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The Smart Take:
Walter was being nosy recently and asking his mom about her retirement plans. When she told him she was planning on living off of 80% of her current income during her retirement years, it raised a red flag. How did she come to that figure?
You guessed it, she didn’t really have an exact answer for why she picked that number.
So Walter turns to Kevin on this week’s podcast to understand how that “80% Rule” worked its way into the retirement planning vernacular and why we’d all be wiser to ignore it.
This is the first of a four-part series on Retirement Rules Gone Awry.
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The Host:
Kevin Kroskey – About – Contact
Walter Storholt:
Welcome to Retire Smarter. Walter Storholt here with you alongside Kevin Kroskey. And you know what? Now that we’ve done more than 90 episodes of this show over the past few years, it’s gotten to the point where we know that we’ve picked up a lot of listeners at various parts of the journey. Maybe you’re one of them. And many of you who weren’t around since the beginning have perhaps never gone back to hear some of our earlier episodes. Well, if you sure wish you could go back and catch some of the best past episodes but maybe you don’t have the time to go consume every single one of them, well, you’re in luck.
Walter Storholt:
We’ve done some of the hard part for you. We’re going to give Kevin a few weeks off from taping fresh material to make it through the end of tax season here, and then he’ll be back of course. But in the meantime, we’ve assembled a special five-part series, a Retirement Rules Rewind if you will, where we’ve selected episodes from our most popular series of the past. Now, these are going to be select episodes that deal with retirement rules that you’ve probably heard before, but we like to challenge those rules on this show and see if they truly should be called that. We’re going to touch on subjects over the next five episodes that relate to everybody’s retirement planning, so there’s something here for everyone. And even if you had listened to these episodes way back when, well, it’s been a few years, so never hurts to have a refresher. So sit back, and we’ll rewind right into the meat of a previous episode as part of our Retirement Rules Rewind. Part one of our series is Rules Gone Awry: The 80% Spending Rule.
Walter Storholt:
On one of the questions about retirement that I think it’s very hard to get a good answer if you just Google this online, Kevin. It’s one of these things where there’s kind of a nebulous answer. There’s not an exact science to it, so it seems, and so I’m curious to get your thoughts on this. And something I was actually talking with my folks the other day about, about how much money they’re going to need in retirement. What kind of income do you need? And my mom kind of just randomly came up with this thought of, “Well, I heard you need 80% of your regular income in retirement.” It was just sort of this figure she pulled out, but she couldn’t put her finger on why she came up with that number, whether that was accurate or not. It was just sort of what was in her mind. So let me ask you, is that an accurate number to pick for how much income you’re going to be in retirement? How does that conversation usually shape up with folks?
Kevin Kroskey:
Yeah, if it’s accurate, it’s usually by chance rather than by design.
Walter Storholt:
That’s okay.
Kevin Kroskey:
It’s one of those rules though, and there’s about seven that I’ve identified and have written a lot about, and actually am assembling into a book that should be out the fall of 2018. I’m calling it Retirement Rules Gone Awry. We’ll see if that title sticks, but one of them is this spending rule that you’re going to need 80% of your pre-retirement income in retirement. Basically, the theory goes, “Hey, you’re not saving in your 401k or your IRA. You’re not paying payroll taxes anymore, so you don’t need 100%. You only need 80%.” I say that is only going to be accurate by chance, just based on a lot of experience and actually looking at the numbers for several.
Kevin Kroskey:
We serve more than 170 families and literally running the numbers for them, understanding their current lifestyle, looking at their current spending, and then how it’s likely to change over time. And then not only doing that upfront but then monitoring these plans for people as they get into and throughout retirement. So practically speaking from experience, it just doesn’t hold water for most of our clients.
Kevin Kroskey:
Now, for those that it does hold true, there’s a segment of the population, I’ll call them kind of “Middle America” if you will. And middle may sound … I don’t want to say, okay. But when you look at the statistics, “Middle America” is basically household income less than $60,000 a year, so it’s not that much money. In middle America, generally, those typically aren’t our clients. So for those people, the “Middle America” people, that probably holds true. They’re spending their take-home pay. They’re going to need to keep spending it all the way throughout retirement, and they’re going to have some costs that are increasing. But those people are really typically the only people that it does apply for, unless it’s purely by chance.
Walter Storholt:
Okay, so purely by chance is where you will find that’s an accurate summation of how much income you’re going to need in retirement. So where do we go from here? If that’s not really going to be that accurate of a model, what do I tell my mom? Tell me, Kevin.
