Spending wisely during retirement

July 1, 2001
Many Americans are depending on their retirement savings to carry them through 25, 30, or even 40 years of retirement. Make sure you plan for your retirement savings to do the same.

Many Americans are depending on their retirement savings to carry them through 25, 30, or even 40 years of retirement. Make sure you plan for your retirement savings to do the same.

You may have already planned your retirement party — maybe even your post-retirement vacation. Hard work and disciplined savings helped build your retirement fund. But have you considered how you will make those savings last throughout retirement?

When you sit down to plan for your retirement distributions, consider your future income needs and other factors — such as tax liability — that may affect distributions. By educating yourself about the common misconceptions below, you can develop a more accurate picture of your financial future:

Misconception #1:It doesn't matter how much you withdraw during the first year. Don't fall into the habit of overspending during your first year of retirement. Many new retirees, suddenly faced with added leisure time, spend beyond their means on luxuries, such as cruises or gifts for grandchildren. While you should take time to celebrate, remember to limit the amount you withdraw from your retirement savings. Taking too much from your funds may deplete your resources prematurely, because you will have less money earning returns.

You may be able to splurge a bit when you enter retirement. But be sure to maintain a standard of living you can afford and establish a reasonable budget for expenses. According to an article in the June 5, 2000, issue of U.S. News & World Report, many financial experts say it's reasonable to project a retirement income of 70 percent to 80 percent of your working income.

Misconception #2:You won't possibly outlive your savings. Believe it or not, one common tendency is to underestimate the amount of time your retirement savings should last. When you plan for distributions, set annual withdrawals that won't exhaust your savings. Many Americans are retiring earlier and living longer, healthier lives. Today, the life expectancy is 80 for men and 84 for women; and, as an article in the July 2000 issue of Financial Planning emphasizes, that's just an average.

This greater longevity has resulted in the need to stretch your retirement funds further. Many Americans are depending on their retirement savings to carry them through 25, 30, or even 40 years of retirement. Make sure you plan for your retirement savings to do the same.

In addition, some Americans are also increasing the length of retirement by leaving the workforce at an earlier age. Today, many workers are retiring at age 65 or 60, and some even while in their 50s. For these retirees, it is even more important that they plan their retirement distributions carefully. They are no longer generating an income that can contribute to their savings, so they must stretch their retirement funds even further.

Misconception #3:Inflation will not affect your retirement savings. Failing to discount the impact of inflation is another common mistake made when planning for retirement. But it's an easy mistake to make when you consider that some online retirement calculators do not account for inflation. While it's true that inflation has been relatively low since the early 1990s, there is no guarantee that this trend will continue.

You need only look back to the 1970s and 1980s to see the negative impact of inflation. "During this time, the purchasing power of $1 in 1970 had decreased to 46 cents by 1980," said Diane Dercher, Waddell & Reed's vice president and chief economist. For example, if you made a purchase that cost $100 in 1970, you would have paid more than $212 for the same purchase in 1980.

While inflation typically does not impact you as much when you're employed — generally as costs go up, so does your salary — once you reach retirement, your income isn't nearly as flexible. If in retirement you plan to live on a fixed distribution each month, you could face a financial crunch if inflation rises.

An alternative idea might be to plan withdrawals that are adjusted to keep pace with inflation. It may mean a smaller initial monthly payout, but the payoff will come when you are able to maintain your standard of living in the later years of retirement. Remember, even after you retire, it's a good idea to keep a portion of your portfolio invested for growth to help offset the impact of inflation.

Misconception #4:Estimate future returns based on the current market. There's no doubt about it: The recent bull market was good news for retirees. Since 1987, most seniors had watched the market — and their savings — rise. But when the market is averaging 10 percent to 12 percent returns, it's easy to forget the bear markets. Consequently, many of today's retirees overestimated the returns their retirement savings will earn. It remains risky to assume bull just market conditions when you make your calculations.

Misconception #5:Don't change the allocation of your assets in retirement. Asset allocation is another key factor in maintaining your quality of living throughout retirement. While the right asset allocation varies from person to person, as a general rule, you'll want to weigh the need for returns against the volatility of the investments to find a mix that's right for you. Once you reach retirement, you will likely want to move the majority of your assets into more secure investments to avoid significant losses to your savings. Your financial advisor can help you determine the allocation mix that's right for you.

Misconception #6:You can time your retirement around the market. Unfortunately, there's little you can do to time the market. If you retire when the market is high, you may watch your retirement funds expand, your earnings outpace your distributions, and your total retirement funds continue to grow. However, if you retire when the market is down, you may find that distributions, coupled with losses in the market, diminish your savings significantly. And, when the next upward cycle begins, you'll have less money working for you — so it may be difficult to recover from your losses.

While you cannot time your retirement around the market, you can implement an investment plan that could help you avoid big losses just before retirement. And, once you reach retirement, you can make distributions that help ensure your financial stability even as the market fluctuates.

Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.