The Cost of Retirement
In 1943, Abraham Maslow released a paper titled “A Theory of Human Motivation.” The premise of this paper is now widely accepted. The core of this paper centers around the human “Hierarchy of Needs.” The basic assertion is that humans have items essential to survival and things that are not essential. We ascribe different values to each of these items based on how crucial they are to our survival. Too often, when we think of our future needs, we fail to consider that these needs are not equally critical to survival. Following is a framework for estimating future expenses and determining how essential these items are to future survival or to future satisfaction.
Let’s start with the basics. Every retirement plan should have a reliable way of estimating the retiree’s life expectancy. Are you in good health? Do you have a family history of longevity? Are you planning for a single life or joint lives? All of these questions help to establish a timeline. For instance, knowing that a person who is 65 will, on average, live approximately another 20 years is somewhat helpful. However, it may be more beneficial to know that the male retirees with the highest 20% longevity (longest lives) will survive until they are 90. The healthiest female retirees may survive until age 94. There are a number of longevity calculators online that may help you estimate how long you will have to enjoy retirement.
Once we establish a basic timeline, we can calculate our essential expenses for each year of retirement. How much will food, shelter, and clothing cost in year one of retirement? This question is probably the most straightforward one because the first year of retirement is the closest to today. Next, we want to know how much those items may cost in 30 years (assuming a 30-year retirement). The rate of inflation can have a significant impact on this answer. Hint: any retirement plan that still assumes a 2% inflation rate should be reconsidered. Finally, consider how your consumption of essential items may change over your lifetime. Will you live in a different location (possibly) or need to spend more on health care in the last five years of your life (probably). Answering these questions will allow you to establish your lifetime financial needs.
Having a solid understanding of your basic recurring expenses is essential. However, retirees should also know what NON-recurring but essential expenses they might also incur. For instance, are you likely to have to purchase a new car, replace a roof, or an air conditioner? Every plan should have a liquid reserve to allow retirees to pay for non-recurring expenses without needing to liquidate invested assets when markets may be down.
Now for the fun stuff! A fear of “running out of money” in retirement may cause retirees not to spend money doing things that they would otherwise enjoy during their retirement. After all, it’s hard to enjoy a vacation at age 65 if you believe you won’t be able to put food on the table at age 85. However, once we have established all the essential expenses, we can enjoy that discretionary spending. It is important to note that retirees are unique in how they spend this discretionary income, but they do generally fall into broad categories. Also, it is helpful to find that these categories have fairly consistent spending patterns. For instance, you may be a “Globe Trotter” who has planned for lots of travel. This category of retiree will spend more in the early years, but this spending will decline as the retiree ages. However, if you are a “Foodie” or “Hobbiest,” then you may have lower initial spending than your “Globe Trotting” friend, but these expenses will likely last much longer into retirement.
Finally, many retirees have Legacy goals. Retirees may want to give to their favorite charity, or they may wish to provide for their children and grandchildren. They may want to provide money while they are still alive, or they may want this money to pass on to their heirs after they are gone. In some instances, these “giving goals” are the most important goals to clients but can only be achieved after essential expenses have been covered. There are numerous tax-efficient ways to give. However, all strategies may not be equally impactful. For instance, donating to a favorite charity might require a different strategy than paying for a grandchild’s college tuition.
As we think about all these goals, we return to Maslow’s Theory of Motivation where he offers that “people who are satisfied in the areas of physiological, safety, love and esteem are those that may expect the fullest (and healthiest) creativeness.” As we plan for our future, we want to make sure these areas of needs are covered and that we have a clear path to a healthy, supported and fulfilled retirement.
Sometimes, as we approach our future financial planning, we are given a list of tasks, which can seem daunting because they raise more questions than answers. Our financial advisors at 49 Financial are on a mission to simplify financial planning by helping to make this seemingly complex task a bit more digestible. Reach out to one of our advisors if you would like to collaborate on building out a retirement plan that supports your “fullest (and healthiest) creativeness.”
The purpose of the report is to illustrate how accepted financial and estate planning principles may improve your current situation. The term “plan” or “planning,” when used within this report, does not imply that a recommendation has been made to implement one or more financial plans or make a particular investment. You should use this Report to help you focus on the factors that are most important to you. This Report does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation.