How to avoid the retirement ‘dark side’

A sound retirement plan begins with evaluating current expenses and considers future inflation, risk and age-related expenditures.

Issue: October 15, 2005

ByKenneth W. Rudzinski, CFP, CLU, ChFC, CRPC, CASL, CAP

Kenneth W. Rudzinski, CFP, CLU, ChFC [photo]
Kenneth W. Rudzinski

Horror flicks – remember them? There was “Psycho” way back when, then “Halloween” in the late 70s and Freddy and Jason in the 80s. “Scream” blew us away in the 90s. So what do these horror classics have to do with financial planning? Well, I think the title of next horror flick – soon to start in a neighborhood near you – will be “Boomers Retire En Masse.” In fact, leading-edge baby boomers (born between 1946 and 1952, like me) are already retiring in numbers too big to ignore, and the second wave of boomers, called the “trailing-edge” boomers, represents a cohort twice as large.

What makes this scenario so scary is that 65% of Americans, according to the 2004 Retirement Readiness & Middle America Survey, do not know what their monthly budget should be after retirement and have not planned to collect a retirement paycheck. What about you? Do you know today exactly how your retirement lifestyle will unfold? Or is your current plan for retirement like throwing darts to a board clouded by the fog of financial uncertainty?

Defining goals

As I write these words, I have fresh in my mind a successful high-income-earning couple, both doctors, both baby boomers, who came to my office recently seeking the proverbial “light at the end of the tunnel.” They wanted to retire soon as they were both suffering from professional burnout. Unfortunately, they had failed to plan, they had failed to save, and they had failed to control their spending impulses. That light they were seeking was still further off, and the prognosis was not good. Contrast this couple with a young doctor, age 30, who needed someone to measure and oversee his goal of accumulating $1 million by age 40 so he could consider reducing his hours and patient load. Do you know what? He did it. These two examples are not unlike many people I see who face the prospect of retiring differently – some who poorly define their retirement goals and retirement standard of living, and are destined to fail, and others who visualize in detail just where, when and how they will retire.

Prospective clients are quick to identify exactly how much they have in 401(k)s, IRAs, savings accounts and home equity. They are equally cognizant of how much gross and net income they bring home. But (and this is a very big but) most people I talk with, even those nearing retirement, are sadly unaware of exactly how much they spend paycheck to paycheck. Sure, they know how much the monthly mortgage payment is, and how much the monthly auto payment is, in addition to other fixed monthly expenditures. However, they rarely have a grasp of how much they spend on discretionary items like entertainment, cash expenditures (like lunch at McDonalds with the kids or grandkids). If you are contemplating retirement soon and have no definite idea what the expense side of your standard-of-living equation is, then how can you financially define retirement success? You can’t, not really.

Inflation and the long term

What are you doing to quantify and secure your retirement standard of living? A study by Ernst and Young postulates that “...retirement life for boomers will be different, more complex, longer, more exciting and probably much more expensive than it has traditionally been.” More expensive? Longer? Many people, but boomers especially, spend nearly 100% of what they earn. Savings rates are at an all time low. When asked what percent of their income they will need at retirement, they say 50% to 60%. Is that you? The higher your income, according to an AON study, the more likely you will need closer to 80% to 90% of your pre-retirement income.

And you’ll need it longer. If you are married, there is a 40% chance or better that either you or your spouse will survive to age 95. Even more startling is that in 1990, only 37,000 Americans were age 100 or older. By 2002, that number doubled. In 2050, it is projected that over 1 million Americans will reach triple-digit age. That means you doctors out there (or your spouses) who are roughly age 45 might just make it to age 100.

When I was struggling financially in my 20s as a French teacher, I feared having too much month and not enough money. As a financial planner and retirement distribution specialist, my fear today, based on what I see of too many pre-retirees, is that unprepared and unfazed boomers will experience too much retirement and not enough income. Between 2020 and 2030, when baby boomers are in their 70s, retirees will come up at least $400 billion short of the income needed to pay for basic living and health expenses, according to a government study. How much of that $400 billion deficit will be yours?

Inflation is one reason for the shortfall. At 3% inflation, to maintain the purchasing power of a $40,000 annual withdrawal at age 65 from your portfolio, you will need $72,000 a year at age 85 and $97,000 at age 95. That’s way more than double your original withdrawal amount with no increase in expense levels, just the relentless sapping of purchasing power from a 3% average inflation rate (Table, above).

In my last article (“Investing is all about avoiding ‘the big mistake,’” October 1, 2005, page 60), I commented that a 4% portfolio withdrawal rate is ideal at retirement as it provides a clear likelihood that you will not go bankrupt somewhere in your 70s or 80s. So, for each block of $40,000 of annual withdrawals you need at retirement (in 2005 dollars), you have to accumulate $1 million by the time you retiree. Are you on track? If so, great! If not, what are you going to do about it?

