Are You Prepared to Retire?

By Henry K. Hebeler


There are a number of general areas people close to retirement must consider including the activities they will pursue, things they will have to do to stay in good shape both physically and mentally, and their financial situation. These are all inexorably intertwined, but this being a business publication, I'll focus on the money ingredient. When looking ahead to your future retirement, remember that no one can predict the future, and turns in the economy may convert a brilliant idea into an absolute disaster.

Those who retired a decade ago, as did I, have enjoyed financial benefits that were largely unknown to many of the generations that preceded us. This makes it a lot easier to be an apparent expert. As an example that's completely opposite, my father retired at age 70 in 1968 and lived until he was 96. He was about as sharp as they come, very energetic, and even golfed regularly until the year before he died. However, because he lived so long, he experienced the same bad financial times of those who started retirement during the period 1964 through 1974. Investments didn't do very well, and inflation took its toll. (To put a number on inflation, from the year he retired to the year he died, prices increased by over 340%.) Whereas he thought he was well prepared for the future (and by the standards of those days he was), it wasn't long before he found himself borrowing money and subsequently needing help from his children.

Having just come through this remarkable financial period where it was almost impossible to lose money coupled with low inflation, many people have only dim recollections of more troublesome times. Although history does not repeat itself reliably enough to make a prediction, the general problems associated with a couple of years of unrecoverable negative returns and high inflation will likely reoccur at some point.

Before anyone retires, I think they should take a look at what could happen on the dark-side and have some degree of preparedness. If they can't do this themselves, they should seek the help of someone with some analytical capability in this area. I've found that you must seek answers to questions about the negative things. Even most professional planners, in my view, are jaded about the future and see through rose colored glasses unless stimulated otherwise.

How do you get a view of the dark-side? Start by asking about really prudent reserves for emergencies, repair or replacement of costly things that may be needed for your health, transportation, and shelter. Then subtract those reserves from the savings that you would otherwise spend on more normal things for retirement. Think about uninsured medical, dental, and drug bills that will almost certainly escalate at a dizzy rate during your retirement. (This includes getting information on alternative insurance possibilities.) Consider how many times you may have to replace your automobile. Estimate costly home maintenance items such as replacing your roof. If you can't pay for these things from your savings, you'll pay a lot more if you borrow the money.

Although I don't like being in a position to borrow money for most things, a home mortgage is normally such a good deal, that I personally don't think people should accelerate payments just because they are going to retire. In fact, in my view, the firm that put up the money is at a disadvantage because it has a fixed income investment in an inflationary environment. Conversely, you enjoy a small tax benefit from the mortgage and can invest at least part of your money in things that will outpace inflation in the long run.

As contrasted with good investment real estate that produces positive cash flow, I don't think your home is a good investment unless you are one of those rare people in a community that will have incredible appreciation over a prolonged period. If you need to down-size for retirement, take the medicine quickly and get the surplus funds to work right away.

A house that has rooms that may be used only a couple of days a year by some grandchildren is certainly not a good investment. After our children flew the coup, we once bought a small house from a retired couple that took the position that they could do more for their children and grandchildren with a larger retirement income than they could with a few night's layover at their house. Not only did they save on the original cost, they saved more every year because their interest, property taxes, and maintenance were significantly lower. Their penalty was that the kids had to sleep on the couch or floor, or spend sleeping time elsewhere while in town. In fact, the money saved would actually have paid for some lavish hotel accommodations with a lot left over.

There are a couple of things that really bother me about many who try to put some financial numbers together for future planning. First is to neglect an emergency reserve. Next is the almost inevitable optimism about returns from their investments, investment costs, and future inflation. Last is the susceptibility to bad advice from people who have little knowledge or are eager to maximize the money they can siphon away from the retiree.

What seems to get people's ear is the braggart who had some success (or at least says so) with one thing or another. It might be a hot stock, a mutual fund, or some real estate. The value is about the same as a tip at a race track. What's better in my view, especially for a person with little spare time, is a mix of a few no-load mutual funds to give some diversity and perhaps some actual bonds. The only discipline required is to convert part of the more rapidly growing stock funds to some fixed income funds or bonds to keep a reasonable mix of stocks and bonds. A portfolio like this is unlikely to need changes but once a year at most. This rebalancing is easy in a 401(k) or IRA because there is no tax consequence. Balanced funds do this automatically. Except for possible sale of the family mansion, there should be no traumatic change near the time of retirement.

Another category of things that bother me is people who estimate future income by adding a fixed pension or annuity to Social Security. These are like apples and oranges and are as different as night and day. A fixed pension is worth only about two-thirds of Social Security. As a rough rule of thumb, a person should spend only the after-tax portion of the pension multiplied by the retiree's age divided by 100. For example, a 65 year old would spend only 65% of a fixed pension. The rest of the after-tax income should be saved.

That's right! Early in retirement, retirees still have to save money, just not as much as before retirement. This means that part of the money must be put aside from bonds as well as a pension, and certainly retirees should not spend capital gain distributions early in retirement. As another rough rule of thumb, retirees should probably not spend much more than their investment balance divided by the number of years they still might live. That amount also has to cover the associated taxes due. In fact, that's one of the things I like about the IRS's "recalculation" method used for post 70 ½ IRA required minimum distribution requirements. It's the same math.

Retirees are likely to see more doctors, dentists, pharmacies, and hospital interiors than they care to think about. Nevertheless, that's something that has to come out well (pun intended), and everything else is a refinement for planning on future retirement. As costly as insurance may be, the lack of it is almost certain to determine the course of your future years.

Of course all of the things I like pre-retirees to consider take time, and most people just don't do it. Even one hour a year would make a huge improvement for many people. The typical person decides on a retirement date without hardly any consideration of the gain from working another year or more for some additional savings. They flourish their intended retirement date to the world much too early and feel embarrassed to back off the "commitment". Too often I see people trying to retire at 55 or younger. Their image is four future decades of mindless recreation. The majority will end up back at work, often at a job with little retirement benefits and a lot less challenge.

My biggest financial mistakes were real estate partnerships. Not one has turned out super, several have been marginal, and most turned out just plain bad. I'd like to blame it on the change in the tax law which really hurt partnerships, but in the same interval, many people built fortunes in real estate. To me this illustrates the uncertainty of our own performance in an unknown future environment. No one can predict the future. But we can do some estimating and, with the proper humility, admit that we need investment diversity because we can't foresee the ultimate outcomes.

During the few years before retirement, it is imperative to try to wear the hat of the broad thinking wise man. Go to some planning seminars, the library, bookstore. Engage a professional in the finance field. You spent a good deal of your life getting prepared to be an adult and be productive. Now spend some time preparing yourself for what could easily be one-third of your life. You may not have any control over the length of your retirement nor how much the government will take or give you, but you do have control over your financial actions. Finally, try the acid test: During your last few working years, spend only the amount you can afford in retirement.