Kevin Kroskey:
You’re going to tell your mom she needs to run the number, Walter. I’ll break it down by some categories here. I talked about how the savings and the payroll taxes are going to go away, but think about some other changes that you’re going to have in retirement. One of the biggest ones is healthcare is going to be different. So you may go in and be on, say, Cobra and stay on your employer plan for up to 18 months after you retire. If you do that, one of the things that you’re going to notice is the employer’s not paying a subsidy anymore for your benefits. So you may go from paying 100 or 200 per pay, or a couple thousand dollars per year, to paying 100% of that. Technically, they’re allowed to charge you 102% of the premium, a 2% admin fee on top of the actual charge for the health insurance. That’s one of the biggest things that people wake up to where retirement’s definitely different, and health insurance is one of those big ways.
Kevin Kroskey:
Now, you’re not going to be on your employer plan, or even on what I would call an exchange policy if you need to use one of those, for all that long, because Medicare’s going to kick in at 65. So that’s going to be another transition, and the cost structure is going to be a little bit different and probably more favorable when you get there. But that being said, that’s a big difference because when you’re working, the health insurance is being subsidized generally by your employer and also being deducted pre-tax from your pay. When you retire, you have no subsidy, particularly before Medicare at 65, and you’re paying with after-tax dollars.
Walter Storholt:
Okay. So a lot of different moving pieces there that come along with trying to determine what your expenses and thus what your income is going to look like during your retirement years. And where do you see this varying a lot for most folks? Because what I’m hearing here is it’s going to be a different percentage for some people. So it’s definitely not going to be 80% across the board, but it’s also not going to be some other number across the board. It’s really going to vary from person to person, and some may need more than what they’re making in retirement. Am I reading the tea leaves correctly here?
Kevin Kroskey:
Yeah, you are. It’s very customized. We’re all different, and we all have different means and desires and goals and dreams. You’re going to have some expenses that are going to be around as long as you are. We really lump that into that needs bucket. Certainly, health insurance is part of that bucket, but that bucket for health insurance anyway is going to increase at a faster rate generally speaking than other expenses that you’re going to have.
Kevin Kroskey:
The other things that are in the needs bucket, I always like to say heat in the house, food in the belly, gas in the car. Those sorts of things. Pay your property taxes, what have you. And those are the things that really do increase at kind of a normal trend line inflation rate, be it 2% or 3% or something like that year in, year out, and you’re going to have as long as you’re on this planet. So those are those needs, you’re going to lump in health insurance as part of those needs, but increase that at a faster rate than that 2% or 3%, probably closer to about 5%, what the averages have been over the last several decades for health insurance cost increases.
Kevin Kroskey:
But those expenses right there, you’re going to have to measure them. There’s different ways to go about doing it, and we’ll talk about those here in a little bit later. But those are the things that are going to be around as long as you are, and then health insurance is going to ultimately comprise a bigger portion of your spending as you age. You’re going to use more care in the later stages of your life. That inflation rate is going to keep driving those costs higher and higher, at least until that trend changes. It’s been that way for quite some time.
Kevin Kroskey:
But then outside of those needs and outside of those expenses that are going to be around as long as you are, you’re going to have some other things that are going to trail off over time. Certainly, when you retire and have all this pent-up demand for going and doing fun stuff, stuff that maybe you didn’t have the time or the energy to do while you were working. Maybe, you’re going to go and you’re going to travel a lot more. We have a lot of clients that will actually have a few different travel goals in their plan. One of them may be a much higher travel expense in their 60s and start pairing it back in their 70s, and maybe it’s just going to Florida in their 80s or something like that. Others may have periodic goals for a big 50th wedding celebration or a wedding for their daughter or for their son. Or maybe there’s some sort of bucket list trip that they want to do, or maybe they want to do a bucket list trip every other year or every third year in addition to regular travel that they do.
Kevin Kroskey:
All those things that I just talked about outside of the needs bucket change over time. We like to call them lumpy expenses. They’re going to be things that are going to show up. They’re going to be things that go away. They’re going to be things that happen from time to time, similar to a car purchase. You’re not going to go out and buy a brand new car every year. And in fact, as you get older, you’re going to buy cars less frequently. You’re going to be putting less mileage on them. You’re going to be driving more with your spouse. As you age, your expense on vehicles is to become less and less, as it is on clothing and some other items.
Kevin Kroskey:
So not only are you going to have needs that are going to be around and these other expenses are going to happen from time to time but are also more discretionary, after all, paying say a mortgage payment or paying your real estate taxes is going to come first before you spend money on a big trip, right? We all certainly need someplace to live. But that spending’s going to change over time, and you can really see a sort of banding approach as you age. More commonly, maybe somebody says, “Hey, the 60s are the go-go years. The 70s are the slow-go years, and the eighties are the no-go years.” But that keeps getting pushed back, too. It just does.
Walter Storholt:
Yeah. Tell that to my 80, 85-year-old grandparents.