‘Retirement bankruptcy’

Let’s dig deeper into this “retirement bankruptcy” issue. If you withdraw too much annually from your portfolio and you invest too conservatively, you will probably see your invested assets diminish then disappear well before your retirement ends. What’s your plan to avoid financial ruin in your golden years? If you are a male doctor, then it is most likely that it will be your spouse who experiences this unfortunate result. Is your portfolio allocation too conservative or too aggressive to support your standard of living in retirement?

Will you or your spouse have a monthly pension benefit at retirement? Is that plan in a surplus or deficit position? When did you last check? According to the Pension Benefit Guarantee Corporation (PBGC), the total underfunding of pensions insured by the PBGC jumped to $450 billion in 2004 from $350 billion in 2003. It is projected to top $700 billion soon (remember the airlines). Does your plan for retirement continue to survive if that pension goes away or is reduced substantially in a corporate pension default? If not, how will you adjust? Government programs? Social Security? Medicare? Not only is the Social Security retirement trust fund in danger, but Medicare is on the ropes as well. Does your plan for retirement take into account increased medical premiums and other medical costs?

Ernst and Young summarized these retirement risks in six main categories: longevity (outliving one’s money); overspending during retirement; underspending during retirement (thus having suboptimal retirement); liquidating assets and withdrawing funds at the wrong time (market down, selling low); exposing retirement resources to unnecessary taxation; and risk on unanticipated events (illness, long-term care) that will accelerate liquidation of one’s asset base.

Does your plan for retirement take these risks into consideration? If it doesn’t, why not?

Did you spend more time in the last 12 months planning for your vacation than you did planning for your retirement?

Evaluate and plan

By now you must be getting my point, I hope. It’s simple. If you haven’t started planning for your retirement, when will you? And if you have, does that plan rest on solid and reasonable assumptions that take into account more than just the best-case scenario – you know, the one that assumes that you will work maybe until age 65 or 70, gradually reducing your hours, in great health and with an investment portfolio that yields 10% year after year? Are you just kidding yourself?

Retirement planning specialist Briggs Matsko, CFP, in Sacramento, Calif., recommends that successful retirement planning begins with a clear understanding of your expected retirement expenditures, which he has labeled “Core expenses” (food, clothing, housing); “Joy expenses” (travel, hobbies and entertainment); “Accumulation goals” (boat, RV) and “Transition of wealth” (heirs, charities). In my experience, Mr. Matsko is absolutely right. A competent financial planner or retirement specialist can assist you in categorizing and quantifying your expenditure levels to better aid you in projecting retirement success. It is the lack of defining such expenses before retirement that is a major reason post-retirement plans to go awry. Don’t let this happen to you – get started now identifying and tracking your normal Core expenses and Joy expenses.

Give serious thought to the expenses that will decrease during retirement, such as those of commuting and dress suits. But don’t forget to include additional expenses like travel, medical premiums (especially if you have the practice paying for them now), added medical costs from simple older-age health issues and a buffer amount for the unexpected. This is called a bottom-up approach, where you start at a zero-expense balance then begin adding in your typical, known expenditures. It is much more accurate than figuring some unscientific number like 50% or 60% of your pre-retirement income, otherwise known as a top-down estimate. The former approach is real and “you”; the latter is contrived and often highly inaccurate.

Mr. Matsko’s Retirement Income Matrix (Figure) outlines the levels of expenses and his suggestions of how those expenses should be funded, ie, interest, dividends and pensions. Do you know how your retirement expenses will be funded? Does your plan for retirement include predictable streams of income, or will it be altered from year to year based on the vagaries of the stock market or the whims of the interest rate environment?

If you are a younger doctor, start looking right now at what it will take to fund a retirement with dignity and prosperity. If you’re a boomer like me, perhaps you’ve already taken the issue of retirement security seriously and have planned accordingly. Great! Consider getting a second opinion from an experienced professional who specializes in the ways and means to enhance and to maximize the assets you’ve accumulated and who can help you test your assumptions against several different scenarios from good to bad to worst-case. Wouldn’t you want to know now (while you can still adjust) what the potential pitfalls of your plan for retirement might be instead of waking up one day at age 75 (when it’s too late) to discover its flaws? Interestingly, while 74% of people surveyed say they’d use a certified financial planner for retirement assistance, only 66% admit to having done so.

I’ve deliberately painted a dark picture above, but that’s only the outcome for those of you who fail to plan. In that case, you will get to star in your own private horror flick. However, on a more positive note, if you take the time now and make the effort now to visualize the future – your future – you can lessen or maybe even eliminate the odds that you will run out of money during retirement. Isn’t that worth the effort? Ask your spouse.

For Your Information:

Kenneth W. Rudzinski, CFP, CLU, ChFC, a certified financial planner in Wilmington, Del., has been cited in Money magazine and in Who’s Who in Finance & Industry. He can be reached at The America Group, Foulkwood Professional Building, 2036 Foulk Road, Suite 104, Wilmington, DE 19810; 302-529-1320; fax: 302-529-0358; e-mail: kenr@americagroup.com.