Ep 4: Rules Gone Awry – Spend 80% Rule of Pre-retirement Income

Ep 4: Rules Gone Awry – Spend 80% Rule of Pre-retirement Income

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.

Prefer to read? See below for the transcript of the show.

Subscribe To The “Retire Smarter” Podcast:

Click the below links to subscribe to the podcast with your favorite service. If you don’t see your podcast listed with your favorite service then let us know and we’ll add it!

The Host:

Kevin Kroskey – AboutContact

Introduction:                     00:03                     Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to Retire Smarter.

Walter Storholt                 00:14                     Thanks for joining us on another Retire Smarter podcast. Walter Storholt here alongside Kevin Kroskey.

Walter Storholt                 00:19                     He’s the President and Wealth Advisor of True Wealth Design serving you throughout Northeast Ohio with offices in Akron and Canfield. You can find us online at TrueWealthDesign.com Kevin hope things are going well for you this week. Great to chat with you once again.

Kevin Kroskey                    00:33                     Likewise, Walter, things are well professional football season is back in and I’m happy. Yeah.

Walter Storholt                 00:38                     Yeah. As we record this, you’re geared up for another season and are you a Browns fan? I mean, is that pretty much a given?

Kevin Kroskey                    00:44                     Walter don’t insult me, please. I’m a Steelers fan.

Walter Storholt                 00:47                     Steelers fan. Okay. All right. I didn’t know they’re in that kind of that Northeast Ohio area, aren’t you? And it’s divided loyalties there, right?

Kevin Kroskey                    00:53                     No, I mean we’re in the heart of Brown’s country here in Akron. Our Canfield office is closer to Youngstown is kind of the dividing point but I grew up in Western Pennsylvania and came out here for grad school, you know, more than 20 years ago and been here ever since.

Kevin Kroskey                    01:06                     So obviously love it out here. That’s why I stayed. And the cities are very similar. I mean they’re, they’re still very, they’re gritty cities.

Walter Storholt                 01:14                     Well that’s what leads to good rivalries, right?

Kevin Kroskey                    01:16                     Yeah. Well, maybe we used to have that. I’m not sure it’s coming back. There’s only one way to go. Right? That’s right. That’s right.

Walter Storholt                 01:24                     Oh man, that’s too funny. Well, so the local area has adopted you though, right? They don’t hold it against you that you’re a terrible towel waver.

Kevin Kroskey                    01:32                     We have some fun.

Walter Storholt                 01:33                     So as long as it stays at that level.

Kevin Kroskey                    01:36                     Yeah. No, completely. Completely. I do, believe it or not, I do root for the Browns when they’re not playing the Steelers. They need all the rooting and the helping that they can get.

Walter Storholt                 01:43                     There you go. Well as a fan of, I live in North Carolina, but I’ve been a fan of New Jersey and New York sports teams my whole life.

Walter Storholt                 01:50                     So I know the feeling of being a little bit of that outsider, but the same thing, you root for the local team as long as they’re not playing the one that’s in your heart. So, we will allow that. Well, we to use a fun pun, we’ll try to deliver some hard-hitting financial information on today’s show in honor of the beginning of football season. But actually we’re going to try and boil things down into a much easier to understand approach here 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, you know 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, for how much income you’re going to need in retirement? How does that conversation usually shape up with folks?

Kevin Kroskey                    03:04                     Yeah, if it’s accurate, it’s usually by chance rather than by design. So, it’s one of those rules though, and there’s about seven that I’ve identified and I’ve 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 preretirement income in retirement. And basically, the theory goes that, Hey, you’re not saving in your 401k or your IRA, you’re not paying payroll taxes anymore. So you don’t need a hundred percent you only need 80% and I say that that is only going to be accurate by chance, just based on a lot of experience and actually looking at the numbers for several, you know, 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.

