I wrote in a previous column that when it comes to retirement security, one concern dominates all others: the fear of running through one’s nest egg too soon. That’s probably because many of us don’t have a clue about how to manage this risk. When actuaries in the U.S., U.K., and Australia surveyed nearly 3,000 working-age adults about the various issues they must grapple with in planning for retirement, they found that longevity risk was the least understood. Only a third of those surveyed knew how long their assets might last, and only half had actually planned for the possibility of a longer-than-expected life.
That may be sobering, but it’s also understandable. After all, to the extent we focus on retirement planning at all, most of our time and effort is spent on trying to build a nest egg. We spend the bulk of our careers preoccupied with such questions as: What are the best ways to free up money to save? How much do I need to save each year? Which is better—a traditional IRA or 401(k) or a Roth? And, how much do I need to accumulate in order to retire comfortably? (aka, What’s “My Number?”)
During this accumulation phase, we also agonize endlessly about how to invest our savings. How much of our nest egg should we devote to stocks vs. bonds, and how should that mix change as we age? Are we better off with actively managed funds, index funds or a combination of the two? Should we try to assemble a portfolio of funds on our own, or maybe go with a target-date retirement fund or managed account?
But as we near and enter retirement, a whole new set of questions arises, questions many of us haven’t given much thought to during our working years. Questions like, What expenses will I face as I make the transition from the work-a-day world to retirement? How much income will I need each year to maintain an acceptable lifestyle after I retire? And the grandaddy of them all: How can I ensure that I won’t run out of money before I run out of time?
There are no quick or simple answers to these questions, but there are some things you can do in the decade or so leading up to retirement than can help you better understand and deal with them.
Start by trying to get a handle on how much you’ll actually have to spend each year to stay at or close to your current standard of living. Retirement is new and unfamiliar territory, so you won’t be able to predict your spending needs exactly. But you can get a reasonable idea by creating and then periodically updating a retirement budget, preferably using an online tool like the free retirement expense worksheets offered by BlackRock and Vanguard, both of which you’ll find in the Retirement Income section of RealDealRetirement’s Retirement Toolbox. As you do this, take particular care to home in on the cost of health care, as this is not only one of the biggest expenses retirees face, but also a cost many retirees tend to underestimate.
Next, you’ll want to get a decent sense of how long you’ll be incurring those retirement expenses—or, to put it more bluntly, how long you’re likely to live. You’ve probably already heard that the life expectancy for a 65-year-old is roughly another 20 years. That’s true, but life expectancy is an average, which means many 65-year-olds will live to 90, 95 and beyond. If you spend down your nest egg as if you’ll live only another 20 years but it turns out you’re still around for another 25 or 30, those extra years may may be somewhat grim.
As with expenses, you can’t determine exactly how long you’ll live. But if you go to the Actuaries Longevity Illustrator and enter your age and gender and select your health status (poor, average or excellent), the tool will estimate your chances of living to various ages. Based on that information—and going through the process again every few years in retirement or whenever you experience a significant change in health—you’ll be able to make a more informed judgment of how many years you may have to count on your savings to support you.
Finally, you want to spend down your nest egg in a way that increases the odds that your money will last as long as you do. For the most part, that means settling on a withdrawal rate that can give you sufficient income while also maintaining your purchasing power over a long retirement. Given today’s low yields and anemic projected returns, a retiree in his or her mid 60s would probably want to start with a withdrawal rate of 3% to 4%.
But whatever rate you choose, you’ll need to be ready to make adjustments as your nest egg’s value changes. If, for example, your savings balance takes a big hit due to a big market downturn or because you had to make an unusually large withdrawal to meet an emergency, then you may want to scale back your withdrawals for a year or two so you don’t deplete your assets too soon. Conversely, if a string of high returns fattens the size of your nest egg, you may want to boost withdrawals a bit to avoid ending up with pile of assets in your dotage, along with regrets you hadn’t spent more freely and enjoyed life more in your early retirement years.
If you’d like to get an idea of how familiar you are with the financial issues you’ll face once you retire, I suggest you take the Retirement Income Literacy Quiz the American College of Financial Services began offering earlier this year. I warn you in advance, it’s no cakewalk. But at the very least you’ll come away with a better appreciation of what you’ll need to do if you want to make a successful transition from work to retirement.