Kevin Kroskey:
Yeah. Yeah. Exactly. Hopefully, I’m disproving that when I’m in my 90s and maybe in my 100s. I have a goal for that, but I keep-
Walter Storholt:
That’s just the super-slow-go phase.
Kevin Kroskey:
Yeah. Yeah. For sure. And even the slow-go phase, I know plenty of people that still go down to Florida to their second home in their 80s and even in their 90s. Now, getting there and back and forth may prove a little bit more challenging, and they need to rely on their kids or something like that. But there’s still a lot of people that do it and kind of disprove that 60s, 70s, and 80s kind of go-go, slow-go, and no-go.
Walter Storholt:
My grandparents were in their mid-80s on both sides. One still does their annual trip out to Arizona from Maine, and they will typically do not just a straight shot. They’ll drive all the way from Maine to Florida, visiting family along the way, then shoot it along the off to Phoenix. And then at the end of the trip, on the way back to Maine, instead of just driving straight back, they’ll head up to Washington State, and then take the Northern route all the way back across the country. Still doing that in their mid-80s.
Walter Storholt:
And then the other set of grandparents just last year came back from an Antarctic cruise, a month-long Antarctic cruise where they left out of, I think maybe New York and went all the way down to Antarctica, slicing in between South America and North America on their way down there and visiting Peru and the temples, and all sorts of different places along the West Coast of South America eventually before they made it down to Antarctica. So they’ve now touched all seven continents in their travels, which is pretty neat.
Kevin Kroskey:
That’s remarkable. Yeah, everybody’s different. We have a lot of clients that take mortgages into retirement and say that they’re going to be paid off maybe when they’re 68 or 72, or whatever it may be. Or maybe they get a mortgage on their second home that they plan on having for a period of years. Maybe they have a pension that doesn’t increase with inflation, which most pensions don’t. So you start factoring in these other things where you have a mortgage, then it goes away, or you have a pension, but it doesn’t keep up with inflation and maintain your purchasing power over time. Very quickly, you start seeing where a simple rule like 80% of your preretirement income falls by the wayside for many people.
Kevin Kroskey:
Once you start getting beyond kind of like a basic living standard and start having a discretionary income, you have the option to go ahead and do more and add a little bit more spice to life, then you’re going to have some lumpy expenses, and those expenses are going to change over time. And even if you don’t have a lot of those, as you age things are still going to change over time. That’s very, very clear from the different spending data that we have.
Kevin Kroskey:
The Bureau of Labor Statistics tracks this. I saw a good study from Chase Bank. Chase has a lot of credit cards and a lot of customers. They’re, I believe, the largest bank in the country and maybe the world. They did a showing that your peak spending typically is reached at age 45 and trends down from there. So when you’re 45, you probably have the kids. They’re in school or college or something like that. You got your mortgage. You got your car payments. And you haven’t built up enough financial resources maybe to pay cash for some of these things. But from 45 on, it starts trending down. Specific retirement research, there’s a gentleman by the name of David Blanchett, who’s the head of retirement research at Morningstar. Just did a phenomenal study a few years ago, and just showed how spending changes in categories as people age, and also based on their wealth levels as they age.
Kevin Kroskey:
And one of the things that applies to a lot of the clients that we serve is, say a high-income retiree as they go through their 60s, 70s, and 80s even as they’re slowing down. Maybe they’re not spending as much money on themselves for their own experiences, their own travel, or taking the family on a family vacation or whatever it may be. Their spending may be similar or even the same, but the character of it changes. They’re giving more money to charity. They’re maybe giving money to their grandkids’ education when they’re in college. They can see with the benefit of hindsight that, “Hey, my financial life plan, my retirement plan, my investment plan worked out really well. I’m good. I’m going to have more money. Some of this money that I have is going to be leave-on money. I’m okay to start doing some of this.”
Kevin Kroskey:
So when you actually look at their spending, even if it’s the same, the character of it is changed. And I would say when you look at something like that, we would put that in the more discretionary bucket. Nobody that is 55 or 60 or 65 that we’re doing retirement plans for typically is going to tell us, “I want to make sure that I work long enough to put all my grandkids through college when I’m in my 80s, and they’re going to be in college.” No. They’re going to say, “Hey, these are the goals that I have. I want to go ahead and preserve my lifestyle, have some fun, do some more trips, do this, do that.” But then if they end up in a position where maybe they did better than what they need for themselves, then their spending will change, and they’ll spend it on those more discretionary things I talked about.
Walter Storholt:
Pretty cool to just see the differences that we all have. What makes us unique impacts how we formulate our financial and retirement plans. And for two people who may be on paper look very alike, Kevin, the actual plan that gets pulled together when you start factoring in the things like emotions and goals and needs and desires and all these non-financial things, it’s probably pretty neat from your perspective to see two people that look the same on paper end up with totally different plans because of all those other factors.
