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Pulling Your Retirement Levers

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How does your retirement equation work? When you finally retire, does your financial life go on autopilot, subject to precise mathematical rules?

three leversOr, is the retirement equation more a guideline than prescription? So your financial life after retirement is subject to a set of variables, but the end result — exactly how your wealth will grow or decline — is never precisely predictable….

In my experience, talking with many people nearing retirement, and hearing how they are advised by financial professionals, I see a stronger tendency to the first view of retirement than the second.

Financial advisers like to project certainty: They collect all your relevant financial numbers, punch them into the computer, and give you a 50-page printed report complete with graphs and projections. So financial independence and retirement become a “yes” or “no” proposition. Either you have enough, or you don’t.

But that’s not my experience of retirement, or the experience of many other early retirees that I know. Retirement is not a static equation with a simple “yes”/”no” answer. Rather it’s a journey or process.

The bad news is that you must pay attention and take care to avoid bad outcomes. The good news is that you’ll have plenty of warning if things are going in the wrong direction. Ultimately you can live a flexible lifestyle that suits you best, while making adjustments along the way, as necessary.

Let’s take a look at some of the levers you can pull to control your money in retirement….

Expenses

One of the most obvious levers in retirement, and before, is your cost of living — how you spend money.

This personal finance variable is the one most clearly under your control. Not a day goes by in most of our lives where we don’t make decisions about how to spend our money.

Most of us live in the prosperous western world and enjoy a lifestyle that, even for the middle class, would appear royal to our ancestors. That means that a great deal of our spending is truly optional.

In retirement now, my own essential expenses boil down to groceries, insurance, medical, personal, rent, taxes, utilities, and transportation. But even within those categories there are many “luxuries” that we could do without — that we did do without for most of our younger lives: Our “transportation” expense is largely gas and car maintenance that enables discretionary vacation travel. At the grocery store, we buy the best quality fresh and organic foods.

My discretionary expenses include contributions, gifts, furnishings, miscellaneous, clothing, recreation, dining out, and travel. Those categories constitute a few thousand dollars of spending most months, that we could easily trim back or eliminate for a while if absolutely necessary.

For many, a good chunk of the housing category could be discretionary. Most retired couples could be perfectly happy in a modest 2-bedroom townhome with a small yard. We are right now. Yet many baby boomers continue to live in much larger houses far into retirement. It’s their right, and many feel it adds to their quality of life. But it’s far from essential.

A final discretionary cost that most people can ill-afford in retirement is investment fees. High investment expenses are a serious drag on financial independence. A seemingly innocuous 1% fee on your assets could actually constitute 25% of your available retirement income each year! Are you really OK sharing that much of your retirement lifestyle with your advisor? If not, reducing investment expenses is a lever you can easily pull to improve your financial position in retirement.

Withdrawal Rate

Multiply your monthly expenses not covered by Social Security, pension, or an annuity by 12. Divide that number by your net worth (less your house, if you’re living in it). The result is your withdrawal rate. This is a lever you can pull indirectly in retirement because you have some control over your expenses, which we just discussed. Change your expenses and your withdrawal rate changes, assuming your net worth stays relatively stable.

But there’s another aspect of your withdrawal rate that you control directly. That’s the risk that you are willing to take of running out of money or reducing your lifestyle.

This is a subtle point that I explain in more depth in my second book. The underlying concept is that retirement security is a matter of probabilities. There is no definite answer for how long your money will last. Just a range of possible outcomes.

Thus, you can choose your withdrawal rate within a certain range generally supported by research. In my opinion that’s about 3-5%. If you choose the lower end of that range, your retirement will be quite safe. If you choose the upper end, you will have to keep a closer watch: If there is an extended economic downturn, you are more likely to need to ratchet down your lifestyle. Otherwise, you could run out of money in the end. Though you’ll have plenty of warning before that happens.

