You’ve worked your whole life diligently saving for retirement, and now you’ve reached the point where you begin transitioning between accumulating wealth and spending it. The question becomes: How long do you need your money to last?
Unfortunately, few of us have crystal balls: While an increasing number of people are living well past age 100, some pass away within months of retirement. Where your lifespan will fall in that spectrum is often impossible to judge. That highlights the problem: It would be awful to run out of money before you die. However, dying with a few million in assets after an utterly boring retirement in which you turned into a miser to guarantee your money would last would be almost equally unfortunate.
So, how do you hedge your bets so you won’t run out of money no matter how long you live, but also have an enjoyable retirement?
Continually Reevaluate your Spending
People often assume you’ll spend about the same amount each year throughout retirement, but that’s almost never the case. A typical retirement often sees a significant amount of spending within the first five years, followed by a sharp decrease. The reason is simple: For those first few years, you’re making up for lost time!
Most people spend 40 years of their lives grinding away at the same job, taking a couple of weeks’ worth of vacation each year, while dreaming of something more grandiose. Now that you’re retired, you’re playing “vacation catch-up.” Early retirees frequently take cruises or enjoy long international vacations. In short, they live it up!
Once you’re in your 70s, you’ll likely slow down. You’ve taken the trips you dreamed of and now, you’re more content to stay near home. As a result, spending naturally drops off. Many assume spending will ramp up again as you age because your medical needs will become incredibly expensive. However, in my experience, the statistics do not bear this notion out. Once my clients’ initial “spending spree” winds down, they do not regularly see a significant, sustained second spending increase for the remainder of their retirement.
What does this mean for you? In short, don’t panic if you think you’re spending unsustainably early in retirement. You probably are, but it’s highly unlikely you will actually sustain that level of spending! That, of course, is not to say it’s OK to spend yourself into oblivion — don’t do that!
Cash Flow Analysis
Instead, consider applying cash flow analysis to your retirement on a regular basis. Life changes, even in retirement. Things happen that you might not have accounted for, such as paying for your child’s wedding, or an unexpected home repair. As such expenses arise, you need to readjust your assumptions. A cashflow analysis can help you do that.
It’s important to understand the difference between professional and consumer-oriented cash flow analysis. There are a number of software packages available for purchase that advertise cash flow analysis components, but few, if any of them, are actually good at the process. Many are more akin to balance sheets than cash flow systems. Professional-level analysis, which a good financial advisor can provide, is considerably better.
If you try to analyze your cash flow on your own, you are likely to miss important factors. After all, you only know what you know, and that knowledge is limited by your experience. Just as I would not attempt to remove my own appendix because I’m not a doctor, it would be of questionable wisdom for anon-financial professional to attempt high-level financial planning without consulting an expert.
At Asset Preservation Wealth & Tax, we regularly perform cash flow analysis for our clients, during which we pay close attention to the details many miss, such as little-known rules that, if not accounted for, could cost them in unnecessary penalties and taxes. The fees you pay a financial advisor often get eclipsed by the penalties you pay if you don’t!
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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