You may need less than you think for retirement

Ty Bernicke, CFP

You hear it all the time-most Americans are not saving nearly enough money for their retirement.

But what if that warning is based on faulty assumptions? A growing num­ber of economists and researchers say that this is often the case, even though the idea that you could save less for retirement and spend a greater amount now is heresy to the financial services industry.

Investment adviser Ty Bernicke is among the leading proponents of the view that financial firms routinely over­estimate the retirement needs of their clients. Their incentive is obvious-the more that people save, the higher the fees these firms collect.

While it's still necessary for you to save aggressively and plan conserva­tively, you may be better prepared for retirement than you think.

WRONG ASSUMPTIONS

Most retirement planners and on­line retirement calculators assume that you will spend at an increasing rate throughout your retirement, but that's not what my real-life clients-both married and single-end up doing.

Most of my older retirees spend far less than younger retirees. For instance, my clients in their 50s and 60s often travel more, go out to eat with friends often and enjoy the freedom that re­tirement brings. My clients in their 70s and 80s are less likely to socialize or go to restaurants, especially because they have a harder time driving at night. They also often have health problems and lower energy levels. These tenden­cies decrease food, travel, entertain­ment and other spending.
   In fact, the latest US government statistics reveal a similar pattern. Peo­ple ages 55 to 64 spend an average of $49,592 a year...those 65 and old­er spend $32,866. . . those 75 and older spend just $27,018. Except for health­care costs, which rise with age, that drop in spending holds true for all individual categories-including food, clothing and entertainment (see the table).

Strategy: Sit down with your finan­cial planner, and run some scenarios based on the premise that your spend­ing may decrease as time goes by, even when you account for inflation.

You might find that you can splurge a little bit more now on things ranging from home improvements to travel to eating out-and yet still be comfort­able during your retirement. Or you may decide to retire earlier than you had planned.

HOW TO PLAN MORE REALISTICALLY

A married couple had contribut­ed the maximum allowed to their 401 (k)s and IRAs for the past 20 years. Now they were both planning to retire at age 55 with a combined nest egg of $800,000, and Social Security payments of $12,000 each per year, which would begin when they reached age 62 and presum­ably would increase by about 2 % a year.

Traditional retirement planning calls for withdrawing 3% to 4% of your sav­ings at first and then increasing that an­nually to keep up with inflation. That supposedly allows investors to keep their lifestyle consistent throughout retirement, but it does not reflect how people really spend as they age.

Using a traditional 30-year retire­ment plan, the couple expected to start out spending $60,000 a year in retire­ment, the same as they had been spending...earn 8% per year on their nest egg... and withdraw enough to fill in for any income needs not covered by Social Security. Using traditional retirement calculations and assuming an average inflation rate of 3%, the couple would run out of money by the time they reached age 85.

They weren’t sure how to solve this dilemma. They would either have to keep working for several years...or boost their savings rate dramatically.

They didn't have to worry.  If they could agree to spend at a declining level as they aged, in line with the US Bureau of Labor Statistic's Consumer Expenditure Survey, the couple would not run out of money. Their nest egg would grow to $1.7 million in 26 years, rather than be completely depleted.

Reality: Many investors should con­sider withdrawing 6% of savings in the early retirement years, when they are most likely to travel and pursue hob­bies. Over time, as activities decrease and expenses drop, that rate of with­drawal can be reduced.

Your housing situation also will have a big impact on your withdrawal rate. If you payoff your mortgage or downsize to a less expensive home when you re­tire, your expenses could immediately be lower than they were before retirement.

THE BIG EXCEPTION

In contrast to other categories, health-care expenses tend to jump as you age. Steps to take...

Budget annual increases of at least 8% for health-care expenses. Unexpect­ed medical bills are, by far, the biggest threat to keeping your retirement plans on track.

Watch the gap. If you retire early, budget enough money to pay premi­ums for private medical-care insur­ance after you retire and up to age 65, which is when you become eligible for Medicare coverage.

If you already have a medical-care insurance policy and are healthy, you can probably find a cheaper one.

Example: A couple, both age 56, had obtained a policy in 1998 with premi­ums of $5,000 per year and a $5,000 deductible for the two of them. By 2005, they both were still in excellent health, but their premiums had nearly doubled to almost $10,000 with the same de­ductible. That's because in many states when you initially purchase insurance, you're thrown into a pool along with other people who buy insurance that same year. Over time, the unhealthy people from your original pool make the policy more expensive for everyone.

By shopping around for insurance, this couple was able to save $5,000 per year in premiums because the couple was put in a pool of healthier insured people.