The article I wrote describing my Retirement Flexibility Scale goes into more detail on this concept, and offers guidelines for assessing your own situation. But the bottom line is this: You get to choose your withdrawal rate (within a reasonable range) as a function of the risk you’re willing to accept to your lifestyle. And, unless someone has figured out how to predict the future, they can’t really say that you’re “right” or “wrong.” It’s a personal decision.

Income

Regular income is as much a necessity when you’re retired as when you were working. But unlike the days when you were receiving a steady paycheck, the timing and amounts of income you generate in retirement can be more under your control.

The most clear-cut example is harvesting capital gains. If you’ve accumulated substantial savings invested in the stock market, you will need to sell those positions gradually in retirement to generate cash for your living expenses. When you sell, if the positions have appreciated in value, as they almost surely will over any long time span, the growth will be considered a capital gain. And that gain is taxed at different rates, depending on your tax bracket.

So capital gains are income where you control the amounts and timing. As long as you aren’t living hand to mouth in retirement — a particularly bad idea — you’ll already have months or years of cash on hand. The exact timing of when you add to that cash stockpile is under your control. If you’ve had a high income year already due to other factors, you can push the sale of further assets into the following year. If you’ve had less income in a given year, especially if you’re underneath a critical tax bracket threshold, you might decide to sell some assets in that year.

Another obvious way to control your income in retirement is by working. Shocking! Retirees aren’t supposed to be working, are they? Yet Chris and I have explored in numerous articles that it is rarely wise for retirees, especially early retirees, to abandon work altogether. Though, being “retired” means you can choose your work carefully. Obviously it will be part-time, and ideally it will be something enjoyable and/or rewarding.

It turns out that some work can be advantageous, if not essential, for your mental and financial health in retirement. It gives you one more reason to get up every day and be involved in the world. And it provides a possibly scalable income stream, if your retirement finances don’t go as planned.

What about annuitizing or taking out a reverse mortgage? In both these cases you are exchanging a valuable asset (cash or your home) for a steady income stream. Once you commit, you usually have little control over the resulting income: it is generally locked in for life and cannot be changed.

So once you buy an annuity or sign for a reverse mortgage, you have given up control of a substantial retirement lever. But the decision as to when and how much of an annuity to buy is a hefty lever at your disposal until you pull it. Optimizing that decision is a challenge I am facing and hope to write about in the future, as others already have here.

Social Security

A related decision in a special class of its own is when to take Social Security. Most, though not all, Americans have paid into this system and will face this decision at some point.

You can choose to take Social Security anytime between ages 62 and 70. The longer you wait, the more you’ll get, but the fewer years you’ll get it for (before you die). Further, the growth in payments should you wait, which is a guaranteed return on investment, is quite attractive, even compared to stock market returns. On the other hand, some people fear the government will renege on its commitments (I think this is highly unlikely) or fear for their own health , which motivates them to take Social Security earlier.

What will you do? How do you decide? I won’t go further down this rabbit hole here and now. If you want more information, I highly recommend Mike Piper’s excellent calculator and book.

Social Security is one of the most important retirement levers many of us will pull. With my wife Caroline turning 62 next year, this is a decision that we will be working through all too soon. Next spring we’ll be running Social Security calculators and analyzing our own situation. I expect to write about the process and share the results here….

Tax Rate

The taxes you pay in retirement are another important lever under your control. Yes, the government dictates non-negotiable tax rates. But the government also puts into place a bewildering thicket of rules and regulations that create options for how you declare income and expenses throughout the year. Those options give you significant control over your taxable income, the tax bracket you’re in, and how much tax you pay.

This is a vast subject and one that I claim no particular expertise in. As I’ve said from my earliest days with this blog, I really don’t sweat taxes in retirement. Part of the reason is that it’s actually easy to pay low (if not the lowest possible) taxes in retirement. I’ve done it virtually every year since I retired, paying an overall effective tax rate, the last time I checked, of less than 5%.

