Financial Opinion and Insights

Think You’ll Spend Less in Retirement? Really?

IFG BlogConventional wisdom:  When you retire you’ll be spending less.  You’re not commuting and you won’t need clothes for work; so your financial needs in retirement will be less.

Not my experience.

I’ve been helping people plan for, and manage, retirement for more than twenty years, and here’s what I’ve learned:

When people retire, they have time to do all the things they’ve been wanting to do for years:  Travel, play golf, visit family and spoil grandkids, take classes, start new hobbies… you get the idea.

Advisors – me included – have been preaching the 4% rule:  “You probably don’t want to take more than 4% of your initial assets, plus a cost-of-living increase, each year you’re in retirement.   It’s a mantra we all have preached.

But, people are living longer and there’s a factor many haven’t considered:  Inflation.

Yes, we did address cost-of-living increases in our 4% distribution formula; but, there’s more that hasn’t been addressed, even by yours truly!

Some time ago, I wrote a paper, ‘Why Investors Fail’, in which I addressed the `order of returns’ as a significant factor in retirement success.  I was by no means the first to talk about this and I certainly didn’t discover it.  But my discussion of the order of returns was limited to the investments.  It applies to inflation, too!

Bob Veres, writing in the current issue of Financial Planning, pointed out something interesting:  Inflation tends to strike retirees harder than preretirees.  The biggest reason:  Health care costs are rising faster than the inflation rate!  But, adding to the mix is the concern about withdrawal rates and their relationship to inflation.

Jim Otar, a Thornhill, Ontario-based financial analyst and planner, conducted a study of withdrawal rates over 111 years.  The results, cited in this month’s Financial Advisor, shows that the sequence of returns and how much prices move up and down contribute 32% to the total return of a portfolio and inflation can contribute 21%, with asset allocation and management making up 31%.   So, the order of inflation numbers, combined with withdrawal rates, can have a significant impact on how long money lasts!

The insurance industry, of course, has been jumping on this issue for some time offering guaranteed future or ‘longevity’ income annuities to ease investors’ worries.  Indeed, many planners are beginning to include these products in their planning for clients; however, there are some drawbacks everyone should consider, including their high internal costs, surrender charges, and high sales commissions – all paid by the purchaser.  Another concern is the risk that the insurance company could fail!  We’ve seen what’s happened in the credit markets before.  If an insurer fails, the policy holders would be subject to the payout limits and state insurance guaranty associations.

Another consideration:  Immediate annuity income won’t likely keep pace with inflation, even with cost-of-living adjustments.  And, government COLA data doesn’t include food or energy, and I wouldn’t put it past them to factor out health care before long.  The old-fashioned approach of simply diversifying assets among asset classes, using low-cost vehicles, according to age and risk tolerance, and using dividends and capital gains to meet income needs, as well as retirement plan distributions is still, in my opinion, the best way to keep your money for yourself instead of making the product sellers rich.


Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  Additional resources:   IFG Investment Blog. Retirement Plan Insights Archive.

Twitter:  @JimLorenzen.