Over the past four decades, private employers have dumped pensions and replaced them with 401(k) savings plans. The result is that millions of Americans are their own pension plan managers, and they get jittery when stocks and bonds tumble.
Markets aren’t the only wild card. Seniors know there is a good chance they will need long-term care at some point, and the cost could run in the range of hundreds of thousands of dollars.
Americans frequently compensate for these twin uncertainties by underspending in retirement. Many retirees actually build wealth as they get further into retirement. By contrast, studies have shown that retirees who have higher pension incomes tend to spend more and not worry about running out of money.
JPMorgan studied customers with total retirement assets of between $1 million and $3 million, including present value calculations for Social Security and other pension-like income. It found that customers who received 20% to 40% of their retirement income from pension-like income spent an average of $50,000 a year while those who received 60% to 80% from pension-like income spent $71,000 a year—an additional 42%.
“The conclusion is that it shows the power of the paycheck,” says Michael Conrath, chief retirement strategist for J.P. Morgan Asset Management. “Having the paycheck gives them the confidence to spend.”
There are steps you can take to make your nest egg more like a pension that sends you a reliable check. They include waiting to collect Social Security so that your benefits check is as large as possible. If that isn’t big enough to cover your essential expenses, you can augment your Social Security check by buying a private annuity that will pay you a monthly sum for the rest of your life.
Financial advisor William Bengen came up with the 4% retirement rule in the 1990s to describe a safe withdrawal percentage from a portfolio. Now he advises retirees to put part of that portfolio in annuities so they won’t be rattled by stock market tribulations.
“Psychology is a huge thing,” says Bengen, who is now retired. “You can’t ignore it. We’re human beings.”
Another tactic: Homeowners can get a reverse mortgage line of credit that they draw down when the stock market stumbles.
Yet another approach is a cash bucket. By keeping enough cash to cover a year’s worth of essential expenses without touching your primary portfolio, you are more likely to ride out a market crash without panicking and selling at the bottom.
Finally, consider setting aside enough money early in retirement to cover long-term costs.
Remember that a successful retirement isn’t just about having enough money. It is also about adopting a mindset that enables you to keep spending through thick and thin—even if you never earn another dollar in your life.
“It can be a challenging transition,” says Richard Faw, a financial advisor in Savannah, Ga. “People are really doing something they have never done in their entire life, which is not earning money and spending money they’ve already earned.”
Cover Essential Expenses With Social Security
Want a stress-free retirement? The simplest approach is to have enough dependable income to pay for key expenses, ranging from housing to groceries to healthcare.
If you are one of the dwindling few with a pension, you are ahead of the pack. The rest of us have to rely on Social Security. The bigger you can make your monthly check by delaying the start of benefits, the better off you will be. The size of the benefit rises 8% for each year you delay it beyond your full retirement age. The maximum benefit in 2025 is $5,108 a month for someone retiring at age 70. Your Social Security benefit is inflation-adjusted, so it will keep growing throughout your retirement.
If Social Security doesn’t provide enough income, consider buying a basic income annuity from an insurance company. Rising interest rates have made the payouts far more attractive than a few years ago, though Social Security is still a better deal. On top of that, the annuities commonly sold today aren’t adjusted for inflation.
“If anyone is thinking about buying an annuity, step one would be maximizing Social Security by delaying it,” says Wade Pfau, author of the Retirement Planning Guidebook. “Because the implied annuity by delaying Social Security is much better than a commercial annuity.”
Fill a Cash Bucket
What if you can’t cobble together enough dependable income to cover essential expenses? Or maybe you prefer to live off your retirement portfolio rather than delaying Social Security. Consider keeping a cash reserve to protect yourself from having to sell depleted stocks during brutal market selloffs.
Retired financial advisor Harold Evensky, who pioneered the concept of the cash bucket, recommends you keep enough cash to cover a year’s worth of essential expenses combined with any pension income you have.
Suppose you need $8,000 a month to keep the lights on, the refrigerator stocked up, and so on. You receive $4,000 a month in Social Security. You would need to set aside $4,000 a month to pay the shortfall. Doing that for a year requires $48,000 in cash.
Evensky’s clients kept cash reserves, and he says it prevented them from selling out during the stock market busts in 1987, 2001-2002, 2008-2009, and 2020. “The most important thing is behavorial,” Evensky says. “People don’t get panicked if they know where the grocery money is coming from.”
Set Aside Money for Long-Term Care
Long-term care insurance is expensive and has been beset with problems. You lay out a lot of money for something you may never need.
Consider self-insuring. If you have the funds, Pfau advises setting aside $200,000 per person at the beginning of retirement. It will be invested like the rest of your portfolio, but you won’t spend it down. That will allow it to grow to keep up with the rising costs of long-term care. If you don’t need long-term care, the money goes to your heirs.
Tap a Reverse Mortgage
Bengen’s 4% rule posits that you can safely take that amount adjusted for inflation annually from a portfolio of stocks and bonds during a 30-year retirement. Bengen has since raised that number to 4.7%.
What if you have a relatively small portfolio, and 4% or even 4.7% isn’t enough to sustain your lifestyle? If you take out more, you risk running out of money.
That’s where the reverse mortgage line of credit comes in. By using it properly, you can sustain a far higher rate of spending from your portfolio, according to published research by Barry Sack, a semi-retired pension lawyer in California.
Here’s how it works. Suppose you have a $400,000 portfolio and an $800,000 house. Under the 4% rule, you could take out $16,000 a year from that $400,000 portfolio.
Now, suppose you take out a reverse mortgage line of credit on your house. That allows you to double the withdrawal rate on the investment portfolio to 8%, or $32,000 a year, according to Sack’s research. Whenever the portfolio goes up sufficiently, you take the entire 8% out of it. When your portfolio drops, you draw down the reverse mortgage instead. That way, you never have to sell depleted stocks to fund your spending.
It isn’t free. The fees to set up a reverse mortgage usually run between $15,000 and $30,000, Sacks says. But unlike other loans, the bank can’t cancel the reverse mortgage down the road
“It still has a 90% or better probability of lasting 30 years,” Sacks says of his approach. “In the bad years, you’re not taking money out because you’re letting the portfolio recover.”
Write to Neal Templin at neal.templin@barrons.com