How is this possible? Primarily two mechanisms: (1) account withdrawal order — withdrawing primarily from taxable accounts where the original deposits were already taxed, and deferring as long as possible my withdrawals from traditional retirement accounts where every dollar is taxed as it is withdrawn, and (2) filling up the first two tax brackets with long-term capital gains taxed at a 0% rate.

As Early Retirement Now explains in a detailed article on income taxes in retirement, with the standard deduction for married couples in 2019 of $24,400, and the top of the 0% tax bracket for capital gains and qualified dividends at $78,750, it’s possible to have six digits of income without paying federal income tax! (There are further wrinkles if you have kids or file for Social Security, which the article explores in depth.)

Chris too has written here about managing your income to optimize using ACA benefits. If you’re buying health insurance on the ACA exchanges and have a “middle-class income” that might cross various critical thresholds, it’s well worth understanding the issues.

As with anything the government touches, the tax code embeds layer upon layer of complexity. Some of us prefer to surf along the top, take the obvious benefits, and not spend time gaming the system. Others delight in paying the absolute minimum taxes, even if it means hours of work and reams of paperwork. Pick your poison.

The bottom line is that, as a retiree, you have considerable control over the taxes you do pay.

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So we’ve discussed most of the major levers you can pull in retirement to control your finances. But that’s not all. Surprisingly, there are still a handful of variables to discuss. Most people consider these out of their control. But they aren’t. Turns out, you are more in charge of your destiny than you might think. Let’s discuss three more levers before we wrap up….

Investment Returns

It’s a truism that none of us can control or predict how the economy will do, or what the market will return. I’ve been reading and writing in this space now for more than 20 years and I have yet to see convincing evidence that anybody can predict market returns in advance.

Or perhaps the more accurate way to say it is that there is no evidence that you can pick, in advance, an “expert” who will correctly predict market returns. Sure, some of them will get it right. You just don’t know which ones will in advance. And they won’t be the same each time.

If you think your hand-picked financial advisor can outperform the market, think again.

But there is one factor over which you do exercise a great deal of control. It directly relates to your ultimate returns from the market. And that is risk. Most specifically and practically, your asset allocation.

To simplify, the percent of stocks in your portfolio is a rough measure of the risk you are taking on. The more stocks, the more you are likely to make over time, but the more your portfolio will fluctuate. And the greater the risk that you won’t be able to achieve short-term objectives with your money.

The less stocks (and more bonds typically), the lower the risk, the lower the returns, and the greater the odds that you can achieve (modest) financial objectives.

So this is another lever you can throw in your retirement — your asset allocation. If you are relying on your portfolio for cash flow in the short-term, it would be advisable to push the lever more towards cash and bonds. If you have the luxury of not touching your investments for many years, then you are free to pull the lever largely for stocks, understanding that it could be a wild ride.

Inflation Rate

How could the general rate of inflation be a lever that you control in retirement? Isn’t that economic variable a function of the economy, and totally out of our control?

Not exactly. It’s true that we don’t control what the government reports as the official inflation rate. But that doesn’t mean we have no control over how it affects us. I wrote years ago about the concept of a personal inflation rate.

I just didn’t see the inflation in my own life corresponding exactly to government figures. I still don’t. If something gets more expensive, I often have the option to switch to a less expensive substitute. And, as a professional and personal geek, technology, one of my biggest expenses over the years, tends to get cheaper over time.

In my experience, part of how inflation affects you is personal. You can see it happening, and you can make adjustments. You can use less, or you can substitute.

You also have complete control over how you inflate your own lifestyle. If times are good, I see nothing wrong with splurging on one-time purchases. But be careful about incrementing your living expenses over the long term by buying expensive assets with high maintenance costs (like houses and luxury cars) or committing to recurring expenses like memberships and subscriptions.

