My 10 word definition of retirement
Quick note: This past week I’ve been up in Sequim, Washington visiting family and enjoying the great outdoors. Today we meet up with some friends and drive south toward California where we’re going to be hiking and camping along a rugged section of coastline called The Lost Coast. Cell reception will be spotty, but I’ll try to post some pics and videos to our Facebook page and (newly created) Instagram page. Tune in if you want to see some beautiful scenery or are just interested to see if I get eaten by a bear. Now on to today’s post.
The traditional definition of retirement contains 4 key elements:
- Age (65+)
- Work status (not working)
- Money (you need millions)
- Idealized pursuits (take those millions and buy a vineyard)
Not surprisingly, I’m not a huge fan of that definition. Among other problems, it puts you on the deferred life plan. You push your dreams off until “Someday” rather than living life to the full now. Not only that, but it doesn’t give you much time. If you retire at 65 and stay healthy and active until 75 (a stretch for many) then you’ve got 10 years to do everything you’ve been putting off for the last 40. Ten years is not enough.
Seneca did a good job pointing out these shortcomings over 2,000 years ago:
You will hear many men saying: “After my fiftieth year I shall retire into leisure, my sixtieth year shall release me from public duties.” Are you not ashamed to reserve for yourself only the remnant of life? How late it is to begin to live just when we must cease to live!
A better definition
My definition takes a different approach and attempts to deal with the problems I mentioned earlier. It has evolved over the years and will likely continue to do so as I live, learn, test and refine. Here’s my 10 word definition of retirement:
A system for living that optimizes for freedom and fulfillment.
Let’s unpack that for a minute:
It’s a system… I mean two things by this. First, it’s a system in the sense that it’s a set of connected parts forming a complex whole. Retirement has a ton of moving parts that need to work together to produce the results that you want. Those parts include things like money, relationships, pursuits, Social Security, Medicare, health, housing and insurance to name a few. Those parts work together in a complex system. If the parts work, the system works. If one or more parts isn’t functioning properly, the system breaks down.
Second, retirement is a system in the sense that it involves a set of principles or procedures for doing something. Your retirement should involve actions that you do on a regular basis with a reasonable expectation that doing them will get you closer to the life you want. Read this for more.
For living… There are no qualifiers here. It’s not a system for living once you hit 65 or have a certain amount of money in the bank. It’s a system for living now. Today. Retirement is not a life stage that you automatically arrive at after a certain number of birthdays. It’s an iterative process that starts today and evolves as you proactively work to gain more control of your time and then use that time in very intentional ways. Read thisfor more.
That optimizes… Your system should be optimized to produce the results you want. Otherwise it’s a bad system. It should move you efficiently and effectively toward the life you want. Fortunately, optimization is a natural byproduct of the iterative process described earlier. Rather than waiting until “retirement age” to figure out what you really want out of life (and wasting some of your best remaining years in the process), you’re testing and refining now.
For freedom… You can have all the plans in the world, but if you don’t have the time and money to get your dreams off the drawing board, then what’s the point? So yes, money is an important ingredient to a successful retirement to the extent that you use it to buy your freedom. Just remember that your goal isn’t to have more money for money’s sake. Your goal is to have a better life. Ralph Waldo Emerson said it well: “The desire of gold is not for gold. It is for the means of freedom and benefit.”
And Fulfillment… Retirement is more than a math problem. Yes, you need money (as we just discussed), but don’t forget about meaning. Money will help you sleep at night but meaning will get you out of bed in the morning. You need both to have a fulfilling life doing the things you want with the people you love. So decide what you really want out of life and then get very intentional about making that vision a reality.
How about you? I’d love to hear how you define retirement. Feel free to share in the comments. Have a great weekend!
Be Intentional,
Joe
The best tool for retirement health expenses
There is a lot of uncertainty with healthcare lately, but two trends will likely continue: It will continue to get more expensive and you will continue to be responsible for more and more of the costs. Even with Medicare, it is estimated that the typical retiree will need between $200,000 and $400,000 to pay for health expenses during retirement. With that in mind you should seriously consider using a Health Savings Account (HSA) to help fund your retirement health expenses. You might be using one now, but if you’re like most, you’re not using it to its full potential. Let’s change that.
What is an HSA?
An HSA is a tax advantaged medical savings account available to people enrolled in high deductible health plans. Think of it as an IRA for your medical expenses. Unlike IRAs, however, HSA money is triple tax free: going in, as it grows and coming out. That is a huge advantage. The only caveat is that you need to spend the money on qualified health expenses or you’ll pay taxes and a penalty. The list of qualified expenses is rather long and even includes things like long-term care insurance premiums. Here are a few quick facts on HSAs:
- Contributions are tax deductible.
