- Go-go:
Like each of these phases, this one is just as it sounds. You’re free! Free to travel. Free to enjoy a latte at the local coffee shop rather than gulping down the searing hot Keurig as you race out the door. Free to spend!
While many people, some planners included, would have you believe that you will spend about 75% of your pre-retirement expenses in retirement, the reality according to research from JP Morgan and others is that spending tends to go higher in the first phase of retirement than it was before you retired. Because of this, the biggest risk is that the market and your accounts nosedive as you are making your largest withdrawals.
Sequence risk is the risk of a bear market either right before or right after retirement. The ten years surrounding your retirement date have an outsized impact on your retirement success, i.e., whether or not you run out of money. There are a number of ways we address this for clients. From a very high level, those accounts that will be tapped early in retirement should be more conservative as you approach your new chapter. Many people attempt this by using target-date funds, which automatically adjust your 401(k) to be more conservative as you approach retirement. While this makes sense on the surface, the 401(k) is often not the account you tap first and ends up being too conservative for those who live a long life. Additionally, research from Michael Kitces and Wade Pfau suggests that some retirees may benefit from increasing their market exposure or equity allocation once they move past the first phase of retirement.
- Slow-go:
You’ve been to Australia and Antarctica. You think the passport stamps are mostly behind you. As you slow down, so does your spending. You had good advice during your first retirement chapter and have spent down your conservative bucket of money. More on the intention behind this later. You claimed Social Security five years ago and RMDs started, too. While you feel comfortable, the last few Aprils have come with unpleasant news from the CPA: You need to write a big check to the U.S. Treasury.
If you haven’t already gotten there, taxes are one of the biggest threats in this chapter. The income streams you live on and that were mentioned earlier come with a higher effective tax rate and are not easy to reduce. The key here is to address this during the go-go phase, when your taxes are often lower than they will be for the rest of retirement. You want to take advantage of this tax sale just as you would when you go to the grocery store and eggs are on sale. JK eggs are never on sale. Just as you would when Cheerios are on sale. We often do Roth conversions and recognize capital gains at much lower rates during this period.
Inflation can also rear its ugly head here if you have moved your investments or allowed your target-date fund to move your investments into something too conservative. As we’ve seen since 2022, inflation can quickly erode purchasing power. There are very few things more frustrating that paying twice as much for the same thing. The only silver lining is that historically stock market returns have outpaced inflation over longer periods.
- No-go:
The passport stamps are definitely done. In fact, the passport is expired and may or may not be lost. The big spending here comes for two seemingly at-odd reasons. In the first, you get sick and must pay for care. In the second, you don’t get very sick, don’t have to pay for care, but also don’t die. Both are hard to plan for, and both are expensive. This is why expenses often spike in the third and final phase of retirement.
As with tax planning, the best way to plan for a long-term healthcare expense is to act years before you have the problem. Long-term care insurance is expensive but is typically most affordable when purchased in your late 50s. The landscape in the long-term care insurance world has changed dramatically in the last fifteen years, but if you’re already sick, it’s probably too late. In that case, you may want to carve out the funds you may need and invest them based on when you think you may need them.
Longevity risk sounds weird to say. I think most people would view dying as the risk and living as the goal, but the risk of living is that you continue to have to pay for life. Let’s say you’re spending $10,000 per month and live five years longer than you expected. That’s $600,000 more you have to come up with.
The best hedges for longevity expenses are a proper financial plan that stress-tests this scenario and an investment portfolio with enough equity exposure to protect you from it. As I mentioned earlier, research suggests that your stock exposure should go up after you get through that retirement red zone, but convincing someone in their 80s to go on a roller coaster can be even tougher than it sounds. One way we achieve this with clients is by spending the conservative bucket of money in the first ten years of retirement. As you spend down that bucket, your equity allocation will drift up.
I once saw a very well-known and well-regarded financial planner say from a stage that retirement success is binary: You either run out of money, or you don’t. While it’s hard to argue that you will either outlive your money or it will outlive you, retirement success and retirement happiness are measured on a spectrum. I can say with confidence that the fact that you have a plan gives you the confidence to sleep at night. The confidence to say yes to that trip. The confidence to be able to help your kids out in a pinch. Those are the things that move you toward “retirement success.”
This article is provided for informational and educational purposes only and should not be construed as investment, tax, or legal advice, or as a recommendation regarding any particular strategy. Whether a Roth conversion is appropriate depends on an individual’s financial circumstances, tax situation, investment objectives, and applicable law. Tax laws are subject to change and their application may vary. Examples discussed are hypothetical and are intended solely to illustrate general planning concepts. They do not reflect the experience of any specific client or guarantee future results. Consult your financial, tax, and legal advisors before implementing any strategy.