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Your Bank > Education and Advice > CNB University

Don’t Shortchange your Retirement Standard of Living

James P. Terwilliger
James P. Terwilliger, PhD, CFP® is Senior Vice President - Group Manager, Financial Planning Strategies and can be reached at JTerwilliger@CNBank.com or (585) 419-0670 x50630.

The rules really do change when transitioning into retirement.

An abrupt switch from accumulating assets to consuming assets, particularly when drawing part of your monthly “retirement paycheck” from your investment and retirement accounts, can be a frightening experience.

No longer is there a steady paycheck from an employer. Now a combination of Social Security, employer pension (for a few folks lucky enough to have a traditional pension), monthly annuity payments, and distributions from savings, IRA, and 401(k) accounts replaces that steady paycheck.

The guidance we give clients who are still working toward retirement is “live below your means”. Put money aside monthly toward building an emergency cash reserve, toward your children’s college fund, and toward retirement. Give to charity. Learn to live on the remainder.

Living below your means helps maintain financial flexibility and prevents the stress caused by living paycheck to paycheck.

Above all, it brings peace of mind.

Unfortunately, we often find that clients bring that several-decades-long practice into retirement and, as a result, under spend and shortchange the retirement standard of living they have worked so long to achieve.

The practice of saving money is a hard one to break. But, frankly, continued saving in retirement generally is not only unnecessary but can erode retirement quality of life.

According to Rick Kahler, CFP® and author, the problems start when the wise scrimping and saving of the earning years continue long past the time when it is necessary. Frugality can turn into under-consumption.

A combination, then, of being frugal coupled with a fear of running out of money results in standard of living that is less than what otherwise could be realized.

This is not to imply that retirees do not need to manage their spending. Not at all.

In fact, retirees on the other side of the coin – those who lived above their means during their working years and did not save adequately for retirement – may find themselves in trouble with a too-small nest egg, lifelong excessive spending habits, and a high probability that they will indeed run out of money.

But those who were frugal and saved adequately should expect to enjoy a standard of living in retirement similar to what they experienced during their working years.

We have often talked about the “4% rule” in retirement when drawing out of accumulated assets to supplement the “retirement paycheck”. That is, when a retiree, individual or couple, starts to draw down assets, it is prudent to set the initial withdrawal rate at no higher than 4%-5% of the market value of the combined investment and retirement assets. Then in future years, one should feel free to increase the dollar withdrawal rate by inflation in order to maintain a constant withdrawal spending power.

For this to work, it is critical that the total investment portfolio be 1) broadly and globally diversified, and 2) balanced. The latter means that the ratio of stocks (or stock funds) to bonds (or bond funds) is in the 50/50 to 60/40 range. Studies of past 30-40-year periods of market returns have demonstrated that retirees following such a withdrawal strategy from this type of portfolio will most likely not outlive their money.

Risk-adverse investors, on the other hand, who invest primarily in cash and bond instruments will mostly likely run out of money with initial withdrawal rates in the 4%-5% range. Maintaining exposure to a broadly-diversified array of stocks is key to staying ahead of inflation and preserving needed assets.

There is no free lunch here. In order to achieve this degree of withdrawal, a well-planned and executed investment strategy is imperative.

Let’s look at an example of what the following couple might expect in terms of gross retirement household income in today’s dollars:

  • Combined savings, investment, IRA, and 401(k) assets of $800,000 
  • Small company pension of $12,000/year 
  • Combined Social Security retirement benefits of $45,000/year

Assuming an investment strategy as described above, a relatively-safe initial-year total income to the household of about $95,000 should be quite do-able. In subsequent years, the initial withdrawal of $38,000 from the nest egg can be increased with inflation. Social Security benefits will also enjoy a cost-of-living increase, at least in most years.

Finding that right balance in retirement is not easy, given the difficulty in making the accumulation-to-consumption switch. Working with a trusted financial advisor to help you manage the transition is critically important to a happy retirement.

This material is provided for general information purposes only and is not a recommendation or solicitation to buy or sell any particular security, product or service. Past performance is not indicative of future investment results. Any investment involves potential risk, including potential loss of capital. Before making any investment decision, please consult your legal, tax and financial advisors. Non-deposit investment products are not bank deposits and are not insured or guaranteed by Canandaigua National Bank & Trust, or any federal or state government or agency and are subject to investment risks, including possible loss of principal amount invested.

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