Experts Weigh In On Solving Retirement

There were a couple of very interesting retirement articles posted last week that are worth pointing out. The first on was from the LA Times and focused on research and comments on the research from Alicia Munnell from the Boston College Center for Retirement Research which, cutting to the chase, concludes most people will not have the retirement they hope for in financial terms.

She says the collectively we only have three options; being poor, saving more (which means spend less) or work longer. The most interesting point she made seemed to be that the Social Security replacement rate, the portion of expenses that SS will cover is going down. She also addressed the transition from defined benefit plans to defined contribution plans and the shortcomings of 401ks. She then made an argument for increased taxes to beef up Social Security’s solvency.

The other article was from MarketWatch and recapped different schools of thought from experts convened by MarketWatch for a conference they hosted on retirement planning.

Most interesting here was an idea put forward by Wade Pfau which was to think about being over funded or underfunded like a pension plan and he offered a couple of different ways to try to answer that question (over funded versus underfunded).

One idea that he offered was that if you can put half your assets into an immediate pay annuity and have the payout cover your expenses then you are over funded, if not then you are underfunded. For anyone new, I am not an annuity guy, I’ve never been paid for an annuity and most of the time they are very expensive. I would note that some of them are not crazy expensive and one thing I have said many other times before the people that I have known who have annuities seem to love them.

It is an easy way to benchmark where you stand regardless of whether you ever buy an annuity. The article had a generic quote that $500,000 into an immediate annuity would pay about $31,000 annually. That is an easy way do a high level check of where you stand assuming you think Pfau knows what he is talking about (I believe he does).

A CFP named Joe Tomlinson was cited for what he calls the Gap Method which simply compares income from ‘guaranteed’ sources like Social Security to expected expenses and if there is gap, then the gap needs to be filled by investments/savings, working in some capacity or downsizing. The concept is not new of course but the term Gap Method succinctly describes it.

The benefits of thinking about how to solve the financial aspects of the retirement dilemma is that it helps reduce it into more digestible parts. You need $5000 a month in today’s dollars (just an example) for retirement so the 4% rule says you need $1.5 million. A $5000 need seems like a middle class lifestyle but $1.5 million may not seem so middle class. Combined Social Security might be in the range of $3000 so investments/savings, working in some capacity only needs to cover $2000 or in portfolio terms is $500,000 which may not be easy but is reasonably attainable.

This all circles back to a lot of the things we’ve been writing about for many years. Anecdotally I’ve known plenty of people who had little to nothing accumulated yet made it work and obviously you’ve known people who’ve made it work too. The $2000 gap above (again it’s just an example) can at least be partially made up through some sort of monetized hobby or other part time, low (stress) impact job.

Five years of filling the gap with your monetized hobby before tapping into your portfolio could let the equity portion of the portfolio double. You’d have to be very lucky to hit a five year window where the market doubles but this is far from unprecedented and in a more realistic scenario the equity portion could grow by 20-25% untapped, so the $500,000 above becomes $560,000-$575,000 (assumes a 60/40 mix and negligible growth in the fixed income portion) and will need to generate income for five years less than originally planned for.

The articles linked above tie in with these concepts and they will become increasingly more relevant as the issues Munnell cites come to impact more people.

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