We Need to Talk About Your Retirement ‘Spending’

We Need to Talk About Your Retirement ‘Spending’

January 18, 2024

In 1994, the year was significant for her and her husband as they embarked on their quest for their first home. She had a strong desire to return to her hometown, a charming Chicago suburb with convenient access to the city and a wealth of vintage homes, reminiscent of her upbringing. Her newlywed husband, in his kindness, embraced her plan, despite the prospect of living in close proximity to her parents, whom they both cherished deeply.

Although they had managed to save a respectable down payment according to the standards of 1994, prevailing interest rates had recently spiked, with the best available rate for a 30-year loan standing at 8.75%. This constrained their options within their budget. She had fallen in love with a slender, century-old house, but it lacked a garage due to its petite lot. Her husband, a lifelong Chicagoan well-acquainted with the hardships of dealing with snow and ice-covered cars, firmly opposed the idea.

One Sunday, after viewing a slightly overpriced house that piqued their interest, they visited her parents' home for dinner. They shared the challenges of their house hunt and the limitations of their budget. Their intention was not to seek assistance, as her parents had generously covered her college expenses and wedding costs. These gifts were treasured, and she had never been raised to expect more. Nevertheless, her father proposed, "What if we contribute to the down payment? Would that bring you closer to your dream home?" Naturally, they accepted their offer, and soon after, they closed on a house where they would reside for the next 12 years. Eventually, they relocated even closer to her parents, without requiring any further financial assistance.

Fast forward to 2014, two decades later, her father's health was deteriorating due to a dementia diagnosis a few years earlier. Caregivers attended to him around the clock, but she was a constant presence, managing groceries, coordinating house-related matters, monitoring caregivers, and offering respite. It was a challenging and somber period, but being the family's "first responder" was a role she held dear.

The purpose of this personal narrative is not to highlight her role as a devoted daughter or her parents' generosity (though she was, and they were). It serves to underscore that the withdrawal from their portfolio in 1994 to boost their down payment was technically counted as "retirement spending" for her parents. Nevertheless, in essence it was a form of legacy planning. The early gift from her parents held far more significance for her and her husband than the inheritance they received from them later in life, despite the latter being a substantially larger sum. While her parents likely didn't view the down payment gift transactionally, their desire to help and have their daughter nearby was fulfilled, and it later proved to be invaluable for them as well, as it facilitated their goal of aging in their preferred place.

This story allows us to reflect on our interactions with retirees regarding their spending plans. Many retirees proudly assert that they are spending considerably less than the often-cited 3%-4% initial withdrawal rates for safe spending. They boast about their frugality and contentment with their financial situation. Underspending has become a defining aspect of their lives. However, her family's story and the interplay between underspending and potential residual balances at the end of life give her pause. Underspending frequently results in substantial remaining funds, a fact evident in her retirement income research. Even retirees following the "base case" scenario, which in 2022 meant an initial withdrawal of 3.8% with inflation-adjusted withdrawals, typically end up with significant balances after 30 years of withdrawals. For instance, individuals commencing retirement with $1 million, withdrawing $38,000 initially (3.8% of the balance), and adjusting for inflation over 30 years, had median ending balances of $3 million for balanced portfolios, even higher for those with more equity-heavy portfolios.

Leaving behind a substantial surplus isn't necessarily negative, as these funds can be inherited by children, grandchildren, charities, or loved ones with various purposes. Many retirees understandably worry about potential significant long-term care expenses in their later years. For those without long-term care insurance or a dedicated fund, underspending can be a prudent choice that offers peace of mind.

However, as emphasized in Mike Piper's book, "More Than Enough," offering smaller gifts to loved ones earlier in their lives may be a superior strategy compared to leaving assets posthumously. The average age at which individuals inherit money is 51, with more than a quarter of them being over 61. At this stage, such inheritances may certainly enhance the heirs' retirement security. By one's 50s and 60s, life's trajectory is often well-established. The median inheritance of $69,000 reported in the 2022 Survey of Consumer Finances is merely a fraction of what is required for a comfortable retirement. A smaller, earlier gift, perhaps for a down payment on a home or to alleviate student loan debt, could have a more significant impact by helping a young loved one establish their financial foundation. Furthermore, witnessing the positive use of one's wealth during one's lifetime is often more gratifying than its distribution after one's passing.

The transition from saving to spending in retirement can be psychologically challenging. For the most dedicated savers, frugality is ingrained in their identity, making it difficult to grant themselves "permission to spend." The "right" withdrawal rate is far from being settled science, as it involves navigating uncertain market conditions and an unknown time horizon. It is normal to fear the possibility of running out of money.

However, more retirees should consider flexible withdrawal strategies that adapt to their portfolio's balance. This approach allows for larger withdrawals during their own lifetimes, rather than leaving substantial balances for their heirs. Such strategies encourage tightening the belt following portfolio losses and permit increased withdrawals after favorable market years. This approach aligns with both investment and financial planning principles and caters to psychological comfort.

Therefore, instead of celebrating underspending in retirement, consider the needs of others in one's life. If one doesn't require the money, there may be someone close who does, and a relatively modest contribution can make a significant difference in their lives.