John and Jennifer are feeling really good about their "golden years." Jennifer retired two years ago, and John just retired last month. John has a sizable 401(k) account, a small pension and Social Security. Jenifer has a small pension and Social Security also. So, they are feeling rather affluent at the moment and looking forward to all the things they can do in retirement and don't really feel that they need a budget.
Running out of money in retirement is like taking a two-week vacation and running out of money after the first week. The second week isn't very much fun. Of course, you would never retire expecting to outlive your savings. So why do people's nest eggs unexpectedly expire before they do? There are several possible reasons actually.
One is that when people retire they usually have a sizable nest egg, which is why they felt capable of retiring in the first place. So, they don't bother to make a budget and figure out what they can actually spend. So, feeling affluent with their large nest egg in hand, they spend more money than they should. They may take more elaborate vacations, buy a vacation home or make gifts to the kids that they really can't afford. Actually, making gifts to family members is one of the biggest culprits to tanking people's retirement. So, be careful!
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Another reason is that, even if you budget, you could still underestimate the amount of money you need. Many people base the amount of income they need on the fallacy that they won't spend as much money in retirement as they did when they were working. While it's true that you no longer have to educate your children or save for retirement, you also have much more free time than you did while you were working. Unless you plan to stay home and watch soap operas all day, you will likely need money to really enjoy all that free time you have.
Also, people are living longer than they used to. Chances are you will live longer than your parents did. Due to the miracle of modern medicine, new advancements are happening practically every day that can extend your life expectancy. Things that used to kill people 25 years ago, don't anymore, and that will also be true 10 years from now. So, if you plan to live to age 90, and you live to 100, the last 10 years aren't very much fun!
Long-term care is costing people a lot of money, too. People in nursing homes or receiving care at home in their old age are living a lot longer than they used to, and it's very expensive. Most people do not have enough long-term care to be comfortable at that stage of their lives.
Finally, the sequence of returns dooms a lot of people's retirement funds. People who were very successful with their investment results before retirement continue using the same method after retirement. However, investing for distribution is very different from investing for accumulation. While you were accumulating your retirement savings, all that really mattered was that you got an adequate compounded rate of return. Whether you had negative returns in the early years of investing or the later years was irrelevant as long as the compounded rate got you to the amount of money you needed. However, when you are taking distributions from your account, negative returns in the early years of retirement can destroy your nest egg to a point that you can't recover from. So, volatility that was unimportant before retirement becomes critical during retirement.
How to Make Your Money Last
What should John and Jennifer do now that they are ready to retire to improve their confidence that it will look like their dreams? With the help of a financial adviser, they should develop a budget that:
1. reflects the cost of the lifestyle they envision for their retirement, including any big purchases such as a vacation home, a boat or expensive vacations, as well as gifts to family members;
2. factors in inflation;
3. adopts a low volatility investment portfolio and maybe even the purchase of some income annuities for their critical lifestyle needs;
4. assumes they will live to age 100 or older; and
5. provides for long term care.
Frustration is what happens when expectations are different than reality. If you account for the five things mentioned above, retirement could be all that you dreamed it would be.
Bruce Udell has more than 40 years of experience in the financial industry. He designs solutions for wealth accumulation and enjoyment for high net worth individuals.
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