The first couple years outside the office make some retirees feel like the proverbial kid in the candy store. It's almost impossible not to spend more money, when you suddenly have ample leisure time and no work responsibilities.
The Employee Benefit Research Institute tried to quantify this phenomenon a couple years ago, and it discovered that this urge is stronger than researchers had expected. EBRI found that 46% of retirees spend at a faster rate in the first two years after leaving their jobs than they did before retiring. And that's factoring in the fact that they were spending less on commuting, work clothes and other general, career-related expenses.
This pattern runs counter to the savings goals many financial advisors set for their clients. Those goals are often based on the notion that a retiree will spend 80% of his or her pre-retirement levels.
Spending more money early in retirement can lead to trouble down the line, especially if the stock market takes a turn for the worse. The double whammy of fast "drawdowns" and a market correction can sharply impair the likelihood that your savings will last as long as your retirement does.
One of the best ways to ward off overspending: Test your strategy before you retire. It's eye-opening to see where you stand, especially if you're inclined to spend large on vacations, home improvement projects or a child's wedding.
Test it out
Robin Young, an advisor at Northstar Financial Planning in Windham, N.H., is currently working with a couple in their early 40s who are taking extreme measures to plan. They took what amounted to a year abroad, during which they traveled the world (while working remotely) to see what their expenses would be like and to test whether they would be happy living the vagabond life in retirement. After they returned from the adventure, they cut back their total spending by approximately 25%; now they're planning to retire at 50 and hit the road again, under the new spending guidelines they've set up.
While that's an extreme example of cutting back, it does offer a lesson for many: It can make a lot of sense to test out retirement, before you retire. This can be done by taking time off, or by choosing to live under the post-retirement budget you've set for yourself--prior to actually retiring--to make sure it fits your lifestyle needs. This doesn't have to happen in your early 40s; you'll learn just as much, if not more, if you try it within a few years of your planned retirement.
If you find yourself low on cash each month during the test-run, then it's probably time for a rethink. You can plan to save more, work longer, or consider consulting or working part-time once you step away from full-time work. (Read “5 Cities With Great Job Markets for People Over 50.”)
Stress it out
Every so often, the Federal Reserve requires major banks to run a "stress test" to see how they'd handle a financial crisis. That idea can prove useful for near-retirees, in case they're struggling to predict how their spending might affect their budget.
George Reilly, an advisor and owner at Safe Harbor Financial Advisors based outside of Washington, D.C., developed a series of tests that he runs for his clients a few years prior to their retirement. This involves taking the estimates that clients have come up with for what they expect to spend in retirement--and then running a simulation of what would happen to their portfolio if they spent 25% more than that over each of their first 15 years. To make the test even more stressful, he couples that spending model with weak market returns. It's like Frank Sinatra sang, he says: "If you can make it there, you can make it anywhere."
For savers, this provides a real-life look at what increased spending will do to their retirement savings. For some, these scenarios prove they're in solid shape, which can free them from the emotional toll of counting pennies. For others, it highlights that their money could run dry much earlier than they'd hoped. Then it's decision time: Do they want to contribute more funds, or work a little longer, or both?
It's not the most fun choice, but it beats having to brush up the resume when you're an octogenarian.
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