In another old article, on debt, I explored how inflation impacts savers and borrowers differently. As a prospective or near retiree, you are a net saver. Inflation is not good for us. It tends to benefit those who borrow, and pay that debt back with less valuable dollars over time. But there are still more levers you can pull to protect against inflation: put money in real estate, stocks, or inflation-protected bonds, for example.

Life Expectancy

There is one last important lever you can pull in retirement. This one is a paradox, because you can adjust it, but you can never know the outcome for certain. Whatever modest success the fortunate among us have in controlling this variable, we all ultimately must answer to our destiny.

I’m talking of course about lifespan: Our lives will end, and none of us knows exactly when. That is the human condition.

The good news is that we live in times of unprecedented average life expectancy. We are awash in information, tools, strategies, and products for extending the quality and quantity of our lives.

Much of it boils down to a few simple habits: eat healthy, exercise regularly, reduce stress.

In my experience, these are the ultimate levers you can pull to control the quality of your retirement. With good health, you can enjoy the fruits of your other financial adjustments as you age. Without good health, all the financial fine-tuning in the world could be for naught.

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[The founder of CanIRetireYet.com, Darrow Kirkpatrick relied on a modest lifestyle, high savings rate, and simple passive index investing to retire at age 50 from a career as a civil and software engineer. He has been quoted or published in The Wall Street Journal, MarketWatch, Kiplinger, The Huffington Post, Consumer Reports, and Money Magazine among others. His books include Retiring Sooner: How to Accelerate Your Financial Independence and Can I Retire Yet? How to Make the Biggest Financial Decision of the Rest of Your Life.]

 

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Comments

  1. Hi Darrow – great roll up article. Nice work keeping your effective tax rate low in retirement – that’s something that is really reasonating with our users.

    Another big strategy / lever people could pull (but many don’t) is to buy a deferred annuity that kicks in at you life expectancy (~ 85). It’s typically much lower cost (since people are expected to be around to collect it) and it provides an “end date” for your plan so that you can optimize your withdrawals against it.

    https://www.newretirement.com/retirement/longevity-annuities-in-retirement-plans-what-are-they-why-buy-now-for-whom/

    This kind of strategy along with the ones you outlined above can be modeled in some planning tools (including ours) so people can assess the impact for themselves.

    • Thanks Steve, good points. I got interested in a deferred annuity at one point. But couldn’t pull the trigger because of the lack of inflation adjustment. Really hard to know what you’re going to get ~20-30 years from now.

  2. Great article Darrow, one of your best as far as I’m concerned. I feel like you are living in my world or vice versa. Just last week I was reassessing my situation due to two factors you mentioned, 1. I will run out of cash next year and start incurring higher capital gains going forward, and 2. The ACA changed for the better in California, as subsidies are now available to those with higher middle class income levels.

    Last year I started going my own taxes so I dove into understanding how to work my very manipultable situation
    ( rental income + portfolio withdrawls) and stay under that $79K income figure to avoid capital gains taxes. That same figure is important for another reason for a married couple, you’ll now be in the 22% tax bracket. I think it’s important to point out this is TAXABLE income, after the $24400 standard deduction, not gross or adjusted gross. In trying to get a handle on my tax situation I was surprised at the imprecise language used in the articles I found on line. Doing my own taxes forced me to learn more and gain more control.

  3. I’ve been reading your blog for many years. I came upon it not at an age (60) when I could retire significant early. But I did determine that I could retire earlier age (62) than I had thought. I am now 4 years into retirement that I had to fully fund/save on my own – no pension, only Trad IRA and 401K, and SS at 70. I continue to read your blog as I periodically check my financial plan’s progress and make adjustments as needed. In particular, I read about the theories on Withdrawal Rate in order to determine how best to not outspend my funds. I am obviously using a flexible withdrawal rate because my withdrawal is greater in my early years in order to benefit from delaying SS to 70. A question I do not see answered in Withdrawal Rate theories is – what to do in the latter years of life. My Mother’s last 5 years of life were quite expensive with home care needs not covered by insurance. Fortunately, she had 5 children willing to make sure she had the best. I do not have children to do so. So I am concerned that using a flat budget amount to calculate the Withdrawal Rate does not take into consideration that in the latter years of life there can be much higher level of expenses, even though I have Long Term Care insurance. How do you account for this significant component when addressing the Withdrawal Rate and estimating that you will not run out of funds?