Kevin Kroskey                    04:00                     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. 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, you know, a middle America is basically household income less than $60,000 a year. So it’s not that much money. And middle America generally, you know, those typically aren’t our clients. So for those people, the middle America people, you know, that probably holds true, you know, they’re going to need or spending their take-home pay. They’re going to need to keep spending it all the way throughout retirement and are going to have some costs that are increasing.

Kevin Kroskey                    04:47                     But those people are really, typically the only people that it does apply for unless it’s purely by chance.

Walter Storholt                 04:53                     Okay. So purely by chance is where you will find that 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                    05:09                     You have to tell your mom she needs to run the numbers. Walter, I’ll break it down by some categories here. So, I talked about how the savings and the payroll taxes are going to go away, but I think about some other changes that you’re going to have in retirement. So, one of the biggest ones is health care is going to be different. So, you may go in and beyond, say Cobra and stay on your employer plan for up to 18 months after you retire.

Kevin Kroskey                    05:33                     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 a $100 or $200 her pay or a couple of 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. So that’s one of the biggest things that people wake up to. Where you know retirement is definitely different and health insurance is one of those big things. 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 is going to kick in at 65 and 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.

Kevin Kroskey                    06:17                     But that being said, you know that’s a big difference because when you’re working, the health insurance is being subsidized generally by your employer and also be deducted pretax 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                 06:17                     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? 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                    07:06                     Yeah, you are. And you know it’s very customized. We’re all different and we all have different, you know, means and desires and goals and dreams. But you know, 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 buckets. Certainly health insurance as part of that bucket. But that bucket for health insurance anyway is going to increase at a faster rate. Then other expenses that you’re going to have. So the other things that are in the needs bucket, I always like to say, you know, heating the house, food in the belly, you know, gas in the car, those sorts of things. Pay your property taxes, what have you. And those are the things that really do increase a kind of a normal trend line inflation rate.

Kevin Kroskey                    07:47                     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 two or 3%, probably closer to about 5% what the averages have been over the last several decades for health insurance costs increases. But those expenses right there, you’re going to have to measure them. You know, there are 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 the health insurance is going to ultimately comprise a bigger portion of your spending. You know, as you age, you’re going to use more care in your later stages of your life.

Kevin Kroskey                    08:28                     That inflation rate is going to keep them driving those costs higher and higher at least until that trend changes. It’s been that way for quite some time. 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’re working. Maybe you’re going to go in and you’re going to a lot more and we have a lot of clients that we’ll actually have a few different travel goals in their plan. One of them may be a much higher travel expense in their sixties and start paring it back in their seventies and maybe it’s just going to Florida in their 80s or something like that.

Kevin Kroskey                    09:11                     Others, you know, may have periodic goals for a big 50th wedding celebration or a wedding for their daughter or further 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. All those things that I just talked about outside of the needs bucket, you know, 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 know, 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.

Kevin Kroskey                    09:52                     You’re going to be putting less mileage on them, you’re going to be driving more with your spouse and you know, as you age, your expense on vehicles becomes less and less as it is on clothing and some other items. So not only are you going to have needs that are going to be around and these other expenses that are going to happen from time to time that is also more discretionary. After all, you know, paying 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 is going to change over time. And you can really see a sort of banding approach as you age more commonly, maybe.

Kevin Kroskey                    10:30                     Somebody says, Hey, the 60s or the go-go years, the 70s or the slow-go years and the 80s are the no-go years. But that keeps getting pushed back too. Yeah. You know.

Walter Storholt                 10:38                     Tell that to my 80, 85-year-old grandparents.

Kevin Kroskey                    10:41                     Yeah, yeah. I mean, exactly. And I’m, hopefully, I’m disproving that when I’m in my nineties and maybe in my hundreds, you know, I have a goal for that.

Walter Storholt                 10:48                     That’s just a super slow slow-go phase.

Kevin Kroskey                    10:51                     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 eighties and even in their nineties

Kevin Kroskey                    10:59                     Now getting there and back and forth and may prove a little bit more challenging. They need to rely on, you know, their kids or something like that. But there’s still a lot of people that do it and kind of disprove that sixties, seventies, and eighties, go-go slow-go, no-go.

