By Keith Whitcomb
Does retirement planning help answer existential questions? Potentially. Because when you look into how you're going to spend money in retirement, it forces you to question what you want from life. For better or worse, finances are intertwined with the answer to that question.
Retirement planning confronts life issues including aging, end of life, death, and even post-death (estate planning). It also forces you to evaluate how successful, at least financially, you have been during your life. For most people, conventional financial measures signal that they are under-funded for retirement. Add it all up and you can understand how retirement planning can quickly devolve into a state of denial or despair.
Maybe a whole new approach needs to be taken. At the very least, the concept of life in retirement should be better understood, updated, and include new alternatives and solutions.
To start, let's take a look at the classic retirement model.
Based on a financial life that consists of two phases a person first works until age 65, and then pursues a life of leisure until death. It assumes that the retiree has, in addition to Social Security, a pension plan and maybe some personal savings to cover all financial needs during retirement.
My dad's retirement was a perfect example of this model. After working his entire career for the same employer, he was able to retire at the age of 58. His retirement package included monthly pension payments and post-retirement medical coverage. The payments were supplemented by Social Security and tax-advantaged company stock and 401(k) savings. He spent the rest of his days volunteering in the community and playing a lot of golf. He never returned to work to support his lifestyle.
Shifting the Retirement Paradigm
For most people, the classic work-for-40-years-and-then-live-a-life-of-leisure model really doesn't exist anymore. Longer lifespans, a transient workforce, the high cost of medical coverage, and disappearing pensions have ended what may be described as the golden age of retirement.
However, there are some other retirement funding models that may fit today's workers. Here are two alternatives that bookend a spectrum, from basically never leaving the workforce to a non-work lifestyle that begins in your early 30s.
Retirement Workscape - Back in 2014, Merrill Lynch published a study that described a four phase retirement: pre-retirement, career intermission, re-engagement, and leisure. The approach features a 2.5 year intermission after which a person re-enters the work force recharged and retooled to re-engage with the working world for another nine years before exiting a final time for a life of leisure. While this approach may be interesting in the abstract, based on a normal retirement age of 67, retooling for 2½ years puts you heading back to the work place at about age 70. A life of leisure would begin around the time of your 80th birthday. According to WorldLifeExpectancy.com life expectancy in the U.S. is about 79 years.
This is a huge change from the 30 years of leisure model. The phased approach does open a door on a different mindset toward retirement. It recognizes the need or desire to continue to work after a customary retirement age. And while making money to pay bills is likely the primary reason for working later in life, research has documented the psychological benefits of continuing to work in retirement.
Financial Independence Retire Early (FIRE) - This early retirement movement is on the other end of the retirement planning spectrum. FIRE advocates a frugal lifestyle, potentially cutting expenses to $10,000 per person per year, and extreme savings, e.g. 50% of your income. This can allow an individual to retire as early as age 30.
With this model you first decide how important "financial freedom" is for you, and then determine the lifestyle sacrifices you are willing to make in order to obtain that freedom. This may end up being an evolving process as you proceed through life. For example, retiring at age 30 to live in a yurt and eat nuts and berries may seem perfectly plausible when you're single and in your early 20s, but not so much later in life after you get married and have two kids.
Once the budgeting is figured out, the process of investing for "retirement" will need to be modified. One consideration is the time horizon associated with your investments. You will likely be drawing on the funds far sooner than at a traditional retirement age, so the need for liquidity should be factored into your investment strategy. The overall portfolio may need to grow for decades longer than a typical post-retirement portfolio, so the allocation to long-term growth investments will continue to be important, perhaps even more so than when planning to retire at age 65 or 70. Finally, given that the need to draw on the funds occurs before the age-related penalties associated with traditional 401(k) and IRA accounts are eliminated, a significant portion of your portfolio may need to be located in taxable brokerage and/or bank accounts.
Retirement is a life phase where the net after-tax income from the use of human capital:
- ... Does not generate enough cash flow to support your lifestyle -- It's when compensation from working does not cover your expenses. It can happen when you're unemployed, get divorced, send a child to college, or during a short-term disability. Symptoms may include an increase in debt or a decrease in net worth.
