Retirement Roulette

Jonathan Clements

IT’S HARD TO OVERSTATE how challenging it is to generate retirement income: We need our money to last at least as long as we do, and yet we don’t know how financial markets will perform, what the inflation rate will be, whether we’ll get hit with hefty long-term-care costs and how long we’ll live.

Moreover, the generic advice offered inevitably doesn’t work for many—and perhaps most—folks because we all start retirement with different attitudes, goals and financial resources. For proof, consider seven issues.

1. About the kids. If our retirement needs and wants were relatively modest, and hence we could cover all expenses with our monthly Social Security check, we’d be in great financial shape. After all, we’d have a government-backed inflation-indexed stream of income that’s paid until the day we die—and that, arguably, is as good as it gets.

Yes, even Social Security has drawbacks. First, Congress could cut benefits, though I can’t imagine that ever happening, given that politicians have a fondness for reelection. Second, the national standard of living rises not with inflation, but slightly faster, with per-capita GDP. That’s why many retirees feel financially pinched, especially later in retirement.

But there’s also a third key drawback: Even if Social Security could cover our entire retirement costs, there’d be nothing left for our children, nieces, nephews and charity—and bequeathing money is an important goal for many. Where we position ourselves on the spectrum from “strong bequest motive” to “die broke” can make a huge difference to how we manage our retirement finances.

2. How optimistic we are. If we knew our end date, managing our retirement finances would be a cinch. The reality: Unless we’ve lived a life of total debauchery or our current health is downright awful, it’s hard to know how long we’ll live. What about family longevity as an indicator of our own life expectancy? We might imagine our parents and grandparents are a great guide to our longevity, and yet genetics might explain just 25% of the variation in lifespans—and perhaps as little as 7%.

The bottom line: It’s awfully hard to know how long our retirement will last. Like saving too much for retirement, there’s no financial harm in assuming we’ll live to a ripe old age. By contrast, there’s great risk in assuming a short retirement. What if we do just that? Before we start spending merrily, we should at least have a backup plan in case we live longer than imagined. Did anybody say “reverse mortgage”?

3. Risks we hate. The biggest risk in retirement is running out of money before we run out of breath. But that’s hardly the only financial danger. Every key financial decision in retirement involves risk. The question is, which risks are we willing to take?

For instance, if we delay Social Security, buy income annuities and take any pension as a monthly payment, we run the risk of dying early in retirement and leaving big money on the table. Meanwhile, if we claim Social Security early and take our pension as a lump sum, we’ll have a fatter nest egg, at least in the initial retirement years. But there are also dueling risks—the risk of sharp short-term losses if we favor stocks and riskier bonds, and the risk we’ll lose ground to inflation if we’re too conservative.

4. Income we want. The popular 4% withdrawal rate is based on withdrawing 4% of our nest egg in the first year of retirement, and thereafter stepping up the sum withdrawn each year with inflation. Is 4% the right number? Those of us without a crystal ball have no idea.

More important, we should be skeptical of the notion that steadily growing lifetime income can be generated from volatile investments. And even if it’s doable, most retirees won’t do it. Instead, faced with a market crash and accelerating inflation, their instinct will be to spend less—and that’s a good instinct, I’d argue. My advice: Treat the 4% rule as a guideline and not a withdrawal strategy to be followed robotically.

But what if folks loathe the idea that their spending will need to fluctuate from one year to the next? That’s a vote in favor of predictable income, and hence a vote in favor of delaying Social Security and buying immediate-fixed annuities. Indeed, research suggests that retirees with predictable income tend to be happier.

5. Whether to work. I know that, for some, retirement means never working again and, indeed, earning any money somehow violates the very notion of retirement. For others, even if they wanted to work part-time, it’s hard to find a position they’d enjoy at a pay rate they’d consider acceptable.

Still, let me offer this contention: Working a handful of hours each week for money is perhaps the smartest strategy, financially and otherwise, for those in their initial retirement years. Think about it: That work could provide us with a sense of purpose, ensure we regularly engage with others, give us an identity beyond “I’m a retiree,” limit withdrawals from our portfolio, and allow us to delay both Social Security and any immediate annuity purchases. In short, a handful of years of part-time work could be the difference between a happy and financially successful retirement, and one that’s marked by money worries, loneliness and a lack of direction.

6. When to spend. Many retirees spend heavily in their first decade of retirement, figuring this is their chance to enjoy life before the slow-go and no-go years arrive. I wouldn’t discourage anybody from doing so—but I also fear that those in their 60s aren’t very good at anticipating the needs of their octogenarian selves. Are we sure we’ll be content to spend our 80s and beyond sitting at home, watching the TV? Do we really have enough savings and long-term-care insurance to cover long-term-care costs? If not, perhaps we should spend a little less freely in our 60s.

7. When we start to slip. Overseeing a portfolio of stocks and bonds, and calculating how much we can safely withdraw each year, might seem easy enough in our 60s. But will we be up to the task in our 80s?

This might again sound like a vote for annuitizing and delaying Social Security. But instead, it could be a reason to keep our finances as simple as possible, and perhaps also identify a family member or younger financial planner who could help us manage our money as we age.

Where do I stand on these various issues? I intend to work part-time for as long as it’s enjoyable, and I plan to do that work from all over the world, as I strive to make the most of my go-go retirement years. But I concede that I’m lucky: With a laptop and an internet connection, I can work from all manner of wonderful places.

What about the 4% rule? I might use it as a guideline to make sure I’m not overspending. But I’m going to be flexible about how much I spend each year, taking my cues from my portfolio’s performance. At the same time, as a cushion, I plan to keep five years’ worth of expected portfolio withdrawals in high-quality short-term bond funds, so there’s scant risk I’d ever need to sell stocks during a market downturn.

Meanwhile, I’m planning to delay Social Security until age 70 and I intend to use part of my nest egg to purchase immediate-fixed annuities from a variety of insurers. My goal: have enough predictable income to cover at least my fixed living costs. That’ll free me up to invest more of my remaining money in stocks and hence go for growth—because I’d like to leave a healthy sum to my kids, grandkids and charity. Indeed, I believe annuitizing and delaying Social Security are the key to greater wealth later in retirement. That predictable income stream should also make managing my finances later in retirement far less mentally taxing.

What if I’m wrong, and I don’t live long enough to break even on my delayed Social Security benefits and my annuity purchases? No doubt I’ll die with some regrets—but, when the end comes, I can’t imagine I’ll be fretting over my financial choices.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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