Older Americans preparing for the move from work to retirement face a big challenge: How can they enjoy the fruits of their labor while making sure they spend at a sustainable level?
Research finds the most popular spending frameworks, such as the 4% rule, are about as likely to cause overspending as they are to cause underspending for any given retiree. Plus, popular spending rules often fail to account for changes in lifestyle experienced by nearly all retirees as they age and navigate the latter stages of life.
This "decumulation challenge" represents one of the biggest opportunities for financial professionals who want to deliver exceptional value to their clients, according to Mark Berg, founder of and lead advisor at Timothy Financial Counsel.
Helping clients answer the spending question is part art and part science, says Berg, who was featured last week in Morningstar's The Long View podcast, hosted by Christine Benz and Jeff Ptak.
During the discussion, Berg dug into the emerging concept of the "retirement spending smile," popularized by the researcher David Blanchett. Berg also encouraged other advisors to avoid "set it and forget it" income planning.
According to Berg, Benz and Ptak, advisors can help their clients make the most of retirement by embracing more flexible spending strategies that more accurately reflect peoples' lives in their later years. This would allow clients to adjust their spending over time in a way that supports lifestyle goals while also keeping the risk of running out of money at bay.
Nuts and Bolts
In Berg's experience, the start of any spending strategy is to identify what level of guaranteed fixed income a client will have coming in from sources such as Social Security or a pension. This income base can then be compared with the client's lifestyle, their portfolio mix and their blend of pre-tax and post-tax wealth.
According to Berg, many retirees who have the means and wherewithal to engage with financial advisors are actually in a better position than they anticipate, meaning they may significantly underestimate their personalized sustainable spending rate.
"We are finding that we are typically doing more to encourage spending than we are to discourage spending," Berg says. "Many people come to us living so well within their means that their actual withdrawal rate is only 1%, 2% or 3%. They could be spending more."
When advisors run the numbers, Berg explains, a 4% to 5% annual withdrawal range tends to be sustainable, especially if the plan is consistently monitored and cuts in spending are made if there's a bad year or two in the markets.
This level of spending often means clients early in retirement can take trips and make purchases they've dreamed about. In many cases, advisors can help such clients spend confidently by implementing (and repeatedly stress testing) a dynamic spending strategy with pre-defined floors and ceilings.
