Your Chances for an Enjoyable & Financially Secure Retirement

by J. David Lewis, Principal/Founder

It is summer, which means our client reports address retirement preparedness.  Each client, whether early in their career or well into retirement, gets our written assessment of their ability to sustain their lifestyle well into advanced years.  Of course, our findings are not magic.  They are estimates, based on our history with each client and assumptions about the future.  When clients can understand the assumptions, it is much better to have an assessment than vague feelings about retirement possibilities.  Vague feelings can produce unwarranted fear of being destitute or an unwarranted belief there is nothing to worry about.  Both extremes can be unfortunate.  You might fail to fully enjoy your resources or fail to accumulate enough to retire comfortably.

In the midst of this season, I was interviewed by Kim Blanton for Center for Retirement Research at Boston College.  “Retiree Paralysis: Can I Spend My Money?” appeared on Squared Away Blog a few days later.  It introduces Anthony Webb’s related study – “Can Retirees Base Wealth Withdrawals on the IRS’ Required Minimum Distributions?”  Webb’s research improves our judgment, with yet another perspective.  I recommend the links below to explore Blanton and Webb’s thoughts.

Our retirement preparedness assessments this year are from a different perspective.  A model estimates the probability for a financially successful retirement, by applying annual investment returns and other assumptions to future years.  The positive and negative range of returns, as well as the way they are distributed among years, is intended to simulate many periods that can reasonably be expected from history.  The difference between the best and worst outcomes, after twenty or thirty years, can be quite broad, with extraordinarily unlikely extremes.  Even the cluster of most likely total investments is not the thing we really want to consider.

Instead, we focus on a more important question.  What is the “probability of success” for your portfolio?  Or, what is the probability your invested resources will be available while you are still living?  In the U.S. you are not likely to be totally broke.  If the portfolio is depleted, most people will still have at least some income from things like Social Security, pensions or other annuity payments that last their lifetime.  (Yes, we still find people with significant pension income.  Financial planners in the future are not likely to be so fortunate.)

Needless to say, assumptions have significant impact on the estimated probability.  For example, we currently assume withdrawals increase at 3% per year for inflation, which is higher than recent years but less than the annualized 4.28% for the last 42 years [Data Source: Consumer Price Index (CPI) 1970-2012].  The 1970s and early 1980s had relatively very high inflation rates.  Since the 1990s, inflation has moderated (2.48% annualized since 1992).  We think there is reason to use 3%, instead of the 4.28% default of our model.  For some clients, we adjust the 3% assumption to recognize income that is not indexed to inflation.  Judgement is important.

Larger withdrawals than we assume will reduce the probability of success.  Well controlled withdrawals improve the probability.  Assuming you will live longer than the model’s mortality table reduces the probability of success.  An unfortunate and expensive health issue could both increase withdrawals for a while and shorten life.  A long period of exceptionally good investment performance, such as the early 1980’s through 2000, could make many financial concerns less important.  If this occurs, we hope to someday ask a beautiful question.  Is there any way you can use money to improve your enjoyment of life?  There is more to money than money®.  

We also address caution.  As useful as it is to know a probability estimate, it is not the ultimate answer in managing resources.  It is one benchmark.  Reconsidering it annually, and with a variety of other tools, is our way to track progress – or lack thereof.

For people younger than 55, events into advanced retirement are likely to produce differing probability estimates for each annual test.  We want to see an improving trend.  As people age, more is known.  The future becomes the past.  For someone over 80, we would not expect these probability estimates to change much.  There is less assumption to the term “assumption.”  Paying attention to the probability through the years can help manage saving and spending, to enhance enjoyment of resources during both the accumulation and retirement lifestyles.

The model is well suited for in-person presentations, where we adjust assumptions such as contributions, withdrawals, inflation rates and life expectancy, with immediate feedback.  If someone wants to see the likely effect of changing contributions or withdrawals, we can do that quickly.  This is the best place to discuss estimated future portfolio size.  By collaborating on the assumptions, insights into the most effective things you can control become clearer.

It often comes down to how much you are willing to manage the costs of your current lifestyle to be comfortable with the prospects for your future lifestyle.  What is the right balance for you?  Or, if your probability of a successful portfolio is extraordinarily high, considering the best ways to use your resources might enhance your life now.  This can be liberating.  There is more to money than money®.  


“Retiree Paralysis: Can I Spend My Money?”, Squared Away Blog, Retirement Research at Boston College

“Can Retirees Base Wealth Withdrawals on the IRS’ Required Minimum Distributions?”, Wei Sun and Anthony Webb

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