- The assets in the account grow tax free.
- Withdrawals for qualified medical expenses are tax free.
- If you take the money out for non-qualified expenses, you will pay taxes and a 20% penalty.
- Unlike FSAs, HSA dollars are not “use it or lose it.”
- Contributions can be made by either you or your employer.
- 2017 annual contribution limits are $3,400 for an individual and $6,750 for a family.
- Those over age 55 can make an additional $1,000 catch-up contribution each year.
- Money in the HSA can be invested in stocks, bonds and mutual funds.
A few things change at age 65…
- Distributions after age 65 are never subject to a penalty, even if not spent on qualified medical expenses. For non-qualified expenses just pay the taxes and use the money for whatever you want.
- At 65 you can pay for all Medicare premiums except Medigap with tax free HSA distributions.
- Once you enroll in Medicare, you can no longer make contributions to an HSA, but you can continue to use the existing money in your HSA.
Your best strategy
HSAs are growing in popularity, but they are not being used to their full potential. Because of the HSA triple tax advantage (in, out and during), the money should be invested for growth and allowed to compound as long as possible. Instead, here’s how most people use their HSA: 1) Add some money, 2) Leave the money in a no risk/no return money market, 3) Use the money as soon as they incur a medical expense.
Here’s how you should use your HSA: 1) Contribute the maximum amount allowed each year, 2) Invest the money in stocks, bonds and/or mutual funds, 3) If possible, pay for your current medical expenses out of pocket and allow your HSA money to grow until you retire. By doing that you are getting the most bang for your buck and creating a pot of money for retirement that can be used tax free for medical expenses or for anything else as long as you pay the tax.
~ Joe
You will probably retire sooner than you think
Hi all. Life got busy and Part 3 of my series on simplifying your life and executing on the things that are most important to you is taking a bit longer than expected. I know. Ironic isn’t it? Anyway, that post will be up soon. Meanwhile I wanted to give you a few quick thoughts on some recent research related to when we expect to retire vs. when we actually retire.
Expectations
When do you plan to retire? If you said mid to late 60s, you have a lot of company. Most people plan on working until then. Here are the specifics. According to the latest iteration of the EBRI Retirement Confidence Survey, 75% of people said they expect to work until at least age 65. A full 38% expect to work to age 70 and beyond. When asked why, some gave lifestyle reasons and some gave financial reasons. In other words, for some it’s a choice. They don’t need the money, but they enjoy the challenge, engagement and structure that work provides. For others it’s a necessity. They need the money. The paycheck (and in many cases the healthcare) they earn from working longer is an integral part of their retirement funding strategy.
Reality
Do those expectations match up with reality? In a word, no. In addition to tracking when people expect to retire, the EBRI study also tracks when they actually retire. And as you may have guessed by now, most people retire much sooner than expected. The study found that 76% of people retire before age 65 with the median retirement age at 62. Almost 40% retire before age 60 (vs. 9% expected) and a scant 4% work to age 70 and beyond (vs. 38% expected). When asked why, some said they decided they didn’t really want to work after all. Others had a health issue or were the victim of downsizing and were forced to quit sooner than expected.
Regardless of the reasons, when expectations and reality are so far off, it causes problems. It reminds me of something Mark Twain once said: “It ain’t what you don’t know that gets you into trouble. It’s what you know that just ain’t so.”
What if you retire earlier than expected? You’ll need to figure out how to bridge the healthcare gap until you’re eligible for Medicare. You may need to claim Social Security early and take a permanent reduction in benefits. You will need to fund your lifestyle for several years more than expected. You’ll need to find other ways to fill your time, find purpose and get social interaction than heading to the office. Those are some serious issues. So as you plan for retirement, outline what you want and what you expect, but always be asking “What if it doesn’t work out that way?” Have a contingency plan. Be ready to pivot or call an audible if necessary. Then if expectations and reality diverge, you’ll be able to adjust and keep your plans on track.
Have a great week! As I mentioned earlier, Part 3 will be on the way soon. Also, we’re heading to Iceland in a few weeks to do some exploring, so I’ll probably write a post on that that includes some stories as well as some of the tools, tricks and strategies I use for planning trips. Until then, stay intentional and touch base if there’s ever anything I can do to help you.
How spending changes throughout retirement
When planning for retirement, you need to make a lot of assumptions. How long will you live? What will your investment returns be? How much income will you need? When it comes to that last one, most people just estimate their first year of retirement expenses and then adjust that amount higher each year to account for inflation. This seems like a logical strategy. It’s predictable. It provides a steady income. It gives you a raise each year to account for rising costs. There’s just one potential problem. New research shows it’s not how the typical person spends money in retirement.
