Making Your Money Last Longer Than You Do

[Midpack]

I was reading an ER.org FAQ on drawdown yesterday, which led me to reread subject chapter in The Bogleheads' Guide to Investing. Nothing new here for most, but interesting how many of the topics we frequently discuss here, are summarized below in relatively few well chosen words. There are concise single sentences below that repeatedly result in threads with hundreds of posts and thousands of views. That's great writing. Some excerpts...

“How much of my portfolio can I spend each year without running out of money?” That’s the big question that all retirees and near retirees want answered in no uncertain terms. The thought of being unemployed and running out of money, with years of life ahead, conjures up all sorts of horrible images. We imagine spending our final years eking out a miserable existence, in an unheated, coldwater flat eating cat food and crackers. We imagine our friends abandoning us, our families ignoring us, and, after dying alone, having very few people attend our sparse funeral.

If that question is plaguing you, you can answer it for yourself with 100 percent certainty. All you have to do is gather together the following information:

• Current value of your portfolio
• Your date of death
• Your portfolio returns every year leading up to your demise
• Your federal, state, and local tax rates each year until your demise
• Inflation rates
• Health care costs
• Amounts of your pension and any other income
• Future value of any real estate you may own
• All unanticipated changes in your pension and health care coverage

Once you have collected all that data, you can then run it through any number of online financial planning programs, and they will give you a spending figure that will allow you to run out of money on your last day on earth. You can even arrange for your check to the undertaker to bounce.

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There are two basic ways you can go wrong when it comes to spending down your nest egg. First, you can live it up, overspend in the early years of retirement, and potentially run out of money later on. Spending too much too soon is a mistake you simply can’t afford to make. Few, if any of us want to spend our final years living as a ward of the state or a burden to others.

The second mistake is to under spend. This is usually driven by an irrational fear of running out of money --- even when your portfolio and other sources of income are sufficient to sustain your desired standard of living. Underspenders deprive themselves and those closest to them of goods, services, and experiences that can make for a better, happier, and more fulfilling life. Underspending can be a difficult problem for people in the habit of saving and investing to overcome.

As British clergyman and essayist John W. Foster remarked, “The pride of dying rich raises the loudest laugh in hell.”

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What most of us want is a plan that ensures we do not outlive our money while enjoying it as much as possible. Choosing your yearly withdrawal rate is a good starting point for planning purposes, but realize that your withdrawal rate may have to be adjusted as the years go by. Stock market returns go through long periods of feast and famine. High inflation rates may come along and diminish purchasing power. Unexpected happenings in your life can raise or lower living expenses in ways you never anticipated. If the Boy Scout’s motto is to “Be prepared,” the retiree’s motto is to “Be flexible.”

There are two simply ways to remain financially flexible and reduce the odds of running out of money. First, keep your fixed living expenses as low as possible. Retirement is not the time to have an enormous mortgage, expensive car payments, credit card debts, and the like. Low overhead comes in very handy when the stock market goes in the tank. You need to have the flexibility of spending less during bear markets and more during bull markets. When the market has a great year, you can spend some of the profits. When the market is down, if your budget is tight, you put those purchases on hold for a year or two.

The second way to increase spending flexibility is to have a viable way to earn income if needed.

Other ways to increase the odds of solvency are delaying retirement, waiting until full retirement age to draw Social Security, and purchasing an immediate annuity. Every year you delay retirement is one more year to add to your savings, one more year for your savings to compound, and one year less that you will be depending on your portfolio for income. Of course, you have to enjoy what you’re doing, or the energy expended isn’t worth the financial benefit.

It’s probably best to begin drawing Social Security at age 62 if you need the money, are not expecting to live a long time, and are not earning over $12,960 a year (2007 threshold). If you’re in excellent health, have great genes, and have earned income over $12,960 a year (2007), waiting until full retirement age is likely a good decision. Waiting until age 70 will garner an even larger pension, but to ensure that it’s financially viable, plan on living well into your nineties and beyond.

