Spending too little of your nest egg
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When people think about how much they need to save for retirement and then how to spend that money wisely later in life, many worry about the risk of running out of money early. They fear the possibility of overspending.
But there’s another, less appreciated danger, according to financial experts: the risk of underspending.
“Overspending is risky. But underspending is risky, too,” said Zach Teutsch, a member of CNBC’s Council of Financial Advisers and founder of Values Added Financial in Washington.
Data shows this happens to many retirees.
Nearly a third of retirees still have 100% or more of their initial savings by their mid-80s, according to a recent study to work By the Employee Benefits Research Institute, a nonpartisan research group.
“When you see so many people in their 80s still performing at 100%, you see that people are very conservative [with their spending]Craig Copeland, director of wealth benefits research at EBRI, said:
Of course, the opposite is also true: “You also see some people with less than 20% income. [of their assets remaining] Others are: ‘If I live another five years, I won’t be able to do anything,'” Copeland said.
According to EBRI research, nearly one-fifth of those entering retirement with more than $500,000 had less than 20 percent of their assets left by their mid-80s.
“That’s going to be the big challenge in retirement: Figuring out how to maximize retirement but still have a buffer at the end,” Copeland said. he said.
Risk of underspending
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The risk of overspending is clear: depleting savings in later life can make it difficult to meet basic needs, let alone enjoy your later years; This may even become more difficult if guaranteed sources of income, such as Social Security, are not secure.
The risk of underspending may be less obvious.
But according to financial advisors, this ultimately means something similar: not living as satisfying a life as one could have.
“It represents a life unlived, vacations you didn’t take because you were afraid you’d run out of money,” said Marianela Collado, a certified financial planner and certified public accountant based in Plantation, Florida. He is also a member of CNBC’s Council of Financial Advisors.
For many people, it’s a difficult psychological leap to move from a savings mindset where one’s net worth is steadily increasing to one where one’s nest egg is falling and seeing one’s net worth decline, according to financial experts.
“Some people spend their whole lives saving money, and then it’s very difficult to move on to spending their assets,” Copeland said. “It’s not a comfortable feeling.”
Many retirees today experienced a “very good period of capital markets” after the 2008 financial crisis, with many years of double-digit annual stock returns, Copeland said.
This dynamic makes it easier to preserve and even build wealth throughout retirement, he said.
Teutsch said he likes to use an analogy with customers to illustrate the risk of underspending: Imagine sailing a ship through a canal. The rocks on one side of the channel show that the money is gone. On the other side, there are rocks that represent the risk of missing experiences.
“Eventually, if you sail too far the other way, you will have to abandon your boat on the shores of regret,” Teutsch said.
“I hope people don’t look back and say, ‘I have more than I need, and that means I don’t need to work nights and weekends, I could have spent more time with my kids and my family, or I could have given more.’ [money] “Go away,” he said.
It represents a life unlived, holidays you didn’t take because you were afraid of running out of money.
Marianela Collado
Certified financial planner and certified financial advisor based in Plantation, Florida
Retirees shouldn’t be afraid to enjoy the money they’ve worked hard to save for years, financial advisors said. Experts stated that this is especially true in the early stages of retirement, meaning that retirees are more likely to be more mobile and active than in later years.
Ultimately, after death, the money will be spent in the retiree’s name — perhaps inherited or donated to charity — but retirees won’t get a chance to benefit from it, the advisers said.
“As long as the financial plan shows that it is a good idea, I encourage clients to give money to their favorite causes, namely children, so that they can live well and enjoy it while they are alive,” Teutsch said. “If you help someone buy a house [for example]You’ll enjoy it very much.”
Why is it difficult to calculate retirement expenses?
Advisers said it is difficult to assess how best to spend one’s egg from year to year because there are so many unknown factors that have a huge impact on success.
For example, it is impossible to predict a person’s lifespan, as is the future return on financial assets.
Retirees are also increasingly having to rely on 401(k)-type plans, where they have to manage their savings rates and investments and determine how to turn that lump sum into future income. Previous generations were more likely to have pensions, and much of this complexity was handed over to employers.
How much can you spend in retirement?
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According to financial planners, there are some guiding principles for do-it-yourselfers.
For example, Collado said the 4% rule is “a really good starting point.”
This rule of thumb gives an approximation of how much money retirees can withdraw from their savings each year to give themselves a good chance of not running out of money after 30 years.
Retirees would withdraw 4 percent of their portfolios in the first year, then give themselves a “raise” based on the inflation rate in the second year. Same in the third year, etc. These funds would be added to other sources of income, such as Social Security.
For example, an investor will withdraw $40,000 from a $1 million portfolio in the first year of retirement, which is 4% of the total. If the cost of living increases by 2 percent that year, the next year’s withdrawal will increase to $40,800, or 2 percent more. Another 2% increase in the cost of living in the third year would mean a withdrawal of $41,616. And so on.
One caveat: Retirees should make sure they’re withdrawing at least enough money from their retirement accounts to cover required minimum distributions, advisors said.
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But consultants said the 4% rule is not perfect and could contribute to underspending because it uses conservative assumptions.
Retirees can also consider a “dynamic spending” approach, where spending is flexible based on market conditions rather than static as the 4 percent rule suggests, Teutsch said.
For example, in a year when stock returns are positive, retirees might withdraw more money — perhaps a 7 percent withdrawal — and reduce that amount to, say, 2.5 percent in down years, he said.
Retirement spending tends to be U-shaped rather than static; So retirees typically spend more early in retirement when they’re more active, cut back when they inevitably slow down a bit, and then spend more later in life when they may have greater need for expensive long-term care, he said.
A dynamic approach also helps reduce something called “return risk sequence”; In this way, retirees withdraw from stocks when the stock market is falling, increasing the risk of running out of money in retirement. This risk increases earlier in a person’s retirement, consultants said.
Retirees may also consider a “dynamic earnings” strategy in such years, Teutsch said. For example, he said, people who can take on some side hustles can supplement their portfolio income by working a few hours a week on a consulting project or similar job.
