Is Your Plan for Retirement Too Safe?

In this episode of Motley Fool Hidden Gems Investing, Motley Fool retirement expert Robert Brokamp looks at some investing rules of thumb that may be overly cautious, causing you to work longer than necessary. He also discusses:

• A study that finds that financial mistakes can be a predictor of dementia

• Saving more for retirement not only boosts your portfolio but lowers the amount you need to have saved before you retire because you learn to live on less.

• The father of the so-called “4% rule,” who says it’s 5.5% for someone retiring today.

• Money management tools that not only track your spending but help you plan for retirement.

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A full transcript is below.

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Robert Brokamp: Is your retirement plan too safe? And how financial mistakes could be a sign of cognitive decline. That and more on this Saturday Personal Finance Edition of The Motley Fool Hidden Gems Investing Podcast. I’m Robert Brokamp, and for today’s main segment, I’m going to discuss a few assumptions about retirement planning that might be too cautious.

But first some recent headlines that caught my eye, I’ll start with a segment from NPR’s Planet Money with the title, How your bank account might predict dementia. It started with the story of Sandra Baliban, who hadn’t been in close contact with her father for a while. When she visited him, his house was a mess, and amidst the clutter were credit card statements showing purchases of scammy-seeming health products and online subscriptions. Her father couldn’t explain them. He had also lost the $1-$2 million he had in his retirement accounts. When Sandra reviewed his brokerage statements, they didn’t make sense. She described them as an extremely erratic pattern of investments. He also hadn’t paid his taxes in years. The segment then brought in Lauren Nicholas, who is a professor of geriatrics at the University of Colorado, and she contributed to a study, which found that wealth begins to decline about six years before a dementia diagnosis due to impaired financial decision-making. As Nicholas said in the interview, “Dementia is one of the diseases where you lose a lot of cognitive capabilities over time, that are unfortunately closely tied to our ability to manage our own money. We actually see some of the earliest signs show up in financial portfolios and checkbooks.”

On last week’s show, we talked about estate planning with Attorney Jill Mastroianni, the host of the Death Readiness Podcast. But as we discussed, estate planning isn’t just about death. It’s also the planning and legal documents you need when you or someone you love is no longer able to handle their own affairs. If you have older relatives, discuss with them in a very loving, gentle way what’s their plan for if and when they’re no longer able to take care of themselves financially or otherwise. They look for signs of money-related mistakes that could be an indication of cognitive decline, things like new spending patterns, bills and taxes not getting paid or being doubly paid, calls or letters from companies or charities you’ve never heard of, evidence of falling for get-rich-quick scams, declining credit score, even basic math mistakes. If you’re getting up there in years, have a plan for how your family will be able to step in and protect you and your financial legacy.

Next up, CNBC recently highlighted an article by Fran Walsh, who is the co-founder of Opulus, a fee-only financial planning firm in Pennsylvania. The article highlighted how saving more for retirement can move up your retirement date in an underappreciated way. Of course, saving more will accelerate the growth of your portfolio. That’s obvious. But to save more, you have to spend less. When you learn to live on less, you’ve lowered the cost of your retirement because you won’t need as much income each year. Here’s an illustration from Walsh’s article, Let’s say you have two households, both of which are 35-years-old, earn $250,000 a year, and their portfolios grow 8% annually. Household A saves 10% a year or $25,000 and spends $225,000. Household B saves 30% or $75,000 and lives on $175,000. As a quick back-of-the-envelope, ask about how much they need to retire. Walsh uses the rule of thumb that multiplies annual income needs by 25, because that’s the inverse of the old 4% rule for how much you can withdraw from your portfolio in retirement. According to this math, household A needs $5.6 million to retire, whereas household B needs $4.3 million. Household B is saving much more for a smaller goal and will be able to retire at age 57. Household A, on the other hand, won’t be able to retire until age 73.

