TIME Financial Planning

Retirement Planning’s “Conventional Wisdom” Needs Rethinking

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Projecting how much money you’ll need in retirement isn’t as easy as it used to be. Longer lifespans, the rising cost of healthcare and a market pushing investors into more lucrative but riskier investments all combine to throw the old stalwarts out the window.

Here are some “common sense” retirement-planning beliefs that experts say you shouldn’t rely on, along with what you should be looking at instead.
The 20-year, 70% rule: “The longer life expectancies we now enjoy have basically made any traditional retirement models obsolete,” says Mitchell Goldberg, an investment professional with ClientFirst Strategy, Inc. People planning for retirement today should plan on making their nest eggs last for 30 years rather than 20. Even with a million-dollar portfolio, Goldberg says, dividing that into a 30-year rather than a 20-year horizon means cutting your annual income from $50,000 to $30,000 — a big drop.

And with retirees living more active lives, assumption that you’ll need 70% percent of your pre-retirement income in your golden years is both outdated and based on a flawed metric, to boot, says Rich Arzaga, founder and CEO Cornerstone Wealth Management, Inc.

“Most retirees actually spend 117% of their current expenses, not 70% of their income. This is a sizable gap, and can have a dramatic impact on financial independence goals,” he says.

“Income and expenses are two different metrics,” Arzaga points out. “And there can be a big difference between the two.” Especially early on, new retirees might overspend on travel, hobbies or other pursuits they finally have the time to undertake. “When you take [assets] out upfront, you start to draw capital very quickly,” he says. A better alternative is looking at your current and projected spending, factoring in your preferred retirement lifestyle and goals.

The linear-growth, steady rate-of-return model: A lot of plug-and-play retirement calculators assume linear growth. But in real life, things don’t always work out like that (as anyone nearing retirement when the 2008 financial crisis hit can attest).

Models that assume a year-over-year 8% or 10% rate-of-return might be simple, but they hide the truth, Goldberg says. “I’ve seen many models from various constituencies in the financial services industry with their models and their expected rates of return. These might work well for the financial services salesmen, but I think the models I see put in front of consumers are overly optimistic. I can’t stand it.”

“One cannot assume that there won’t be market corrections and negative returns,” says Debra A. Neiman, principal and founder of Neiman & Associates Financial Services, LLC. “It is better to incorporate negative market returns into the mix to give people a better sense of the parameters in the form of average case and worst case scenarios,” she says. Neiman says Monte Carlo simulations, which take both good and bad market swings into account, come closer to approximating what a retiree can expect (although even they can’t predict the future).

Personal finance expert Peter Dunn has a table on his blog that shows the difference between a 12% annual return and a 12% average return over 10 years. They might sound like they’d be the same, but a steady rate of return — which is much less likely to happen, given the typical market volatility — yields 7% more at the end of a decade.

And long-term bonds aren’t a panacea. Today, they’re attractive because cash equivalents earn so little interest, but when interest rates go up — as they inevitably will — that dynamic is going to change.”With a 1% increase in the prime rate, a 30-year bond can go down by as much as 17%,” Arzaga says. Intermediate bonds with 20-year terms will be impacted about half as much, he says. “The longer the hold, the bigger the drop.”

The 4% withdrawal and 3% inflation assumptions: “Advisors tend to use a 4% draw rate to achieve success, but studies show it could be as low as 2.75% for the calculation to work,” Argaza says. “We don’t know what’s going to happen in the future, which is why that 4% assumption can fail.”

How the market performs overall, especially early in your retirement, has a greater impact on your nest egg over the long term. If you have the bad luck reach retirement age in a downturn, consider reining in your spending, withdrawing less or just putting off retirement for a few years.

And although the core Consumer Price Index is a widely-used metric for inflation, Goldberg says it’s a flawed barometer because it doesn’t include volatile food and energy costs. “The issues is food and energy are very big components” of many retirees’ budgets, he says. Healthcare costs — which seniors tend to incur to a disproportionate degree — are also rising faster than the overall rate of inflation.

“$50,000 today with even a little bit of inflation is going to be like $40,000 in the next seven or eight years,” Goldberg says.

The other mistake is in using net work, rather than liquid assets, as your baseline for withdrawal, Arzaga says. Yes, you may have equity in your home, but unless you get a reverse mortgage — a step that isn’t a good idea for everybody — there’s no way to tap that equity without finding another place to live.

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