Retirement 101: Ch-ch-ch-ch-chaaaanges…
Table of Contents
- Before we begin
- The who and the what
- What is retirement, anyway?
- Estimating your retirement number
- We need to talk... about investing
- Asset allocation and risk tolerance
- Setting up your portfolio
- COMING SOON - Making it work
- COMING SOON - Keep on keeping on
- COMING SOON - What if something goes wrong?
- COMING SOON - The non-monetary side of retirement
- COMING SOON - OK, I've retired. Now what?
So far, the work we’ve done to estimate your retirement number has been assuming that your spending habits in retirement match your current spending habits. It’s a good starting point, but it’s very likely that your retirement spending will be different than your current spending, at least a little bit. Now we’ll start to estimate how much it could change.
Putting things together
A few steps back in the series, you took a few minutes to imagine what your retirement would look like. Where you would live, how you would spend your time…. Now it’s time to use that list to modify your yearly expenses. Take a moment to look at each of the lifestyle changes you imagine for your retirement and consider how those changes may impact your expenses.
Travel is a typical way that retirees might spend more than people who are still working. Do your best to imagine how much more travel you will do when retired, and adjust your number accordingly. Don’t worry about getting exact numbers. To be safe, for now, you can lean toward the higher end if you’re not sure.
Many expenses will probably decrease. If your current job requires you to wear suits, but you imagine retiring to a life where jeans and a t-shirt are perfectly adequate, then you’ll likely be able to reduce your clothes shopping expenses in retirement–and possibly dry-cleaning, as well, if that’s something you currently use. Maybe your current job requires heavy use of your personal vehicle. Those expenses could be less, too… unless you plan on spending your retirement making road trips!
Here are some more expense changes to consider:
- Do you currently pay for childcare? That’s not likely to continue into retirement!
- Do you plan on being able to lavish your kids and grandkids with random gifts? Add that to your expenses.
- Are you currently paying off student loans? You’ll hopefully be done with those by the time you retire.
- Did you plan on downsizing your house? Moving to a different city or state? Factor that into your retirement budget, using your best guess based on current prices.
- Do you eat lunch at restaurants often due to work? You may be able to remove much of that expense during retirement. (But also, start packing lunch! You’d be amazed how much you can save every month.)
Beware the hedonic treadmill and lifestyle inflation
Humans are very good at getting used to our living conditions. If you buy a bigger home, or a new car, or move to an nicer location, you will probably feel excited and impressed for a while. But soon enough, it just feels normal. You get used to having that extra bedroom, that all-wheel-drive. We call that hedonic adaptation, or the hedonic treadmill.
Eventually, you may start to feel a desire for an upgrade. Not necessarily something crazy and ostentatious. Just something a little bit better. We call that “Lifestyle Inflation.” Over time, our preferences tend to get more and more expensive. At the same time, it gets harder and harder to go back to a “lower” level. In other words, it’s unreasonable to expect that in retirement you will suddenly be OK with spending less on many of your current expenses. Sure, some expenses will no longer be relevant, like childcare, and we can eliminate those from our retirement budget. But others, like eating dinner out multiple times a week… those will be harder to stop.
Do you have a car loan? Don’t remove that expense from your retirement budget. If you’re used to the lifestyle of having a new or new-ish car, it’s unlikely that your preferences will suddenly change when you retire. You may have a few years after paying off the loan, but soon enough you’ll probably want to upgrade to a newer model.
If you are convinced that you’ll be fine with spending less on something in retirement, then give it a practice run now.
If you have a newer car now, either sell it and buy a cheaper one–and invest the savings into your retirement–or commit to not replacing it until it gets to the point where it would cost more to repair than to replace.
If you think you will eat out less during retirement, give it a try now. Pack brown-bag lunches. Get used to meal-planning for dinners. Not only will you get a feel for whether you’ll actually be OK with it in retirement, but you could potentially save quite a bit of money along the way. You might even slow the progression of lifestyle inflation.
If this isn’t the condition of your current car, don’t plan to suddenly be OK with it in retirement!
How to plan for a mortgage during retirement
Even if you’re not planning on selling your house, you may have paid off the mortgage by the time you’re retired, or shortly after your retirement. If that’s the case, it’s easy to make adjustments to your retirement expenses. Just remove the mortgage payment from your expected expenses… but don’t forget to leave in the property taxes and home insurance that’s probably currently included in your mortgage payment!
If your mortgage will continue for more than a few years into retirement, though, you’ll need to make sure that your retirement number accounts for that expense.
You can choose to leave the whole payment in your expense calculation, and have a bonus/buffer of sorts once you’ve paid off the house. (That’s what I’m choosing.)
Or, you can remove the mortgage payment from your retirement expenses, calculate your retirement number that way, and then add your expected remaining mortgage balance to that retirement number. For example:
If your current expenses are $80,000 per year, and you are paying $2k per month (on just the mortgage, not including taxes and insurance) as a part of that: Subtract the $2k/month from your yearly expenses. That’s $80k minus $24k. So your expected expenses (less mortgage) are now $56,000/year.
That makes your retirement number $1.4 million instead of $2 million. But now you have to add back in the remaining balance on the mortgage at the time of retirement. Let’s say that’s expected to be $100,000. So your actual retirement number is now $1.5 million. When you retire, you will then have enough saved to pay off the remainder of the mortgage all at once; or you can choose to keep making payments and invest the difference for a small bonus of additional growth.
There are ways to optimize this even further, and I’m happy to discuss them with you if you want… but there’s a diminishing return on that kind of optimization, especially when no one can really know for sure exactly what their future expenses will be!