    • Hi Pixie, congrats on your retirement. Good question. The Safe Withdrawal Rate is a very rough rule of thumb. Like you, most of us retirees find that constant annual spending doesn’t match life in the real world.

      The best way I know to analyze varying expenses is to put the actual estimated numbers in a high-fidelity retirement calculator. You can look at my list of the best retirement calculators, if you don’t already have a preferred one.

      Also, though I haven’t looked at the research in a while, my impression has been that though expenses usually do go up at the end of life, it’s not usually enough to outweigh the generally downward trend in living expenses over a full retirement.

      • Good point, Darrow, about the downward trend in latter years of certain discretionary expenses – such as less travelling. I will revisit that when I next analyze using a high-fidelity retirement calculator. Thanks and keep up the great articles.

  4. Really like your blog, and just re-read your second book over the Thanksgiving holiday. So many helpful points.

    On thing I have been thinking about is Long Term Care. While I like the principle of Long Term Care insurance, I don’t like the way the product is priced and how it works. Also, I don’t understand the market and it seems very uncertain – for insurance. So my wife and I have decided to self-insure/self-fund LTC, if needed.
    I want to connect this to something that is on the surface unrelated – Social Security. One of the reasons both my wife and I have decided to wait until 70 to start Social Security (besides treating it as longevity insurance) is to get the monthly amounts high enough so that they could make a dent in the costs of LTC. (Both my wife and I have 33 years of paychecks), should it be needed. I have never heard anyone else justify waiting until 70 to start SS to help defray Long Term Care coverage. What do you make of it?

    • Thanks Wendell, I share your reservations on LTC insurance. When I researched my articles on the topic, I was underwhelmed by the value. So we are self-insuring, and also looking at delaying Social Security. It makes a lot of sense to me to mentally “match” increased SS payments with a possible LTC obligation. Those payments also serve as longevity insurance, as you note. There are no real downsides that I can picture to guaranteeing more income for our later years.

      • Thanks for the response. It is very helpful to hear from someone who is thoughtful about these matters. My plan is to retire at 60 (closer to the traditional “plush” retirement) but your work is allowing me to look forward to this with confidence and assurance, not fear. Seeing what you’ve done has been an inspiration.

  5. Chicagojon says

    My question is related to your personal health insurance experience during retirement. You have written in past blog posts on the various health insurance options available to retirees before the magical 65 y.o. Medicare coverage. You recently mentioned some health challenges (& costs, no doubt) that you experienced this past summer (as well as some great travel tips & ideas. Thanks!) Did you find that your health insurance planning was adequate/acceptable from a cost standpoint during your latest run-in with the healthcare industry?

    • Thanks. We are incredibly fortunate to have a high-quality BC/BS group plan through my wife’s retirement benefits. It costs us about $700/month. I’m fairly confident in the coverage, if either of us has major health problems. This summer I spent a few thousand on physical therapy and assistive devices without preapproval that I’ll probably get minimal to no reimbursement for. That’s not enough to blow our budget. I’m not complaining, compared to many people’s health stories.

    • Hi Darrow … another great article! Thank you for continuing to write about, and prompt comments about what I call “real-time” and “real-life” issues that I for one face and have a great deal of interest in.

      The topics of safe withdrawal rates, health insurance, and real examples that you use in your blog and books are incredibly helpful. Another great article and once again for me – perfect timing. Thank you!