To me, this is the real magic of the FIRE movement. FIRE, standing for financial independence retire early. These are people who have cut their spending significantly in order to save 30-50% or more of their incomes and retire well before their 60s. I know that many people may not be comfortable with the sacrifices these FIRE folks make, but I also believe that many Americans can cut their spending without a huge drop off in satisfaction, especially if it means they can retire sooner. Now I will point out that the rule of 25 usually overstates how much someone needs before they can retire for a couple of reasons. First, it doesn’t factor in Social Security. The second reason brings us to the number of the week, which is 5.5%. That’s how much a retiree could withdraw in their first year of a 30-year retirement, according to Bill Bengen, the father of the original 4% rule. He came up with that rule back in 1994, but it’s gradually ratcheted up over the years, including in a book published last year. As he explained when he was a guest on this show in August, 4.7% is the historical worst-case scenario. As he said on the show and has repeated in more recent interviews and LinkedIn posts, he’d recommend 5.5% based on today’s market valuations and inflation levels. Instead of needing 25 times your annual retirement needs, you may need just 18.2 times that amount. Again, that doesn’t factor in Social Security, so most people retiring around their mid-60s won’t need nearly that much. Such overly conservative assumptions could result in people working longer than they needed to or spending less in retirement than they could, which is our next topic of conversation, when Motley Fool Hidden Gems Investing continues.

Determining when you can retire and how much you can spend in retirement requires a tool that can do the math, factoring in several important variables and assumptions. One key assumption is how long you’ll live, since that will dictate how long you need your money to last. Most retirement experts recommend that you plan to live until your 90s, with 95 being the most common age. As I hinted at in the previous segment, most of the research about safe withdrawal rates in retirement assumes a 30-year retirement, so someone who retires at age 65 will live to 95. It’s a prudent assumption. There’s just one problem: You probably won’t live that long. Using the longevity Illustrator from the Society of Actuaries, I calculated the odds that members of a 65-year-old, married, retired, heterosexual couple will live to age 95 based on their health status and assuming they don’t smoke. For a female in poor health, she has a 13% chance of making it to 95, average health 22%, excellent health, 30%. For a male in poor health, it’s 7% chance of making it to 95, average health, 14%, excellent health 21%. Now with married couples, it actually increases the odds that at least one of them will make it to an older age. If both spouses are in poor health, there’s a 19% chance that one of them will make it to 95, average health 32%, excellent health 44%. Those are not high probabilities. But for those in excellent health, the odds that at least one spouse will live to 95 is close to a coin flip, so using age 95 in retirement calculations could be reasonable.

But how many older Americans are actually in excellent health? Not many, according to a report from Health Youth Services that questioned whether people should plan to live to age 95. According to the report, 95% of retirees in their 60s or older have at least one chronic health condition that will reduce their life expectancy. The reduction will depend on the condition, so ranging 1-2 years in the case of high blood pressure, to five years in the case of obesity, to 6-8 years if someone has cancer. When you input a life expectancy of 95 into a retirement calculator, the result will be that you have to work longer and/or spend less in retirement than if you assumed a shorter lifespan. Which life expectancy should you choose? I think it’s helpful to think through a range of possible scenarios and ask yourself how they make you feel. What would be your plan B if things don’t turn out as well as you hope?

Let’s just consider two scenarios. As I go through them, think about which you’d prefer. Scenario 1, you plan to live to 95 and you spend accordingly in retirement. This may mean you have to work a bit longer. It also limits the lifestyle you can enjoy in retirement, the trips you can take, the amount you can dine out, the adventures you can have. You actually end up dying at age 82 and leave a large bequest to your heirs. To some degree, that inheritance represents all the experiences you could have had but didn’t because you played it safe. Now, here’s scenario 2: you plan to live to age 85, and that’s the life expectancy of a 65-year-old woman in average health. This allows you to retire sooner and spend more in retirement; you travel, you dine out, you enjoy all the adventures you envision for your retirement while still in good enough health and shape to do them. However, because you end up living to age 93 and have spent a good deal of your life savings, your last several years are pretty lean. You’re living mostly on Social Security, maybe a little bit of savings, maybe a reverse mortgage on your home. There’s not much of a cushion to pay for long-term care expenses, and the bequest that your heirs eventually get is pretty modest.

The degree to which those two scenarios seem more or less appealing to you comes down to your risk tolerance for the possibility of outliving your money. Type of researcher Moshe Malewski calls this your longevity risk aversion, which he defined as “Different people might have different attitudes towards the fear of living longer than anticipated and possibly depleting their financial resources. Some might respond to this economic risk by spending less early on in retirement, where others might be willing to take their chances and enjoy a higher standard of living while they’re still able to do so.” In a recent article on advisorperspectives.com, William Bernstein and Edward McQuarrie explain it as the fear of being the richest person in the graveyard, RPIG versus the fear of running out or FORO.