What about Social Security?!
You may have heard it called “Social Security Insurance.” That because that’s exactly what it is: insurance. Personally, I choose to think of it from that point of view: It will cover the emergencies and things that I didn’t plan for. Because of my personal situation, and especially because I’ve retired early, the amount I expect to receive in Social Security payments only covers a small fraction of my expected retirement expenses. That’s a big part of why I’m not even factoring it into my plans as anything other than a bonus. If you’re expecting to retire around the normal retirement age, and receive a reasonably large payment relative to your expected expenses, then it absolutely makes sense for you to factor it into your plans and reduce your retirement number.
Here’s how you’d do that:
- Check your estimated payment online: https://www.ssa.gov/benefits/retirement/estimator.html
- Multiply your estimated monthly Social Security payment by 12.
- Subtract that total from your yearly expense total.
- Multiply that result by 25 to calculate your adjusted retirement number.
If you’re planning on relying on Social Security income as part of your retirement, there area few more things to keep in mind as well:
When to start taking payments
As you may know, social security payments get larger if you delay when you start taking them. It might seem like an obvious choice, then, to wait to start taking social security payments until they’ve grown significantly. The problem with this plan, though, is that we don’t live indefinitely. The Social Security program has been carefully set up based on average life expectancy so that if you live an average lifespan, you will receive the same total payout over the course of your retirement no matter when you start taking payments. By starting later, you get larger payments, but you get fewer of them.
The practical takeaway, then, is that the biggest factor in when you start taking social security is how long you think you’ll live. This can be hard to think about, for some, but it’s worth the effort. Think about your current health, and your family history. If you have any reason to believe that you might not live as long as the average American, then you’ll probably be better off taking social security sooner rather than later.
Another thing to consider is how likely you are to be able to retire on time. If you’ve run the numbers, and you’re concerned that you won’t be able to save up enough for retirement on time, then you may want to plan on working a few extra years past traditional retirement age, and delay taking Social Security as long as you can.
One last note on when to plan on starting Social Security: It’s likely that there will be changes to the age requirements that push back when you will be able to start. You may want to plan on a later start-date for social security than the current one. Which leads us to:
The future of Social Security
The solvency of Social Security is often in the news… particularly near elections. There are a lot of myths and misunderstandings about the state of the trust that funds Social Security. No, Congress didn’t “raid social security” to pay for other things. They took loans, and those loans are getting paid back with interest. But that doesn’t mean that there are no problems with funding for the program. The main problem is that population growth has slowed, and there are about to be many more retirees entering the system, with fewer younger workers paying in. Meanwhile, average life expectancy is higher than it was when the program was last updated, and so the payout per person is higher.
The “bucket” of funds available for social security is draining faster than it is being refilled. That can only go on for so long before the trust’s buffer runs out. But even then, that doesn’t mean there won’t be any money left. There will still be a constant stream of funds coming into the bucket, it just won’t be enough to cover 100% of planned Social Security payments. Current estimates say that when this happens, the program will have enough to continue at a 75% payment rate.
So, you might want to make your plans based on 75% of the amount that the Social Security website says you’re entitled to, just to be on the safe side. I don’t believe it will actually come to that, but it’s worth being prepared. The most likely change will be a push back of retirement age to account for our longer life-expectancy. There may also be tax increases to help offset the funding deficit.
What about Medical Expenses?!
This is a tough one. There’s no easy answer, because it’s impossible to know what’s going to happen with medical costs in the long term, and it’s impossible to know what specific medical care you may need. In general, there are two main approaches to dealing with medical costs during retirement.
- Estimate based on current costs and averages for retirees. Perhaps add adjustments based on your own family medical history. I’d start by looking at the current costs for platinum-level insurance on healthcare.gov.
- Plan to keep your retirement income low enough to qualify for assistance. This can be a tricky line to walk, and I don’t recommend it unless you already plan on having a fairly low retirement income for other reasons.
- Combine the above: Come up with an estimate based on platinum level insurance, and be ready to cut back enough to qualify for Medicaid if things go sideways.
- Write a list of all of the ways that you expect your spending to change during retirement, and by how much. Remember to keep it in today’s dollars. There’s no need to adjust for inflation, because we’re handling that with our investment calculations.
- Use your adjusted expenses to calculate a new retirement number. Did it go up? Down?
- Use that new retirement number to recalculate how much you need to invest each month. How much did that change?
One more thing…
What to do about scary savings rate estimates
So far, we’ve looked at defining our retirement savings rate based on how much we’ll need during retirement. We haven’t yet evaluated how realistic that savings rate is when compared with our current income and spending habits. So, before we get into the details of investing that savings, I want to take a moment to acknowledge that, for many of us, the monthly savings amount that we came up with in the last step will look intimidatingly large. I also want to take this time to acknowledge the great privilege that many of us have to even be able to take a moment to consider long-term savings plans at all.
We’ll come back to this topic in overwhelming detail in a later part of this series. We’ll look at reducing current expenses, increasing income, and possibly having to reconsider some expectations for what retirement will look like. Figuring out how to make your monthly retirement savings fit into your current lifestyle is honestly the hardest part of this whole process for most people. So, know that it’s coming. We’ll address it.
For now, do your best with what you’ve got. Remember, it’s better to start saving less than your ideal amount right now than to wait until later when you have a “better” plan or can invest more. If the work that you’ve done in this series so far tells you that you need to save $1100 per month for retirement, but you can only currently do $200, Save the $200! Don’t panic, and don’t give up!
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