There are millions of articles, videos and podcasts out there covering topics related to saving and investing, yet very few that talk about spending.
I find this baffling considering we spend most of our life, well, spending money! Way more than we do saving and investing.
That's what I'm here to talk about today is: "How to safely spend more money in retirement." Stick around, let's get into it.
Welcome back to another video. I am your host as always Eric Presogna, CPA, CFP here to help you maximize your income, reduce your taxes and invest smarter.
So we're talking about spending today, a topic that doesn't get nearly enough attention as it deserves.
The financial media knows very well what sells and what doesn't. They know how to capture eyeballs and lockdown your attention.
"Save X dollars today, invest in this and in 30 years you'll be a millionaire!"
"This 12-year old started a side-hustle selling widgets from his tree house and now he's making 6-figures a week."
You get the idea.
Content like this is interested solely on the journey to creating wealth and completely disregards what to do when you arrive at the destination.
Look I get it, no one wants to read articles of how millionaires spend their money. They want to know how to get the million dollars, not how it's spent.
But learning how to spend your money is a valuable skill that if done right, can lead to a rich and fulfilling retirement.
The problem is most people spend their entire life focused on saving for tomorrow that when the future actually arrives, they don't know what to do with their money.
Even worse, they're afraid to spend in fear of running out of money.
Whether you've enjoyed a lucrative professional career or ran a successful company that's now left you with a substantial amount in the bank, you want to make the most of those dollars with the time you have left.
👉 Here are 5 ways to help you safely spend more money in retirement:
Shift to a "Spend" mindset
For starters, you have to be comfortable spending your savings.
This is much easier said than done as we're conditioned to be savers for most of our career.
It's not easy to flip the switch from being a diligent saver to super-spender as most investors have trouble parting with their hard-earned dollars when the paychecks stop coming in.
To make the transition easier, try and look at your financial life in stages.
Stage 1: Earning and accumulating wealth.
Stage 2: Distribution of wealth
Just like you're supposed to be earning and saving money in Stage 1, you have to give yourself permission to comfortably spend your savings in Stage 2.
It's a normal part of the distribution phase.
You have to be in the right mindset or else everything I discuss from here on in will be useless to you.
Quickly apply the 4% Rule
With the right mindset, you'll want to estimate what a comfortable spend might look like.
The retirement spending strategies I use for my clients go beyond multiplying their nest egg by a percentage (and we'll get into that later), however I always start with applying the 4% rule which states that a retiree can safely take 4% of her savings each year, adjusted for inflation.
For me, the 4% Rule is a good entry point in determining if the spend being considered is "reasonable" given the amount of savings.
To apply the 4% Rule, take your total portfolio value and multiply it by 4%, then add in social security income and see where you stand.
For example, a $2M portfolio and annual social security income of $40,000 would mean you could spend $120,000/yr.
Is that reasonable? How do you know?
If your annual salary was $200,000/yr and you paid 20% in taxes with another 20% going towards retirement, well, you're in the ballpark since the remaining 60% of your pay, or $120,000 was likely spent.
If, on the other hand your portfolio was $1M instead of $2M, then we know we're a little short in our calculation and need to make some adjustments.
Regardless of how the math comes out, quickly applying the 4% Rule to your retirement will get you started in determining what you can safely spend.
Develop a spending plan
To take your spending analysis a step further, take your projected annual spend amount and run what's called a "Monte Carlo analysis." This is a mathematical calculation designed to generate 1,000 different investment return scenarios based on your spend and overall financial situation to assess the likelihood of your money lasting in retirement.
Think of this as the 4% rule on steroids.
Now, this type of analysis is typically managed by a financial advisor but if you don't have one, or worse, if your current advisor hasn't run a retirement spend analysis for you, there are a variety of simplified tools available to you online.
When we run the Monte Carlo analysis for our clients, we go beyond simply increasing your annual spend by the rate of inflation which is the most common approach.
In addition to the inflation-adjusted spending approach, here are three other spending strategies to consider:
Spending Smile - Created by David Blanchett, the "spending smile" is similar to the inflation-adjusted approach except that it assumes general retirement expenses decline as you age while healthcare-related costs increase. Accordingly, the Spending Smile strategy adjusts your annual spend for inflation and subtracts 1% each year to account for the net effect of reduced living expenses and increasing healthcare costs.
Floor Ceiling - This strategy is designed to give you a bump up or down in pay based on how the market performs using pre-determined floor (15%) and ceiling (20%) percentages. For example, if your portfolio is up 12% in year 1, your spend is increased 12%. But if the portfolio is up 22%, your increased spend is capped at 20%. In year 2, your portfolio drops 8% and as such, your spend is adjusted down, but no more than the floor of 15%.
Ratcheting Rule - While I like the Floor Ceiling approach, the biggest drawback is the spending cuts. No one likes to see their pay reduced, right? Enter the Ratcheting Rule which simply states that you can increase your spend by 10% only when your portfolio is up 50% from the initial value. Downside is you have to wait until your $1M portfolio reaches $1.5M to take more money out, however, you don't have to worry about taking a pay cut, even when the market is down.
Fund your spending plan
Regardless of the spending plan you choose, you'll need to fund it with cash while being mindful of taxes.
But if you have a variety of savings and retirement accounts, some of which are taxable, tax-deferred and tax-free, it may not be easy to determine which account(s) to pull from and when.
Generally speaking, those retiring in their late 50's/early 60's will likely see their taxes go up later on in retirement when social security and RMDs kick in. As such, the traditional order of distributions to fund your retirement while minimizing taxes goes as follows:
Taxable account (brokerage)
Tax-deferred (IRA, 401(k))
Tax-free (Roth)
While this hierarchy of tax-efficient retirement withdrawals may work for some, the reality is that everyone's situation is different. For example, someone receiving deferred compensation or a temporary stream of annuity income early in retirement may see their taxes actually decrease in their later years and accordingly, may want to reshuffle their distribution order.
Point is that you'll want to fund your retirement spend as tax-efficiently as possible. If you need help, consider reaching out to a licensed CPA or tax professional for assistance.
(Note that HSAs are the wild card here as distributions can be tax-free if used to pay for (or reimburse you for) qualifying healthcare-related costs.
Review and monitor
One of the few constants in life is change.
There is no one strategy that works for everyone in all situations.
The spending plan that worked for you in your 60's may not be the most appropriate in your 70's.
Remember to consistently review and monitor your spending plan early and often in retirement.
When in doubt, seek professional help.
Thanks as always for watching our videos. If you're interested in staying up-to-date with our. market and financial commentary, please subscribe to our blog at oneupfinancial.com/blog or follow us on LinkedIn and Facebook.
Thanks again, and we'll see ya in the next one.