Kevin Kroskey:
Yeah, everybody’s different. I mean, that’s one of the cool things about just working with people, getting to know them, and getting to understand them, and then tailoring the advice to them. One of the other things that I think is just … I really like is if you really understand this numbers aspect that we’re talking about, the spending, not only being able to measure how much you’re spending today, which frankly we haven’t really even dove into on how to do that. That’s probably the most difficult part of financial planning, something that we’ll pick up in a future conversation, but really how it’s going to change over time.
Kevin Kroskey:
One of the things that Blanchett found in his article, and we found this in practice over the years that we’ve been doing this and helping clients, is that if you actually can go ahead and model how spending is likely to change over time, and not only understand it today but then take it forward throughout retirement, typically what you’re going to find is people are going to be able to retire about two or three years sooner than if all that they did was understand what their current spending is and project that forward in a straight line fashion.
Kevin Kroskey:
Let me say that again. If you understand how to go ahead and model how spending is likely to change for you over time, starting with how much you’re spending today, usually you’ll find that you can retire two to three years sooner than if all that you did, which is understand your spending today and project it forward on a linear fashion. Which if anybody’s doing planning, it’s a pretty good starting point right there, but most people just kind of come up with say, “Well, I think I’m spending this,” and they certainly aren’t doing any sort of adjustments for how spending changes as you age.
Walter Storholt:
I think those are good thoughts, Kevin. We’ve covered a lot of ground in today’s podcast I think as we’ve kind of broken down this mentality of another one of those retirement rules gone awry. Like you said, there’s a lot of those. One of them being that 80% of my income is what I’m going to need in retirement. Other than the fact that’s wrong … Unless you’re lucky, that’s not going to be probably the right answer for you. What should be our other biggest takeaway from the podcast today? What’s the final point we should kind of let linger in our minds a bit?
Kevin Kroskey:
These retirement rules, this being the first one that we’re going to talk about in several more over the coming weeks, they may apply to you, but it’s only by chance. You really do have to run the numbers, understand your own situation, and make the most out of what you have. Giving mass financial advice similar to what Suze Orman or Dave Ramsey tries to do, I mean, maybe well-intentioned, but generally misses the mark for most people, particularly the kind of people that aren’t Middle America that do have fairly well-paying jobs that have been able to save a lot and do have discretionary income. That advice, Suze Orman, Dave Ramsey’s advice for those people is definitely going to miss the mark. Or if it does hit it, it’s only by a slim chance that it is the right advice for them. So you really do need to understand your own situation. If it’s something you don’t feel comfortable doing or you’re doing it, but you’re not sure if you’re doing it right or what you’re missing, then that’s really where you need to go ahead and find a good professional that can give you that second opinion and make sure that all the dots are connected for you.
Walter Storholt:
If you would like to get in touch with Kevin Kroskey and the team at True Wealth Design, offices in Akron and in Canfield, so there’s a convenient place to come by, say hello, and have a conversation about your financial plan. If you’d like, you can give them a call to 855-TWD-PLAN. That’s 855-TWD-PLAN, or the number version, 855-893-7526. Or the best place to do it probably for you is online, truewealthdesign.com. Click on the Are We Right For You button to schedule your 15-minute call with an experienced financial advisor with the True Wealth team, and you can just find out if you’d be a good fit if you need to do a deeper dive into your financial situation, get kind of a health report if you will of where you stand currently with your financial plan. That’s truewealthdesign.com. The place to go to learn more information about Kevin and the team. Listen to past podcasts, read the blog, check out all sorts of great information there on the site as well.
Walter Storholt:
Kevin, thanks for the help as always. I guess good luck to the Steelers this season. I don’t know. It’s kind of hard to say that. But for you, I can wish that luck, I suppose.
Kevin Kroskey:
Well, I hope Cleveland goes 14 and two, with their two losses to Pittsburgh, and everybody will be pretty happy.
Walter Storholt:
There you go. There you go. I like that. Always towing that line, I see. All right. What happens when they meet in the playoffs, though? Oh, I don’t know if you can use that stipulation, though.
Kevin Kroskey:
Well, it did happen since the Browns returned and after not having a team for a short period of time. They did meet in the playoffs. I can’t remember. It was 0:2 or 0:3. The Steelers did come out victorious, so I think that’s the ending I would prefer to see again.
Walter Storholt:
There you go. We’re getting you in all sorts of trouble with the Brown faithful here on the Retire Smarter Podcast, so we’ll take that as our cue to go ahead and end it before we stick our foot in it anymore, right?
Kevin Kroskey:
Smart man.
Walter Storholt:
For Kevin Kroskey, I’m Walter Storholt. Thanks for joining us on today’s edition of Retire Smarter, and we’ll look forward to talking to you on the next one.
Disclaimer:
Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.