They propose that it could be quantified, calling it Omega, which, of course, is the last letter of the Greek alphabet, and it scales between zero and one. Someone with a lower number fears leaving money unspent, whereas someone with a higher number worries about depleting their savings. I think it’s best explained by a couple of paragraphs, and their article, “Omega determines the spending path that optimizes utility during retirement.” I’ll just add to here that utility is the economic turn for satisfaction and pleasure and things like that. “Low Omega retirees who perceive themselves to have enough money spent freely, especially today, right now. The low Omega retiree does seek to steal the title of Bill Perkins best seller, to Die With Zero. The higher Omega retiree, on the other hand, fears that vengeful market gods or personal misfortune might send them spiraling down a white-knuckle toboggan ride towards cat food and worse. The calendar always reads 1929. Dying with zero is a guess and a hope, a wish, not a plan. At high Omega, today’s spending matters less than money kept in hand. Utility flows from having surplus funds that will never be spent.”

As you hear all that, what’s your Omega? You’re likely somewhere in between the two extremes. You want to enjoy the retirement that you worked decades for, but you also don’t want to spend your last years pinching pennies and perhaps becoming a burden to your family. Finding that balance starts first with determining how much you’ll spend in retirement and how much it’ll change over the course of your retirement, and this is an important point. Most retirement calculators, most financial planners, and most of the research on safe withdrawal rates in retirement all assume that a retiree’s expenses go up every year along with inflation. But the evidence is clear that this isn’t what happens for most retirees. Their highest spending years tend to be the first decade, and they’re not spending nearly as much once they reach their late 70s and 80s, in many cases, because their health prevents them from doing too much. This is another way that many retirement plans are likely playing it too safe, and why low Omega retirees, those willing to spend money while they can, may be onto something.

It’s also important to distinguish between essential and discretionary expenses so that you know the bare minimum income you need each year in retirement and how much you can cut back during bear markets. Being willing to pay back withdrawals after your portfolio has lost value adds another half percent to 1% to the initial safe withdrawal rate in the first year of retirement. Under the category of discretionary expenses, have what you call your adventure fund. That’s the amount that pays for the trips, excursions, the fun times. It can be adjusted year by year, depending on your portfolio’s performance, unexpected non-fund expenses, and other factors. This makes these expenses more intentional and puts them in the context of your overall plan. Here’s another suggestion. Create a reserve fund worth, I don’t know, 10% or so of your portfolio when you retire. It’s an emergency fund to be left alone unless your other savings run too low. It could also be used later in life to pay for long-term care. With such a fund, you’ll feel more comfortable enjoying the other 90% of your savings.

Finally, as stated at the beginning of this segment, using a tool is the best way to quantify the consequences and trade-offs of your choices. You’ll find plenty of free tools on the Internet, my favorite being the CalcXML retirement planning module, but I also think it’s worth the money to pay for access to a more sophisticated tool, some of the most popular being MaxiFi, Projection Lab, and Boldin, and I’ll once again disclose that Motley Fool Ventures, a sister company of The Motley Fool has an investment in Boldin. With such a tool, you’ll be able to incorporate your own longevity risk aversion and spending assumptions and see how they affect when and how you can retire. It’s time to get it done, Fools, and next week will be our next installment of our 2026 financial planning challenge. As you may recall, we began the year recommending that you find a way to track your spending and net worth, perhaps using a tool such as Monarch Money, Quicken, Empower, Tiller, YNAB, or just spreadsheets. Knowing that information will be crucial in determining how much your expenses will be in retirement, which is a key variable when using a retirement calculator. Also, some of these tools actually have retirement calculators built into them. Come up with a way to monitor your finances if you haven’t done so already. If you’re already on board, dig around the services used to see if they offer any retirement planning tools. And while you’re in there, see if there’s one expense you can reduce or eliminate and immediately have that money automatically sent to your IRA or 401(k), and that my Foolish friends, is the show.

Thanks for spending part of your weekend with us, and thanks to Bart Shannon, the engineer for this episode. My goodness, what a talented guy he is. As always, people on the program may have interest in the investments they talk about, and The Motley Fool may have formal recommendations for or against; don’t buy or sell investments based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. I’m Robert Brokamp. Fool on, everybody.

Robert Brokamp, CFP, EA has no position in any of the stocks mentioned. The Motley Fool recommends Comcast. The Motley Fool has a disclosure policy.

Is Your Plan for Retirement Too Safe? was originally published by The Motley Fool