Why Your Retirement Plan Will Fail: Part One

Unfortunately, most articles out in the media today focus on a few financial topics; reducing spending/budgeting, paying down debt, buying a house and investing in low cost index funds. While all these topics are important there is one aspect of financial planning that is rarely discussed; describing what retirement is actually like.

Over the next month or so, we are going to take a deep dive into describing retirement from a financial perspective. We are going to look at what risks can derail a retirement and how to create a plan to mitigate those risks. Let’s start with the most common question I get as a financial advisor: “Can I retire?”

The “can I retire” question is a tough one to answer without the right information. For example, if someone has $2 million most people would assume that is enough. If that person spends $300,000 a year, that $2 million won’t last very long. While assets are important, determining a person’s spending rate can be more important.

Many articles online will tell you that the best way to estimate your retirement expenses is to use a percentage of your income usually between 70 -80%. While this may be good for financial planning on a napkin, it’s not ideal. Coming up with retirement expenses should start with outlining fixed expenses and variable expenses.

Fixed Expenses:

Fixed expenses are the types of expenses that you know will come in every single month regardless of what you do. A few examples are rent/mortgage payments, utilities, groceries, Medicare payments and taxes. Knowing the baseline expenses that come in each month can be a critical part of financial planning in retirement. We need to make sure that we have an income plan that is designed to cover these expenses regardless of what would happen in the market. Social Security may be able to cover fixed expenses, but if not, other consistent income sources should be evaluated.

Variable Expenses:

This is where the fun comes in. People have different goals for their retirement. Is playing golf everyday a priority or how about traveling? Some people want to spoil the grandkids, and some want to pick up new hobbies. New inventions are always coming to the market as well. 12 years ago, the smartphone didn’t exist, and Netflix was still sending out DVDs. Who knows, in another 12 years we may all have robot maids. Either way, determining one’s goals or desires in retirement can help determine a person’s budget in retirement. Determining how a person wants to spend their time in retirement is important and it should take some reflection.

Capital Expenditures:

Other than the fun stuff, capital expenditures should be considered when determining expenses in retirement. Retirees spend more on housing costs in retirement than pre-retirees. Retirements can last up to 30 years which means two or three new cars, the roof will probably need to be repaired and houses will be updated. Unless you think shag carpets are still cool.

Timing of Expenses:

Most people assume that expenses in retirement will steadily increase each year since things tend to cost more over time (i.e. inflation). While this is partly true, there is a slightly different flow to retirement spending. When someone first retires, they go from working 40 plus hours a week to doing nothing. They are also the youngest they will ever be in retirement. Naturally, new retires are the most active and end up spending more of their money earlier on. After a few years, retirees tend to slow down which means the spending slows down as well. As the retiree ages, they will usually need more medical care and spending tends to increase again. Learning or anticipating the flow of expenses in retirement can be a key factor in having a successful retirement.

What Can You Do?

Tracking your spending prior to retirement can help you get an idea of all the different types of expenses to account for in retirement. Figure out what you want your retirement to look like. Really try to think of what you want and what you don’t want your retirement to look like. Often it can be easier to know what you don’t want. Keep track of when you made significant changes to your house and understand when you may need to make changes/updates again. It can take a little bit of work, but it will help you understand if you’re on the right track or not.