New spending research
David Blanchett, Michael Finke and other academics have studied how spending changes throughout retirement and what they found might surprise you. Rather than starting at a certain amount and then moving higher with inflation, people spend more in their early years and then gradually decrease spending as they get older. This trend typically continues until later in life at which point healthcare costs cause spending to rise again.
Why is this important? First, your retirement plan is driven by assumptions and perhaps the most important assumption of all is how much you need to spend each year in retirement. If you have that number wrong, your plan won’t be as accurate as it could be.
Second, most people, planners and software assume a static rate of spending in retirement that needs to increase every year with inflation. If that’s not correct—and real spending gradually decreases instead—then we’re overstating the cost of retirement. That means you might be able to retire sooner, retire with less or take a higher distribution rate. Here’s an example to show you what I mean.
In his research, Blanchett found that a household that needed $50,000 in income at age 65 would decrease real spending by about 15% by age 80 and 20% by age 85. Let’s assume you retire needing $50,000 in income and you plan on getting half of that from Social Security and half from portfolio withdrawals. Even if your spending goes down, your Social Security won’t, so any spending reductions can be used to reduce portfolio withdrawals. So if you want to decrease total spending by 20%, then you can decrease your withdrawals by 40%. That means less strain on your portfolio which, as mentioned earlier, means you might be able to retire sooner than expected, retire with less, or spend a bit more early in retirement when you’re healthy and active, knowing that you’ll decrease spending later.
Applications
There are some important ways that you can incorporate this new spending research into your planning.
Make a Core/Discretionary budget: Not all spending changes equally during retirement. Certain core spending on things like food and housing will be with you throughout retirement and are more likely to increase with inflation. It is your discretionary spending—such as travel and entertainment—that will likely decrease as you move through retirement. To better predict how your spending will change, make a budget that itemizes core spending (e.g. grocery money) and discretionary spending (e.g. travel or a new car).
Shrink core expenses: Once you know how your spending breaks down, get rid of as much core spending as possible before entering retirement. Housing is the largest retiree expense and more and more people are retiring with mortgage debt. This is especially easy to justify in a low rate environment. But the downside of servicing a mortgage in retirement is that you’re not servicing it from your paycheck, you’re servicing it from your investment portfolio. If your portfolio drops, you still need to pay your mortgage. That means selling into weakness and increasing your odds of running out of money. Core spending is riskier because there’s little flexibility. Discretionary spending, however, tends to decrease as you move through retirement and you can adjust it if necessary (e.g. postpone your vacation if the market drops).
Rethink your distribution rate: In Blanchett’s research, he found that a 4% initial withdrawal rate over 30 years under the constant spending model has the same approximate probability of success as a 5% initial withdrawal rate if spending changes as discussed earlier (assuming $50,000 in initial spending). If you can take 5% instead of 4%, then you would need 20% fewer assets when you retire. For example, a 4% withdrawal from a $1,000,000 portfolio gives you the same dollar amount as a 5% withdrawal from an $800,000 portfolio.
Stay healthy: Obviously you can’t prevent all illness, but do everything you can to be healthy. This will improve your odds of a long, active retirement and can delay or even eliminate some of the health costs that cause spending to rise later in retirement.
Insure against rising costs: You might be asking, “Why do health costs rise later in retirement? Doesn’t Medicare cover those expenses?” Medicare covers a lot of things, but with very few exceptions, long-term care—where you need help caring for yourself—is not one of them.
What are the chances you’ll need this type of care? Seventy percent of the people who reach age 65 eventually require some form of long-term care. Those are good odds. It reminds me of the time I picked up a rental car in Dublin. I found out the car was a stick, the steering wheel was on the right, you drive on the left, and the place we were going only had single lane roads. The guy behind the counter asked <insert Irish accent> “Are ya gonna be wantin’ the insurance today then?” “Yeah,” I said. “Better give me everything you got. There’s a good chance you won’t be seeing that car again.” The lesson? Insure against bad things that are likely to happen.
Enjoy life: There’s a good reminder embedded in the research we’ve been discussing. If spending decreases as you move through retirement, then for whatever reason, the typical retiree is doing less—either by choice or necessity—at 75 than at 65 or at 85 than at 75. If you retire at 65 and stay healthy and active until 75, then you’ve got 10 years to do everything you’ve been putting off for the last 40. That’s not much time. Be ready to hit the ground running when you retire. Yes, that means the early part of your retirement will be a little more expensive, but if incorporate this new spending research into your plan with the help of a competent adviser and the results hold up, then you should be in good shape.
~ Joe