Wednesday, April 10, 2013

Defense in Depth (Budgeting in Retirement)

In “Betwixt and Between” I began to explore the concept of budgeting in retirement, as the normal preretirement budgeting process no longer makes any sense to me. Before retirement, income is balanced against outflow (projected expenses, savings, and giving) until the two numbers sum to zero. This is just basic bookkeeping. We undertake this discipline to build our wealth, so that we can retire with dignity. In retirement there is no longer a regular (or even an irregular) paycheck. In retirement the purpose of a budget is to responsibly spend our hard earned money in a manner that will make all that effort worthwhile.

Betwixt and Between

In researching this problem, I discovered Farrell Dolan’s concept of different boxes for different kinds of money and different kinds of expenses. Since then I have read a book that contains some of the same ideas. I have too many problems with that book to recommend it, but I think in this particular case both authors are headed in the right direction.

I concur with Larry Burkett, the godfather of Christian personal finance authors. He stated that if you haven’t paid off your mortgage, you have no retirement plan. Don’t carry debt into retirement. It is a recipe for disaster. The only exception to this rule might be someone with a truly golden pension or parachute and only a few years left on a 3.5% mortgage. Even then debt in retirement worries me. Go ahead, pay it off.

There is a hierarchy of resources in retirement. There is also a hierarchy of expenses. These items require different treatment. The best analogy I have at the moment is defense in depth, a military concept. Rather than committing all your assets to stop an enemy at a single line of defense, say a border, different kinds of assets are positioned in a manner that trades space for time and enemy casualties. The use of multiple, over lapping, redundant layers of protection are more effective than any single barrier, no matter how strong.

The first category of money contains your renewable resources. These are the checks, however small, that come in on a regular basis such as pensions, social security, and annuities. Ideally, these assets should be balanced in a conventional manner against necessities including rent or property taxes, health and other kinds of insurance, utilities, groceries, transportation, and clothing. Allow a line under food for restaurants. Although I no longer eat lunch at the cafeteria, it is unlikely that I will completely give up the convenience and pleasure of eating out.

The second category of money is cash. This would include your little stash of twenty dollar bills hidden in a drawer somewhere in your house, checking accounts, money market funds, and plastic money. If you use a credit card, pay it off every month. If you ever carry a balance on a credit card, lock it up until you have paid it off. If you use a debit card make certain that you turn off the so called overdraft protection feature. U.S. banks collect $31.5 Billion a year in overdraft fees. You don’t need to accidently pay $35.00 for a cup of coffee because you made a mistake balancing your checkbook.

The purpose of cash is paying for irregular and somewhat unpredictable expenses in the foreseeable future, say a year. These expenses can be considerable. Over the next five or six months, I will buy a new house in a different city. I will pay someone to move one pile of stuff from where I live to my new home. I will also pay to move a pile of my mother in law’s stuff from a storage unit in a third city to my new home. Before I can sell my existing home, I will need to do all those cosmetic things like paint, install new carpet, replace a badly stained toilet, and possibly buy a new air conditioner. I need to have the cash ready and available when the time comes to pull the trigger. Someday, when I am living near a city that is warmer and cheaper than Washington, DC I hope I will be using some of this money to take a Mediterranean cruise.

The next line of defense, now the source of my cash, are investments held in taxable accounts. These include bond funds, stock funds, and individual assets. In an ideal world these investments would generate enough income to pay for the country club, the cruises, classes, and our other dreams. Unfortunately we do not live in that world. Although preservation and income rather than growth are the paramount issues, I still hope my assets continue to increase over time.

The next line of defense is tax favored accounts. This would include 401-K accounts, IRAs, and Roth IRAs. Leave that money alone for as long as possible. Continue to let it grow tax free until you really need it.

Your final line of defense is the equity in your home. Someday, barring an unexpected death, you will be old enough that you are no longer able to maintain a home. When that day arrives, or when your other funds are growing low, it is time to sell your home and move into an apartment or a retirement facility.

I have worn myself out studying safe withdrawal rates. Nothing is perfectly safe in this imperfect world, but all the evidence seems to point back to the 4% rule. I have written a large number of posts exploring this and other options. Basically it comes down to this. If you withdrawal an amount equal to or less than 4% of your investment total when you first retire every year during retirement, there is a high probability that you will not outlive your money.

A Few Additional Considerations:

4% Rule Assumptions:

Most withdrawal simulations assume a well diversified 50% stock 50% bond portfolio or a 60% stock 40% bond portfolio. Some more conservative researchers recommend a 3% draw; the more optimistic allow for a 5% draw; still others allow a certain amount flexibility based on market conditions and age.

Annuitizing your 401K:

If you find that your total renewable resources are just too low to meet your basic needs, explore any options your company might offer for annuitizing your 401K account. Although I do not generally recommend retail annuities due to the very high fees associated with these instruments, my former employer offers a pretty good deal that would allow me to convert my tax favored retirement account into a guaranteed lifetime income stream.

The Emergency Fund:

I have decided to leave my official six month emergency fund sitting right where it has been for many years, in a 6 month insured CD in my beloved Credit Union. To continue with my military analogy, I consider these funds my personal bodyguard regiment.

Giving in Retirement:

Because I have accumulated some wealth over the course of my life, I hope to continue giving at a level greater than would be indicated by my inflow of “renewable resources.” I am also in the process of setting up a charitable remainder trust as a part of my will, so that God willing, I will be able to care for others and give to charity after I have passed from this vale of tears.

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