Thursday, February 7, 2013

Betwixt and Between

I have received the last paycheck from my employer of the last 27 years. It will be something like two months before I can expect to receive the first check from my pension. My wife has applied for Social Security but it will be about two months before she gets her first check. Of course I knew this was coming. I have spent the last 12 years preparing for this day. Still, while it is exciting to be free, it is a little unnerving to be facing a lot of ill defined expenses without a regular pay check.

I need to make some known and unknown repairs to the house before I put it up for sale. Most should be small, but I think I will need to replace the air conditioner. That will not be cheap. Of course there will be the cosmetic work, carpet and paint. That is expected. I will be buying a house in another city. Then there will be the expense of moving. When the dust settles, I should be showing a profit, but a lot of cash could be flowing out over the next few months without any guaranteed return.

Once the move is complete I will be officially, at least in my mind, finally retired. Right now between planning the move, taxes, and my mother in law’s estate I still feel like I have a job. Once I am “really” retired I will need to live on a budget. A normal budget, such as taught in financial literacy courses will not quite work in retirement. It will be time to enjoy all that money I have so carefully saved and invested. Most retirees will spend more than they earn over the 20 or 30 or more years the Lord sees fit to give them. Farrell Dolan, a principal at Dolan Associates, David Blanchett, the director of retirement research at Morningstar Investment Management, and John Olsen, the president Olsen Financial Group have proposed a four box solution to the question of a retirement budget.

Box one contains the essentials of life. That would include food, clothing, house, utilities, transportation, medical care, and taxes.

Box two would consist of discretionary expenses such as entertainment, travel, and hobbies.

Box three would consist of guaranteed income; defined benefit pensions, annuities, and Social Security. This box is getting pretty small for most Americans.

Box four would consist of 401-K accounts and their tax favored kin as well as any investments held in taxable accounts. I would also add the value of your home to this box. It is likely that the time will come when one or both partners in a marriage are no longer capable of living in their own home. Then that money can be used to support the cost of assisted living.

Dolan et al. propose funding box one expenses with box three money; then funding box two with box four money. This sounds like a pretty good idea if you have a sufficiently large amount of money in box three. If an individual only has Social Security in box three that may not be sufficient to cover all the expenses found in box one. Then some of the money from box four will need to flow into box one expenses.

Let’s assume that you have enough in box three to fully fund box one. There is the simple 4% rule for withdraw from savings during retirement. For new readers that means if you draw 4% or less from your retirement cache per year there is a better than 90% chance you will not outlive your money. There are really four sides to this problem. If I expect to live only 5 years after I retire, my lifestyle would be radically different than if I expected to live another 30 years. If you are alive and kicking at 62 the Social Security actuarial tables gives you another 19.40 years above ground. At 66, full retirement age that number drops to 16.48. It isn’t just that simple. Besides longevity risk there is quality of life risk. Is it better to take that cruise of the Eastern Mediterranean and visit the Aegean Islands while I can still easily walk 3 miles without a cane and have at least most of cognitive abilities intact or should I save that money for a nursing home I may or may not ever reach?

Before retirement the purpose of a budget was to increase your net worth. It seems that in retirement the purpose of a budget is to responsibility spend that hard earned money in a manner that will make all that effort worthwhile and at the same time living responsibly, so that you will never become a burden to others.

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