Shifting Gears into “De-saving” Mode

During our working years, we try to consistently save money and grow our net worth. This nest egg funds emergency spending, other big purchases along the way such as homes, weddings, and educations, and our retirement.

When we retire, we must make a mental shift as we start to spend down our savings and watch our net worth shrink over time. This “de-saving” can be a difficult adjustment as we understandably fear running out of money before we run out of time.

It’s challenging for several reasons. We don’t know:

  1. when we’ll expire
  2. the uninsured medical and nursing care we may require in the future
  3. future investment returns
  4. how to determine a safe spending level and track our financial health over time, even if we knew answers to 1, 2, and 3

What is the resolution to this quandary? There is no perfect one, but there are steps you can take to limit the financial risks you face.

1. Know your after-tax income.

Include all your remaining income sources — Social Security, pension, annuity, part-time work, etc. — and understand if they’re going to change over time and if they’re inflation-adjusted.

2. Track your actual spending.

Determine your current spending and review it monthly. Have a sense of how it divides into mandatory versus discretionary spending so you know how much leeway you may have. To start, make it easy by just focusing on your total spending and ignore all the different categories.

3. Know your net worth.

Ignore your home (you need a place to live) and reduce the value of pre-tax retirement accounts (IRAs and 401Ks) by the amount of future taxes you’ll owe. The nominal value of these accounts overstates what’s really yours as part of that account balance is the government’s money and you’re just temporarily holding it for them. Track this “after-tax” net worth over time.

4. Be realistic about your life expectancy.

For example, if you’re a healthy married couple at age 70, there’s a high likelihood that at least one of you will still be around in your 90s.

5. Set a monthly spending target.

Use your life expectancy, income and net worth to determine your target spending level. The challenge is to neither under- nor over-spend, especially in the early years of retirement when your health is at its best. Easy to say but hard to do. There are different approaches and it may be worth engaging a financial planner who can help with this analysis.

6. Re-assess your net worth and spending over time.

Ensure your net worth is tracking to where you believe it should be as your age and circumstances change. If not, re-set your spending target (up or down) to get back on-track.

7. Optimize your investment strategy.

You can’t control future returns, but you can ensure your investments are well-diversified, incur minimal fees, are tax-savvy, and have an asset allocation appropriate for your circumstances.

8. Consider annuitizing part of your savings.

There’s no right amount for all circumstances, but one approach is to ensure you have guaranteed income to cover the mandatory portion of your spending (see #2 above). That is, purchase a lifetime annuity to cover the shortfall from Social Security and any other guaranteed income you may have to fund that spending.

This is easier said than done as annuities can be confusing and everyone is in favor of them until they discover that you have to give up a significant amount of savings to purchase them. However, this “longevity insurance” can be valuable if you’re lucky enough to live a long life (see #4 above).

9. Lastly, prepare yourself psychologically.

Adjust your mindset to understand that you’re now shifting gears into the de-saving phase of your life and it’s OK to begin to spend down your net worth. If your spending and net worth remain on target, then focus on trying to stay forever young.

Questions?  Get in touch

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