Saving for the three stages of retirement
Experts have ditched simple rules of thumb in favor of careful planning for early, middle, and late retirement.
Will I spend less when I retire?
Probably not at the beginning. The first phase of retirement, roughly encompassing the period until you reach 75, is often referred to as the go-go years—a term coined by financial planner Michael K. Stein—because this is when you’ll be most inclined to pursue leisure and travel activities. Costs during this initial phase can vary wildly. For some, the period will mean a lot of golf and travel, which can be expensive pursuits. For others, it may mean less expensive options, such as taking classes. More free time can also mean more time to buy stuff, without the distraction of work. Additionally, you may have adult children who still need financial assistance, or grandchildren to whose education costs you may want to contribute.
How much income will I need at this stage?
For years, conventional wisdom held that you would need about 70 percent of your pre-retirement income after you stopped working. But that’s clearly not enough for the early part of retirement. Dan Ariely, founder of Duke University’s Center for Advanced Hindsight, has done research that indicates 130 percent of your pre-retirement income is a more realistic amount. He suggests thinking of the early stages of retirement as a time when every day is like a weekend day. Do you spend less on the weekend, or more? Remember, too, that these are the years when you actually can achieve what’s on your bucket list. A dream trip to Florence or the Andes is going to be most rewarding when you’re 65 and healthy.
So what happens later on?
The second phase of retirement, roughly stretching from ages 75 to 85, is known as the go-slow period. Retirees wind down their activities as advancing age and declining health start to catch up with them. During these years, many spend time with their families, while also downsizing their homes. But though travel and leisure costs decline, health-care costs start to go up. The third phase, the no-go years, starts around your mid-80s and lasts for the rest of your life. This is a largely sedentary period. Medical costs are often significant. Additionally, long-term care, which is not covered by Medicare, can take a huge bite from your savings, and most Americans will need some form of long-term care at some point in their lives.
Is there an easy way to estimate my costs throughout retirement?
Unfortunately, there’s no single rule of thumb. Many traditional models of retirement use an estimate—really, often a guess—about how much of your pre-retirement income you’ll need in retirement. Often these “replacement ratios,” based largely on studies of retirees in the 1980s, are pegged at 70 percent to 90 percent of your working income. But many experts now advise a more careful budgeting approach to figure out what you’ll actually need. One contemporary method is to look at the different phases of retirement as “age bands” and consider how the spending on each category—such as travel, health, taxes, or housing—changes as you age. Financial advisers also consider inflation in each category. While overall inflation has been low for years, some costs—notably, health care—have risen much faster.
I know how much I’ve saved. How much can I spend?
Many planners still stick to the “4 percent rule” when it comes to withdrawals, advising you to draw down no more than about 4 percent of your retirement savings annually. But this approach assumes a fairly consistent rate of return on your investments; that certainly didn’t hold in the 2008 financial crisis. However, being too conservative in your withdrawals might deprive you of the chance to achieve some of the things you’ve looked forward to for your go-go years. The calculations are also affected by your age at retirement, and whether you continue working part-time. A common strategy is gradually scaling down on work, downshifting from age 60 to 70 and putting off withdrawal. Once you hit 70½, you must take a Required Minimum Distribution (RMD) from your tax-deferred accounts [401(k)s and IRAs]; failing to do so will result in a huge tax penalty.
Are the calculations different for men and women?
Absolutely. The life expectancy for American women is almost five years longer than it is for men. But women not only get paid less than men, they also tend to spend fewer years in the workforce, with longer gaps in employment, often because of time spent raising kids. That presents some massive challenges: If a man needs to save 10 percent of his income for retirement, a woman would have to save 18 percent of hers to reach the same financial goal. And remember, she will probably need more money in her later years, because she’s likely to live longer. As a result, women not only have to be more aggressive in saving, but may also want to look into ways to plan for a guaranteed lifetime income, perhaps through an annuity, to insure against running out of money in their later years. ■