Simple to Ask. Complex to Answer.
You are nearing retirement age and may be beginning to ask yourself, “Can I retire yet?” This simple question is one of the most difficult to answer because it relies on many variables as well as the spending and saving choices you make leading up to and during your retirement years.
Taking it to the Next Level
In a previous post, I provided you with a quick and dirty method based on the 4% rule to assess whether you are financially ready to retire.
However, like all rules of thumb, simplifying assumptions are needed for them to be easy to use. The 4% rule is based on retirees always defaulting to a 4% withdrawal of their assets to fund their retirement that is completely disconnected from their actual spending patterns and what’s going on in the financial markets.
So while I love the 4% rule as a starting point in your planning process, a next layer of analysis is needed to help you answer, “How soon can I retire?” (For more, see: What's the Minimum I Need to Retire?)
How Much Will I Actually Spend in Retirement
David Blanchett, CFA, CFP® is the head of retirement research at Morningstar Inc. In 2013, he published an important study entitled, “Estimating the True Cost of Retirement.” One of the big conclusions from the study is that retirees spend more early on in their early retirement years and less in their later years.
Whether you know people who have been retired for a while now or think about it for yourself, this makes sense, right? You’re much more likely to do things like travel more, pursue more expensive hobbies, go out to eat more or spend money on your grandkids in your mid 60s than you are in your mid 80s.
Blanchett found that in inflation-adjusted dollars, retirees spend an average of 20% less in retirement by the age of 85 than they did at age 65. (For more, see: Saving for Retirement: The Quest for Success.)
So What’s This Mean for My Retirement Plan?
If you’ve worked with a financial advisor to develop your retirement plan, you may want to revisit the spending assumptions that were used. Based on the above-referenced Morningstar research, you may be able to:
- Retire sooner than you’d initially anticipated.
- Retire from your day job to go pursue an encore career that either requires fewer hours or in a new field you’ve always wanted to try.
- Need less money to fully fund your retirement.
- Keep your retirement date and target savings the same but enjoy a higher retirement standard of living.
What if I Haven’t Done a Retirement Plan Yet?
If you haven’t done a retirement plan yet, that’s fine. First start with the 4% rule method that I linked to above. If you’re in the ballpark of being able to retire, but want to do a more detailed assessment, reach out to your financial advisor and ask for help. (For more, see: Can You Retire on $1 Million?)
If it makes sense to you based on what you have planned for retirement, ask your advisor to gradually reduce your spending (in inflation-adjusted dollars) from the start of your retirement through age 85 as suggested by Blanchett’s research.
In addition to gradually ramping down spending for my clients, I like to run at least three scenarios with the following assumptions:
Scenario 1: The Bulletproof Retirement (if Nothing Goes Well)
- 5% investment returns
- 3.50% inflation
- Social Security raises indexed at 50% of inflation (1.75%)
Scenario 2: The Most Likely Retirement
- 7% investment returns
- 2.80% inflation
- Social Security raises indexed at 75% of inflation (2.1%)
Scenario 3: The “Everything is Beautiful” Retirement
- 9% investment returns
- 2% inflation
- 2% Social Security raises
If you have enough financial reserves to weather scenario one, you can plan to:
- Retire now
- Consider bumping up your standard of living
- Work only if you want to
If your cash reserves won’t cover scenario one, but will last through scenario two, you can think about: (For more, see: Delay in Saving Raises Payments Later On.)
- Retiring now but being prepared to trim expenses if we have a major market downturn early in your retirement.
- Working a few more years to add to your retirement savings.
- Pursuing an encore career that may not pay as well, but is something you love to do and can fill in some financial gaps.
And if you need an “Everything is Beautiful” scenario to play out for your retirement math to work, I’d recommend staying employed for a few more years to shore up your finances and be able to retire with dignity.
Work with a qualified financial advisor on your retirement plan. Adding in an assumption to gradually ramp down spending may significantly brighten your retirement outlook and have you packing up the RV sooner than you’d planned. (For more, see: Will Your Retirement Income Be Enough?)