      DJ

  6. Darrow, if you haven’t already read “Get What’s Yours – The Revised Secrets to Maxing Out Your Social Security” you may find it a good read as you begin your Social Security project this spring. It was originally authored by Laurence Kotlikoff, Philip Moeller and Paul Solman before Social Security was impacted by the Bipartisan Budget Act of 2015, and revised in the spring of 2016 to cover the changes. Kotlikoff is an economist; Moeller and Solman are journalists. All three are well-respected in their field. If I’m remembering correctly, one of them, Moeller maybe, used to work for the Social Security Administration. The book provides excellent explanations of various situations and claiming strategies, and I learned a LOT more than I expected to. If you do look into it, just be sure you pick up the revised edition!

  7. Darrow…another terrific post that’s spot on. Just prior to making the decision to retire this past May my wife and I had long conversations about the various choices available to us to adjust our budget and consumption in the event there was a necessity and I was using the word ‘levers”. Somehow I thought I was the smart one for using that term! In any case, as you point out, all of our models and forecasts are simply that and life will get in the way and mess up all those projections. We have comfort in knowing there are many adjustments available to us, both large and small, to put us back on track if the need arises.

    PS. I’ll be including CanIRetireYet.com this week in my list of favorite blogs and websites. You and Chris are the best at sharing your experiences and insight for the rest of us to contemplate!

  8. Darrow: Happy Holidays to you and your family!
    Another wonderful and thought provoking article. As I read the different sections of your post, I kept thinking about how important it is to be educated about a lot of different retirement subjects in order to be in a position to optimally pull the different levers that you spoke about. It is so valuable to have resources like “canIretireyet.com”, to fill in the knowledge gaps that are often missing from the media. You and Chris share very valuable real life knowledge – not just the output of a financial model that financial advisors provide. This is not to say that financial models are not very important – but topics that are balanced with actual experiences provide much more nuance that can guide a retiree. Thank you for your work!

  9. I often see recommendations wrt delaying Social Security for a potential higher benefit. While this may be true on an individual basis; wouldn’t the SSA use the same actuarial tables and calculate when a group of individuals would be dead to estimate the payout.

  10. Thanks Darrow for the post. There is much info for the investment and retirement community. The problem is the info is usually to show the viewer a complexity that only works to threaten or scare a person. We mostly have average problems or share common problems and need insight on practical solutions. I’m thinking financial people make a living scaring people, discounting social security, and offering complicated advice with tons of data to prove accuracy. Very few offer the advice you guys do given you share your personal thoughts, evaluations, and conclusions as you face the same problems we do. You do not have an conflict of interest other than make a more popular blog. I don’t think a financial advisor would divulge the personal power to manage finances and retirement that you have. For most they would never talk of the value of part time income. Nor make comparables to rental income or downsizing cost of living to secure investments. May they be incapable of such as they haven’t the knowledge or ability themselves? The advisor may have high wealth and can’t relate to these solutions. If the only tool you have is a hammer every problem looks like a nail. Yes, the challenges we face continue to change over time. Every year or two the “best” credit card changes, checking account, cell phone provider, and the rest of services. Even financial and personal finance solutions will continue to evolve and we best keep up to date to add to our basic competence. No such thing as permanent portfolio especially as our needs and timeline changes the risk profile. Yes, our best investment is improving health and quality of life. sometimes spending more for example quality food is a better investment. Maybe spending more on a reliable car may be more inexpensive. The blog does an excellent job of making financial evaluations of such choices that we face common-day. I have gained on the HSA advice and withdrawal comparisons. Thank you.

  11. Darrow- Wow! Another great thought provoking article that really underpins the idea that retirement is a process, not so black or white, and that income needs are also not a straight line. My Dad just turned 85 and his living expenses are significantly lower than when he was 65. So, now he has more money, but limited ability and energy to spend it. That’s not how he thought it would go.

    Keep carrying the torch, Ed

  12. Darrow, another great overview article. As someone who’s life and circumstances closely mirrors yours (except for the early retirement, alas), I continue to get great value out of reading your blog. Keep up the great work!

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