven years later or reduce their annual spending needs by an initial $12,000, or 20%.
Reverse the assumption that spending has to increase, though, and the couple can not only retire early but would leave heirs a substantial estate of more than $2 million, Bernicke said. Even if you just assume their spending stayed steady -- the natural declines in spending offset by inflationary pressures -- they could retire early without running out of cash, he said.
Since the article appeared, Bernicke said other planners have contacted him to say he confirmed their long-held suspicions."
Several planners said, 'I already knew that this happened, but it was on a subconscious level,'" Bernicke said. "This brings it out into the open."
What about emergencies?
Whether Bernicke's research will change the financial-planning world -- or your own retirement plans -- is a whole different matter.
Bob Veres, who runs a newsletter and forum for financial planners, thinks most advisers will stick to the way they're currently projecting retirement needs. The consequences of being wrong -- of advising an earlier retirement or a more aggressive withdrawal rate -- are simply too great.
"My take is that Bernicke is suggesting that advisers and financial planners remove a valuable fudge factor from their calculations," said Veres, editor of the "Inside Information" newsletter and author of "The Cutting Edge in Financial Services." "If something catastrophic happens (with traditional retirement planning), they still have the ability to reduce their spending. If the planning is for reduced spending, then what happens if something significant happens? There is no elasticity."
I've written a few times about how pulling out too much money early in retirement, especially when combined with a market downturn, can spell disaster. You can find yourself drawing slices from a fast-shrinking pie, leaving you with the dismal prospects of returning to work in your old age or living on far less than you imagined to avoid running out of cash. That's why many financial planners and researchers recommend initial withdrawal rates of 3% to 5% -- not the 8.75% Bernicke used in his "reality retirement" projections. (For more details, see "Will you run out of money?" and "Make your money last in retirement.")
Holes in the theory
There are a couple other issues to consider:
Bernicke's research doesn't include long-term-care expenses. That's a pretty big wild card to ignore. Bernicke points out, correctly, that most traditional retirement planning doesn't specifically earmark money for custodial care, either. But assumptions of ever-rising spending might give more of that "fudge factor" that Veres mentioned. For his part, Bernicke recommends that those concerned about such expenses use some of the extra money they can access at retirement to purchase long-term care insurance.
You may need more gold for your golden years. Financial planners report that many of their well-off clients actually spend more in early retirement than they did in their working years as they travel, pursue hobbies and transfer money to their kids. Even if you're not jetting off to Aruba or touring the states in your brand-new motor home, your expenses might not follow the typical trend. If you still have a mortgage in retirement, for example, your housing costs aren't likely to drop much, if at all, compared to retirees who have paid-off homes or who downsize. If you live longer than average, or develop a chronic illness sooner than usual, you may need that money you've already spent.
A phased approach
Bernicke's research does highlight a reality of old age, however: We tend to slow down in later life. Although some 90-year-olds are still out there playing tennis and traveling the globe, many people in their late 70s and beyond find they have less energy, which is perhaps one of the reasons spending declines.
The early years of retirement are when you're most likely to have the health and vigor to pursue your passions. So it would be unfortunate to miss too many of those by postponing retirement unnecessarily.
Perhaps a compromise might be phased retirement -- working fewer hours or switching to a job, like teaching, that allows for more time off. That could allow you to postpone big drains on your retirement funds while you "keep yourself active and relevant," as Veres put it.
"People are beginning to recognize," Veres said, "that cutting themselves off entirely from work is not healthy.
"Another fallback option
Bernicke's research also might make the idea of an immediate annuity more appealing.
Immediate annuities are insurance products that promise a lifetime stream of monthly payments in exchange for an upfront lump sum. But typically, the amount you get remains the same over time. Buying inflation protection for an annuity is costly, requiring you to either shell out more up front or accept lower payments initially. If our couple devoted their entire nest egg to a Vanguard immediate annuity, for example, they could get a $3,754 monthly payment without inflation protection. If they wanted payments that increased 3% annually, they'd have to settle for a third less, or $2,454 a month.
If you believe Bernicke might be right, and you have enough money to buy an immediate annuity that covers your basic expenses, you might forgo the inflation protection. You would be betting that the steady payments would cover your essential living costs as they decline.
Ideally, though, you'd still have enough cash and investments in reserve to cover any surprises.
By Liz Pulliam Weston
http://moneycentral.msn.com/content/Retirementandwills/
