Unrealistic Expectations In Your Retirement Plan
This article orginally appeared in the May 2009 issue of Southern Neighbor newspaper, Chapel Hill, NC
by Todd Washburn, CFP©
In recent months I’ve written articles talking about the financial crisis and actions you can take to weather it and position yourself for the eventual recovery. A lot of things have contributed to our current economic woes. Many of them were out of our control. We didn’t write, or ignore the various rules and regulations. We didn’t do the big deals. We didn’t move assets off the company balance sheet. But we weren’t exactly innocent either.
One critical error that many of us are guilty of is unrealistic expectations. They cause us to take outsized risks and ignore sound financial guidelines. I’m not talking about investment returns (expecting 15-20% per year), or housing prices going up forever. The biggest errors in judgment that I’ve heard repeatedly over the years have been: what age the person was going to retire at, how retirement was going to be funded, and how much retirement income was possible. The current downturn didn’t make these assumptions unrealistic. It’s just much more obvious now.
In recent years it’s been common for people to say they’re going to retire at age 55, maybe 60. For most this never was realistic. Our current “retirement” system isn’t geared towards that. Retirement account withdrawals, with some exceptions, are limited or come with penalties prior to age 59½. Health insurance for pre-62 retirees is limited to private coverage or employer-provided retiree coverage. Social Security starts at 62, but starting then may mean a monthly benefit reduction of up to 25% over waiting until full retirement age (65-67 now). Waiting until age 70 may mean a 25-30% INCREASE over the full retirement age benefit. Finally, with life expectancies continuing to increase, an age 55 retiree may be looking at funding a 35-40 year retirement- possibly longer than he or she worked.
Many people expected their home to be a major component of their retirement fund. At some level it may have made some sense, but it probably wasn’t going to work out even if housing prices didn’t fall. At retirement one of two things likely occurs. Either you decide not to move and the equity remains tied up in the house and you have to borrow against it to get to your “retirement” money. Or, you do sell but instead of buying a much less expensive place to live, you buy a smaller place with many more bells and whistles which ends up costing close to what you sold the other one for. In either case the house didn’t become the funding source it was expected to be. Another source of funding some people expect is the sale of their business. This can be an incredible opportunity. Unfortunately, in many cases, reality doesn’t meet expectations. Many businesses, once they’re on the open market, turn out to just not be worth what the owner thought. There can be many reasons. The owner may just have had unrealistic expectations. The company may be highly dependent on the owner and therefore less valuable to a buyer. Or the company is behind the times- in technology or processes- relative to its competitors. In any case, it doesn’t provide the retirement resources the owner may have been banking on.
Determining a sustainable withdrawal rate from a retirement portfolio is a topic of much research. A lot has changed with the decline in the number of retirees receiving pensions. Research is showing that the withdrawal rate is likely less than what many folks are anticipating. I’m going to use a broad rule-of-thumb here. There are subtleties within the rule but it’ll make the point as is. In order to have reasonable chance of a portfolio lasting 30 years (increasing the income each year by the inflation rate), the initial withdrawal rate needs to be somewhere between 4 and 5% of the portfolio’s value at retirement. For a $200,000 portfolio, that’s $8-10,000 of income per year. For a million dollar portfolio, $40-50,000 (pre-tax). That may not come close, even with Social Security, to your preretirement income. The point is, you can’t assume you’ll be able to withdraw 8-10% of your portfolio, even in a year where it earns 15%. There are going to be years where it loses 10% and you’re still going to want to take money out. It has to be managed on a long-term basis.
The goal of this article isn’t to depress you. It’s to make you think about the assumptions you’re using to plan your retirement. It’s OK to dream about retiring at 55, and even to work towards it. But it’s going to mean a whole lot more saving and perhaps sacrifice of other things to make it happen. The numbers work against you. You have fewer years to save and more years to live off your savings. You need to create a portfolio from which a 4-5% withdrawal rate, combined with Social Security, rental income and perhaps a pension, will provide an adequate income that will keep up with inflation. Being realistic in your assumptions allows you to properly prepare for retirement. You’ll know what you need to save, what you can afford in retirement, and maybe most importantly how long you need to work so you’ll be sure to keep your skills sharp and marketable. Doing these things can make retirement something you can truly look forward to and enjoy.
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