Walter Storholt                 11:13                     My grandparents in their mid-eighties 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 along the South 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-eighties. 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 you know, 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                    12:11                     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 and 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 know you have a mortgage, then it goes away or you have a pension but it doesn’t keep up with, you know, inflation and maintain your purchasing power over time. And very quickly you start seeing where a simple rule like 80% of your pre-retirement income now falls by the wayside for many people. Once you start getting beyond 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.

Kevin Kroskey                    13:05                     And even if you don’t have a lot of those as you age, things are still going to change over time. And that’s very, very clear from different spending data that we have from like 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 there. I believe the largest bank in the country and maybe the world that they did a study showing that your peak spending typically is reached at age 45 and trends down from there. And so when you’re 45 you probably have the kids, they’re in school or college or something like that. You know 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 you know from 45 on it starts trending down and specific retirement research.

Kevin Kroskey                    13:51                     There’s a gentleman by the name of David Blanchett who’s the head of retirement research at Morningstar 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 the age. And one of the things that apply to a lot of the clients that we serve is say a high-income retiree as they go through their sixties, seventies, and eighties even as they’re slowing down, you know, maybe they’re not spending as much money on themselves for their own experiences, their own travel or taking, you know, family on a family vacation or whatever it may be. They’re spending maybe that similar or even the same, but the character of it changes. They’re giving more money to charity. They’re maybe giving money to the 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.

Kevin Kroskey                    14:50                     I’m good. You know, I’m going to have more money. Some of this money that I have is going to be left. I’m okay to start doing some of this. So when you actually look at their spending, even if it’s the same, the character of it has changed. And I would say when you look at something like that, we would put that in 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 eighties and they’re going to, 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. You know, have some fun, do some more trips, do this, do that.

Kevin Kroskey                    15:30                     But then you know, 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                 15:40                     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 nonfinancial 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                    16:03                     Yeah, everybody’s different and I mean that’s one of the cool things about, you know, just working with people, getting to know them and getting to understand them and then, you know, tailoring the advice to them.

Kevin Kroskey                    16:19                     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, you know, 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 will pick up in a future conversation. But how is it going to change over time? One of the things that Blanchett found in his article and we found this in practice, you know 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                    17:11                     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 projected forward on a linear fashion, which if anybody’s doing planning, that’s 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                 17:46                     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, you know, another one of those retirement rules gone awry. As 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 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                    18:15                     You know that rules, these retirement roles, 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 know, 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 the Susie 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, you know, middle America that does have fairly well-paying jobs that have been able to save a lot and do have discretionary income. That advice Susie Orman, Dave Ramsey 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 that you don’t feel comfortable doing or you know you’re doing it, but you’re not sure if you’re doing it right or what you’re missing and 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                 19:16                     If you would like to get in touch with Kevin Kroskey and the team at True Wealth Design offices in Akron and 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 at (855) TWD-PLAN that’s (855) TWD PLAN or the number version (855) 800-893-7526 or the best place to do it probably for you as 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, a 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. 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                    20:26                     Well, I hope Cleveland goes 14 and 2 with or two losses to Pittsburgh and everybody will be pretty happy.

Walter Storholt                 20:32                     There you go. There you go. I like that. Always towing that line. I see already what happens when they meet in the playoffs though. Oh, I don’t know if you can use that stipulation though.

Kevin Kroskey                    20:41                     Well you know it did happen since the Brown’s returned after not having a team for a short period of time. They did meet in the playoffs. I can’t remember. It was 2002 or 2003 and the Steelers did come out of victorious, so I think that’s the ending I would prefer to see again.

Walter Storholt                 20:55                     There you go. We’re getting you in all sorts of trouble with the Brown’s faithful here on the Retire Smarter podcast, so we’ll take that as our cue to go ahead and ended before we stick our foot in it anymore. For Kevin Kroskey, I am 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:                                                          The 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 references historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.