A final way to ensure income for life is to use part of your savings to purchase an immediate annuity that guarantees a fixed monthly income. Although an annuity can be a good option for those ages 75 or older, it has it’s drawbacks, especially for younger retirees. First, the younger you are, the lower the payout is. Second, the monthly income rate is based on current interest rates, and in recent years, interest rates have been low, making the payout relatively small. Third, most immediate annuities have no provision for inflation. Finally, if you give the insurance company a hefty sum without choosing a term-certain payout option, and then die prematurely, it can be a very bad decision for your heirs. The money does not go back into your estate; rather, it’s retained by the insurance company.

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In summary, the most important key to making your money last is to be financially flexible, particularly in the early years. Keep your fixed expenses low and have a viable way to earn extra income if needed. It may be reassuring to have an ironclad rule telling you to withdraw no more than a certain percentage of your portfolio each year. However, to dogmatically follow such a rule is to risk both over- and underspending. During our working years, we have to make financial decisions in the face of uncertainty, and this new stage of life is no different. Most important, don’t let your money concerns deprive you of enjoying the freedom to spend your time pursuing other activies --- and enjoying the people --- you treasure most.

 

[Danmar]

Thanks for posting this. I think the most controversial part for the some (frugalistas) on this site would be the section that says" spending more can enhance your quality of life" I think I agree with everything he said. Very concise.

 

[samclem]

Thanks, Midpack, this is a good summary of a lot of discussions here.

My own little suggestion is that they could have specifically addressed the differences between a withdrawal strategy based on "starting value on date of retirement adjusted every year for inflation" and "fixed percent of each year's end portfolio value." They discuss the need to be flexible in general terms, but a little bit more on how to automatically build in that withdrawal flexibility would be welcome.

But then, it would be less concise I suppose!

 

[67walkon]

Good post. That book has a wealth of info.

Getting our fixed expenses down to a minimum is part of my goal. My income has varied my whole adult life because I'm more or less self employed. We've dealt with it by keeping debt under control. When you don't have money, you don't spend it. When you have extra, you replenish the kitty and then splurge on something if you need to do that. It works.

I'm thinking we'll be the same in retirement. I suspect we will spend less than budgeted, but I'm a bit afraid I'm wrong, so will likely be too conservative in the early years. I guess that makes me a Boglehead.

 

[Midpack]

Thanks, Midpack, this is a good summary of a lot of discussions here.

My own little suggestion is that they could have specifically addressed the differences between a withdrawal strategy based on "starting value on date of retirement adjusted every year for inflation" and "fixed percent of each year's end portfolio value." They discuss the need to be flexible in general terms, but a little bit more on how to automatically build in that withdrawal flexibility would be welcome.

But then, it would be less concise I suppose!

The chapter is an overview but there's quite a bit more in the book itself including the underlined above. I was afraid I was getting close to the copyright line as is (don't know where to draw that line) so I tried to leave out some detail and/or ideas that I consider common knowledge here. It's a great book IMO...

 

[RetireBy90]

It’s probably best to begin drawing Social Security at age 62 if you need the money, are not expecting to live a long time, and are not earning over $12,960 a year (2007 threshold). If you’re in excellent health, have great genes, and have earned income over $12,960 a year (2007), waiting until full retirement age is likely a good decision. Waiting until age 70 will garner an even larger pension, but to ensure that it’s financially viable, plan on living well into your nineties and beyond.

Thanks for the post. Could be some common sense for long time posters, but even if your on this track, it can be comforting to hear that others agree with you and your not way out there.
Sorry to dwell on details, but earned income in this case would be any income other than a draw from your retirement funds?
We have pensions so to follow this line of thought, they would qualify as the earned income, correct?

Finally, if you give the insurance company a hefty sum without choosing a term-certain payout option, and then die prematurely, it can be a very bad decision for your heirs. The money does not go back into your estate; rather, it’s retained by the insurance company.

One comment, the insurance company wouldn't retain these funds, they would be paid out to those that live longer than expected. They aren't lost, they are the cost of providing you a guarneteed income or peace of mind, or what ever reason you purchased an anunity.

 

[Finance Dave]

Good info, thanks.

We have so much "fun" built into FIRE that if things start looking bleak, it's as simple as cancelling one of our 2-week vacations to Europe in a given year.

I think about 40% of our FIRE budget is for hobbies, travel, and entertainment.