How to Avoid Outliving Your Money in Retirement

By Carl Lachman, CFP®, MBA

It’s a Common Fear

The decision to retire is an anxious one for most people, and the root of that anxiety is very often a fear of running out of money in retirement. While we are working, we make money mistakes or have emergency expenses we didn’t plan for, but we are usually confident that our income will allow us to make up for those mistakes or emergencies in the future. Once we retire, we don’t have the confidence that comes from a regular paycheck. Retirement involves a lot of changes, and it takes an adjustment in how we think about money. Most of us find that adjustment unsettling, and you could end up fearful of outliving your money in retirement.

Make a Plan

Don’t guess, play it by ear, or “see what happens.” It might not be fun, but you or your financial advisor actually needs to take the time to make a detailed plan for your retirement. At our fee-only financial planning office in Fullerton, California, this is something we do often and regularly for our clients. It is an integral part of financial planning.

We call the primary part of this retirement planning a “retirement projection.” This analysis estimates sources of income and investment returns over the next 20 or more years, then gives an evaluation of how much can be spent each year in retirement. It is impossible to know the future, but this projection helps our clients know if they are going in the right direction or if they risk running out of money.

Conservative Assumptions

When we are constructing retirement projections, we make conservative assumptions. We include inflation, we use average investment returns, we look out further than most people think they will live, we include money used to pay for taxes, and we don’t assume their retirement will be cheaper than their current life.

Many financial advisors assume that people will spend only about 80% of their current living expenses in retirement. We have not found this to be consistently true, so we do not make this assumption. Rather, we find that many people’s retirement is actually more expensive than their working life. Usually, this is because once they have the free time, they fill it with things like travel and other experiences that are costly. Free time is expensive time.

Later in retirement, although many of us are less active, our medical bills go up. So, again, this is another reason we don’t assume expenses will drop in retirement.

Also, another conservative assumption we make is that we do not include home equity as an asset available for retirement expenses. Instead, we set aside the home equity or value of the home as a sort of last-resort insurance policy. If something goes drastically wrong in retirement, a home could be sold or the home equity tapped, but otherwise we do not include it in our projections.

Have a Contingency Fund

Speaking of things going wrong in retirement—you can plan on it. Most of the time, it won’t be so severe that you need to sell your home, but smaller emergencies will happen. So, you need to have the equivalent of three to six months of living expenses set aside and saved as a contingency or emergency fund.

The reason to have three to six months of funding set aside is because your emergencies in life will not be evenly spread out. Life clumps together. Isn’t it true? We have all experienced this sort of situation: Your roof will start leaking, the car will have a flat, and your stove will burn out all in the same week. And, these will all happen four days before you are supposed to leave on vacation! I hate to be the bearer of bad news, but this will happen eventually! Make sure you have an emergency fund ready.

In retirement, a contingency fund is particularly important because you don’t have the financial flexibility you had while you were working. You can no longer pay for the emergency by working extra hours or using your next bonus.

Don’t Be Too Conservative with Your Investments

This is counterintuitive advice. It would seem to make more sense to get super-conservative with one’s investments the day after the big retirement party. But, after you retire, how much longer are you planning on living?

Average life expectancies are now around 80 years in the United States. So, if you retire at around 65, your investments will need to last at least 15 years. But, if you are married at retirement, there is about a 50% chance that one of you will live to at least 90 and a 20% chance one of you will live to 95.

So, there is a good reason to plan on your money needing to last 30 years if you retire at 65. Thirty years is a long time, and you will not be able to make your money last and have the same standard of living if your investments are too conservative.

The reason for this problem is inflation. The cost of living your life will go up. If your money is just in savings or CDs or bonds, it almost certainly will not grow enough for your living standard to stay the same. Instead, with such a conservative group of investments, you will need to sell your house, downsize, eat out less, skip travel, and live very simply. Inflation will eat up your money and you will have to drop your living standard.

However, putting around a third (or maybe more) of your investment assets in companies (stocks) will give your portfolio the power to grow and stay ahead of inflation. The reason for this is that good companies will be able to raise their prices during times of inflation, and that should translate to the company (and your stock) being more valuable.

Update Your Projection AND Spending Every Couple of Years

As I mentioned earlier, a retirement projection is good directionally, but it does not predict the future. So, you will need to revisit the projection and update it every couple of years. You need to take a look and see if you are still on track.

When you update a retirement projection, sometimes you will find that you need to adjust your spending. This might not be fun medicine to take, but do it anyway. If you don’t, you may irreparably harm your standard of living in retirement—or run out of money. If you really don’t want to outlive your money in retirement, then revisit your retirement projection with your advisor and be willing to adjust the ways you are using your money.

Although updating a retirement projection takes some work and adjusting spending isn’t fun, it will usually lead to peace of mind. It will probably give you the confidence to stop worrying about running out of money in retirement.

Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.