Compared to saving for retirement, spending money in retirement involves a tricky set of decisions. For instance, think about the typical “big picture” pattern of spending in retirement. In early retirement, a retiree is typically more active, spending more and thus requiring a higher income for a period of time. But at some point, a retiree becomes less active and needs less income. And then as a retiree reaches even older age, medical expenses may grow drastically (think nursing home or some form of residential care), and then the retiree may need a much higher level of income again. The upshot of these changes in the retirement years? Retirement income needed will often rise and fall and rise again over time. How in the world do you plan for some form of regular income that will follow that pattern?
And then there are the typical set of risks faced by a retiree. For example:
- Poor or negative investment returns, especially if they occur early in the retirement years.
- Low interest rates, resulting in low interest income.
- Unexpectedly high rates of inflation, again particularly damaging if they occur early in the retirement years. And even regular “tame” rates of inflation, like 3% or 4% annually, can cut a retiree’s standard of living in half in about 2 decades.
- Unexpected financial emergencies—a major car repair, replacing a roof, supporting an adult child out of work, caring for an aging parent, paying for long-term care, etc.
- Not being able to work part-time, especially if doing so was “part of the plan” in retirement. A retiree might not be able to work due to poor health reasons, due to a poor local economy, etc.
- Death of a spouse. Loss of a spouse may mean loss of an income source, such as monthly payments from a deceased spouse’s pension plan.
- Living longer than expected. A longer lifespan means income needs to last longer. But using up income resources may mean leaving a smaller (or no) inheritance for a retiree’s heirs.
So you can begin to see that for all but the super-wealthy, most retirees face a series of tradeoffs. Consuming more retirement resources now (higher income) means a smaller inheritance later. Under-consuming now (for fear of overspending and running out of money later) means a lower standard of living now. Taking more investment risk now with retirement assets means more uncertainty (more sleepless nights) for a retiree; taking less investment risk means lower returns—and the nagging worry that a retiree may indeed run out of money too soon. Investing safely now may give a retiree peace of mind in the early years of retirement, but it also usually means more exposure to inflation risk later—such as being forced to cut medical pills in half because prescriptions have gotten too expensive.
The goal then is to have the “Goldilocks” retirement income level: not too much too soon (you don’t want to run out of money later), nor too little too soon (you don’t want to look back at the end of your life and realize you really could have afforded to do more in your retirement years). Somehow, in the face of all the above risks and tradeoffs to consider, you have to figure out an amount of retirement income that’s “just right.” And that’s what we’ll try to tackle next time.