- ... Will not, in the future, generate enough cash flow to support your lifestyle -- There is no desire, or perhaps ability, to employ human capital to change the condition of underfunding of your lifestyle in the future. However, this is an income issue and not necessarily a net worth problem. Some people will actually accumulate assets late in life as their expenses drop along with their level of activity, i.e. a "no-go" life stage.
- ... Is not required to drop to $0 -- Retirement is no longer narrowly defined as the end of all work. The discontinued use of human capital to produce income is now a phase or subset of a more broadly understood financial concept of retirement.
Retirement is a life phase during which compensation from working underfunds the finances required to support your lifestyle over the remainder of your life. Gone from the definition is a specified chronological age for retirement and the immediate initiation of a life of leisure.
Lifestyle Planning Over Your Lifetime, Not Retirement Planning
"Pepper...and Salt," a comic appearing in The Wall Street Journal, portrayed an older man looking as if he were ready to explore Europe using a rail pass and youth hostels. The woman next to him commented that she had heard about taking a gap year but not at age 52.
Why not? Should gap years be the norm and not the exception? While this concept likely breaks down in a world of people living paycheck-to-paycheck, it's still important to inject this into an evaluation of a work life balance. And who's to say that it isn't realistic when FIRE as a lifestyle is a reality? In academia, they call it a sabbatical. In the Bible, every seventh year was one of rest. So, is retirement readiness a thing anymore, or is it more about financial readiness over a lifetime?
Maybe it's a melding of the FIRE and Workscape concepts with planned negative cash flow during certain life phases or events, and not just something to plan for at age 60-something. Perhaps, it's a plan of retirement compartments over a lifetime to pursue dreams as a 20-something, or take a year off as a newly married couple before buying a house and having kids.
Balancing Life Priorities with Financial and Biological Reality
The Tubes, a rock band from the 1970s, wrote a song that asked the question, "What do you want from life?" over and over, with quirky answers designed to elicit a reaction. While used only for entertainment purposes then, the process of repeated questioning is a legitimate planning tool to get to the root of an issue. This is a Six Sigma technique that you can use when making your financial plans. What do you want from life? Once you know, it is a process of folding in how the finances and realities of aging work into the plan. Making choices over a lifetime by understanding not only your means but your personal priorities and your physical capacity as you age is the key.
A starting point is knowing average life expectancy, using a generalized 80% replacement ratio of income, and a typical 4% inflation-adjusted withdrawal rate. However, this is just the start. Take a more proactive approach in planning your spending with a "go-go, slow-go, no-go" retirement "smile" model augmented with lifetime spending priorities. Maybe funding your children's education is more important to you than living large in retirement. Effectively throttle that into your plans in a way that the FIRE approach does when determining a personalized floor of non-discretionary spending and human capital budgeting over your lifetime.
Another way to personalize your plan is to move beyond a generic chronological target age for retirement. Moshe Milevsky has done research into the use of a biological age versus a chronological age for retirement planning. The adage "you are as young as you feel" actually has planning validity.
Putting It All Together With a New Attitude
Initially, the end of classic retirement sounds a little depressing. Like, what happened to the promise of the gold watch, the send-off retirement party, and living a life at the club under the warm sun? Plus, the "old" retirement model was easy - whatever the company pension and Social Security added up to was the plan.
This "no planning" plan seems to have carried through to today. Debt accumulation that front loads spending in early years (and also increases the expense of supporting a lifestyle), is de facto retirement planning, given it ultimately takes away financial resources that could be used later in life. Avoid this by incorporating retirement planning into lifestyle decisions over a lifetime.
Instead of a binary working/not working construct, consider retirement as a life phase in a continuum of lifestyle planning. It should be a cohesive, integrated, and systematic decision process. Retirement should be viewed as part of an ecosystem of personal finance, not a sub-optimized life phase stuffed in a silo. And, this "new" retirement reality can actually lead to a healthier (physically and mentally) and more rewarding life.
So, what do you want from life?
About the author: Keith Whitcomb MBA, RMA, is the director of analytics at Perspective Partners and has more than 20 years of institutional investment experience.