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The Basics Of Retirement
Planning
Forget 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.
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
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