What If Your Retirement Plan Fails?

rogernusbaum

Marketwatch had an article about the virus not changing peoples intended retirement age. Per the article, the average age that people plan to retire at is 66 which is up a year when the same survey was done in 2018 and came up with 65 as the intended age. The article also took a look at how people would build their incomes in retirement; how much are people relying on Social Security, pensions, their savings, part time work and so on.

Hopefully everyone has some idea of where their income will come from once they retire. As we've been exploring resiliency lately, how screwed would you be if the thing you're counting on as your primary source of income failed? Will Social Security be your first source? With all the debate over the last umpteen years about its solvency and the potential for a 23% reduction in payouts starting in the mid-2030's, what is your back up if Social Security does not come through in the manner you are expecting?

Yes, there is a good chance they will figure something out but contingency planning is not preparing for what can go right. Everyone should know what their full retirement amount is from Social Security, mine is $2900/mo if I take it on my 67th birthday going up to $3400 if I wait until 70. The most my wife can get is half my FRA which is $1450. As of now our fixed monthly expenses in retirement would be about $2500 (these are all in today's dollars), our mortgage will be paid off this summer so that will be long out of the picture. Obviously the $4350 covers our monthlies as we now know them. At some point we will need to replace our cars which are 14 years and 18 years old respectively which will add to the $2500 if we finance. So yeah, Social Security is our Plan A.

We've all paid in to Social Security, we are entitled to whatever our payout is scheduled to be but what if our scheduled payout is cut? It is not wrong to plan on Social Security but the relevant question is still how screwed are you if Social Security is significantly reduced? What if benefits get cut in half?

In many (most?) instances Social Security as promised will not cover all expenses unless you live far below your means. Estimates range all over the place but in your circumstance would your Social Security benefit cover half of your expected expenses? What then about lifestyle spending like trips and unbudgetable one-off expenses? The difference between your Social Security benefit and expected spending need is often called a gap. Typically, savings (like in an IRA of some sort) is the go-to to fill that gap. If you think you need $6000/mo and your Social Security will be $3000, then your gap is obviously $3000 which assuming the 4% rule for withdrawals means you need $900,000 saved. The gap can of course be filled from multiple sources like a job or investment property in addition to portfolio income.

If you're lucky enough to have the $900,000 (sticking with the same example) and Social Security holds up then you'd be in good shape. If Social Security did cut in half then either something would have to give or you'd need to rely on some sort of contingency. Contingencies could include living a less expensive lifestyle, having some sort of job or monetized hobby, downsizing your home such that you cash out some money, spending more than 4% and hoping for the best.

What if your Plan A involves getting 75% of you retirement income from a $1.5 million investment portfolio and the portfolio cuts in half shortly before you retire or shortly after you retire? Also related, what if you retire at 65 and having been pushing it with a high withdrawal rate, you make it to 80 with out a problem and then your portfolio cuts in half? To make that last wrinkle more complicated, you're 80 and in fantastic health/shape?

Ideally this could be mitigated before it happened with some number of months or years worth of cash set aside ahead of time. Three years' worth of expenses seems like a relatively safe way to go given the duration of the typical bear market. I don't have that much set aside for clients but for people managing their own accounts and not wanting to make a full time job out of it, that would mitigate many calamities.

Is cutting expenses by a meaningful amount something you could do on very short notice? Cutting is always a potential contingency. At its worst, the S&P 500 was down 34% from its peak during the current event and although it snapped back quickly (for now?) what if it had gone down just a little more to a drop of 40% and stayed there for more than ten minutes? The drop occurred in about a month which is obviously very fast. A $900,000 portfolio allocated 60/40 in this scenario could have been down $216,000 just in the equity portion, maybe more if the fixed income was allocated to anything but US treasuries and CDs.

So now the portfolio is $684,000 and if you stick with $3000/mo in withdrawals then you're withdrawal rate bumps up over 5%. That's not insanely high but makes you more vulnerable if a large one-off expense comes.

Someone planning to work part time as an important part of their retirement who then finds they can't do so for whatever reason needs to figure something out. The list is almost infinite as everyone who has thought about has some sort of plan in mind and whatever the plan, something can go wrong and the time to think about how to mitigate an adverse circumstance is before it happens.

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