Retirement Getting Closer? Beware These Common Financial Blind Spots
Pennies really add up when you've got a realistic investing and spending plan for retirement.

By James Werner

Four years ago, I had a client (let's call him Howie) who was contemplating retirement. At 55, he qualified for his pension based on his age and years of service with the company. He attended a pre-retirement seminar hosted by his union, and scheduled an appointment to double-check his retirement numbers.

When I pulled up to Howie's house, the first thing we noticed was the "For Sale" sign on his front lawn. After a few minutes of small talk, he showed me the new set of golf clubs he had bought himself as a retirement present and which he planned on using while enjoying his retirement in South Carolina.

As we sat down to discuss business, it became quickly obvious to me that Howie wasn't ready to retire. I found myself in the difficult position of telling him to cancel the open house scheduled for the next day, return the golf clubs, and call the union hall to withdraw the retirement paperwork.

As with many things in life, when emotions take over, poor decisions are made. Howie had a euphoric vision of a retirement lifestyle, but no plan to achieve it. Needless to say, Howie asked me to leave his house. His actual words were a little more terse.

Sometimes telling people what not to do is as valuable, or even more valuable, than telling them what to do.

As I drove home from the appointment, I felt bad that I had ruined his weekend. But in my heart, I knew that this was he needed to hear, regardless of what he wanted to hear.

Here's a snapshot of what Howie had planned for himself, and the financial blind spots that were not obvious to him:

Expense planning: Howie budgeted $5,000 of monthly living expenses in South Carolina. While this seemed reasonable, he did not plan for future costs. A cost-of-living increase of 3% per year means that the monthly expenses could be $6,500 to $7,000 in 10 years, and $10,000 or more in 20 years.

Pension review: Howie calculated his pension to be $4,000 per month. This is a maximum pension based on a single-life option before taxes and healthcare costs. After taxes, retiree healthcare costs, and the spousal option, the pension was actually $2,700 per month. While the pension is a strength of his retirement income plan, the pension is fixed and does not offer cost-of-living adjustments. The fixed income wasn't enough. Howie needed a plan that could offer an increasing income.

Gap analysis: In Howie's mind, his monthly expenses were $5,000, and the pension income was $4,000. The gap between the income and expenses was $1,000 per month or $250 per week. This seemed reasonable for Howie, as he was planning on being able to work part time and make $250 per week.

In reality, the gap was $2,300 per month, or $600 per week -- significantly more than he had planned. Spending less and working more was not how Howie pictured retirement. Taking income from the investments and Social Security would be options down the road, but not appropriate at this time. Showing him these numbers made him realize the importance of a plan.

Turning the clock forward 10 years (when he is 65), didn't help him. The future expenses are likely to be in the $6,500 to $7,000 range. The pension remains fixed at $2,700 after taxes, which creates an income/expense gap close to $4,000 per month. This was a bigger gap that he had imagined, and he didn't have the financial resources or investment assets needed to cover the gap.

Six months later, Howie gave me a call, asking to schedule another appointment. I accepted the appointment under conditions that he had not moved, the golf clubs were returned, and he continues to work. We sat down for a second time with the goal of developing a plan to help him achieve his dream of retiring to South Carolina. A comprehensive financial and investment plan we would allow Howie to retire ready, with financial confidence, within three to four years.

Here is a summary of plan and suggestions:

Increase Savings by Lowering Expenses

Brown-bagging breakfast and lunch would lower his expenses $15 per day. Over three years, this would lower expenses and increase savings by about $10,000. Shop around for better deals on cell phones, insurance, and television providers. This helped lower expenses $150 per month, or $5,000 over the next three years. Howie directed this money, along with an additional $850, into his 401(k), a strategy that helped lower his taxes and increase savings.

Investment Assets

Howie's investment assets were $300,000, which included a 401(k) and an annuity from his union. He was told by a customer of his route that the "stable value fund" (paying 1.5%) was the best investment going into retirement, as it doesn't lose money. The stable value fund helped protect the principal, but offered no support to increase the purchasing power of the money. In conversation with Howie, we told him that this option was not appropriate for him at this time. We had to consider other investments that could offer returns more consistent with his goals.

To support his retirement-income goals, the plan defined the future investment value would need to be closer to $800,000. To achieve that goal, he would need to save an additional $1,000 per month for another 10 years and change his asset allocation to produce a 6% to &% expected rate of return. The plan helped Howie define a time-frame for this money. Howie now realized that he would not need access to the 401(k) funds for 10 or more years. With this time frame, the advice was to reorganize the investments in favor high-quality dividend-paying stocks and balanced funds, which are more appropriate for his future income goals.

Employment in Retirement

The plan helped Howie have a more realistic vision of his responsibility of earned income in retirement. Additionally, working in retirement would give him the potential to save more toward his investment goal of $800,000.

Retirement Income Strategies

At age 65, Howie has the option of turning on income from Social Security and his investment assets. Social security would offer him and his wife an estimated monthly benefit of $3,000 (after-tax). Combine that with the pension, and the income is now $5,700 a month. But keep in mind that the expenses will be closer to $7,000. In this case, the gap is now $1,300 a month. The gap can be narrowed by lowering expenses, working longer, or generating income from the investment assets.

Let's say Howie achieves his savings goal of $800,000 when he turns 65, and decides to turn on income from the investment assets. Using a 4% withdrawal rate and a 20% effective tax rate, the monthly income is estimated to be $2,100. While the investment income fulfills the estimated income/expense gap of $1,300, Howie must also realize that the gap will continue to increase over time, putting more pressure on the assets.

Additional Considerations

As part of the planning process, we also made sure that Howie had a sufficient emergency plan which includes liquid cash available, and adequate disability and long-term care insurance. We referred him to a local attorney to make sure his power of attorney, healthcare proxy, and wills were up to date and consistent with his wishes. Since we started the plan, Howie also had the good fortune of receiving an inherited IRA, which provides an additional after-tax income of $500 per month.

The Results

I'm happy to report that almost four years to the day of being thrown out of Howie's house, he is living his dream in South Carolina. He's driving a school bus and teaching driver's education, which allows him to save more now than when he was working full time. As an added bonus, the school bus company offers a pension after 10 years of service. There is a renewed sense of confidence knowing that a high-quality plan is being used to guide his decisions, and not his emotions. Working with an experienced adviser allowed him to see his blind spots, and be better prepared for an increasing retirement income. Finally, professional support provided him with clear answers to his important questions, helped him understand his options, and make smarter decisions with his finances in the best interest of his goals.

About the author: Jim Werner, CFP® is a vice president with Halliday Financial, a full service financial planning and investment advisory firm in Glen Head, NY. Jim and his specializes in helping union members, educators, and administrators make smart decisions with their finances.