If you want to play you’ve got to pay. Living the life of an xtreme geezer can be a retirement gig or part of a working life. But no matter what your current status is, it’s worthwhile to have some ideas about how you’re going to pay for your fun once you do stop working.
Here’s four fundamental principles and a basic calculation to determine what you can spend during retirement and what you need in savings and other income (retirement, social security, etc.) to go play without running out of bucks:
1. No debt. Sorry, you just can’t carry debts into retirement. It’s too expensive. That’s a little simplistic, and some mortgages run at such a low interest these days that it’s almost justifiable, but as a basic rule, money you invest is unlikely to earn enough after taxes to offset debt. So the simplest thing is to pay off debt before you worry too much about any investments other than tax deferred stuff like IRAs.
2. Once you consider yourself partly or full retired, don’t spend more than 2 percent of your savings in a year. That’s not so it can last you for fifty years, it’s so your savings can grow as it needs to. Over time your savings have to grow to deal with inflation and must accommodate dips and flat spots in the earning of your investments. There may be times when you are earning five percent on your investments and savings, but if you spend that you’ll have nothing to compensate for inflation. There have been several good studies on this, and from all of them comes this rule of thumb–if you spend 2 percent of your saving and investments per year you have a 95+ percent chance of never running out of money.
3. Keep enough liquid savings to support yourself for two years. Liquid doesn’t mean stuffed in a mattress, but savings that you can’t withdraw without incurring large penalties are not very liquid. Bonds with a far off maturity date can be sold, but if interest rates have increased while you held the bonds you’ll be taking a bit of a liking by selling them. You need to look at your general portfolio to assess the overall liquidity.
4. Maintain a highly balanced portfolio that optimizes return for the risk level you are comfortable with.
Once you are retired your total money available to spend is your income (social security, pension, part time job, etc.) plus the 2 percent from savings. To keep it simple lets say you’ve saved a million bucks. Two percent is $20K per year. If you get another $25K from Social Security that’s $45K per year. You might be enthusiastic about that number, or you might think you’ll be eating dogfood.
If you think that’s not enough then you have a few choices. You can work part time, you can save more, or you can reduce your expenses. Part time work is problematic unless you have a great skill that’s in demand. Otherwise it might be at a lower rate than a job you left, requiring more effort to get adequate money. In many cases reducing expenses is a fine route. While houses are certainly assets and are part of your net worth, they are also expenses. Downsizing can be both practical and pleasant. I’m in the process of selling off a large house in Oregon. We bought a much smaller, much simpler house which we actually enjoy more than our big house. I also sold off a vacation house. The money goes into the retirement kitty, but it also decreases expenses.
Another choice is to consider an annuity. These take many forms, and financial advisers will almost always say they are too expensive. But they can serve a good purpose. One form of annuity is pure insurance called an Immediate Annuity. In this case you’re making a bet with your insurance company about how long you are going to live. The annuity kicks in at an agreed on age and begins paying. When you die there may be no benefit remaining. With this kind of annuity you’re aiming for maximum monthly payout. Instead of 2 percent per year you might get 8, so your million bucks might yield $80,00 per year. Add in your social security and you’re at $105K.
One problem with Immediate Annuities is that in some cases there is no remainder to pass on to a spouse or kids, another is that they are fixed–inflation can eat them up. There are many other flavors of annuities. Some deliver a remainder to your beneficiaries, some are essentially stock funds with a minimum monthly return. Some hedge inflation. In all cases they are relatively expensive in terms of fees and likely returns, and the more remainder there is, the less they pay out immediately, but they take a great deal of risk off the table, especially if you allocate them among numerous companies to cut the risk of company failure.
With annuities as part of your portfolio you may choose to take a little more risk in other places. You might pick some more aggressive strategies that can yield more growth–perhaps enough to outweigh the expense of the annuities.
At this point you probably want to talk to a financial adviser. Good idea. Understand two things though. First of all, the quality varies greatly and ultimately you need to be the judge of how good your advisers advice is. Second, whatever company they work for, they will much prefer to sell you the investment vehicles their company offers. There are some independent financial advisers around, but most work for an insurance company or a bank. You may find it shocking that they take a fee from you, and then sell you their companies products and get a commission. But that’s pretty much how it works. That’s okay, just know what their biases will be up front, pass everything through that filter, and make decisions yourself.
You also need to protect yourself from fraud. Your adviser shouldn’t be both handling your money and reporting on it’s status. You need checks and balances. You need to look at the financial reports to ensure your money is where your adviser says it is.
NOTE WELL: I am NOT a financial adviser, in fact I’m a financial moron. I’ve had no training and I hate reading financial planning books. But I’ve sat in enough meetings and heard enough presentations to have absorbed some of this boring crap.