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Will You Underspend in Retirement?

Vanguard's global head of advice methodology, Joel Dickson, talks with Christine Benz about not spending enough to enjoy retirement.

Christine Benz: Hi, I'm Christine Benz for Morningstar. Many retirees are terrified of running out of money in retirement, but they need to balance that worry against a competing consideration: underspending and not enjoying their retirements to the fullest. Joining me to share some thoughts on how retirees can strike the right balance is Joel Dickson. He's Vanguard's global head of advice methodology.

Joel, thank you so much for being here.

Joel Dickson: Great being here, Christine. Thank you.

Benz: Joel, when I heard we were sitting down, I wanted to discuss something with you that came up when you taped our podcast, our Morningstar podcast. And we were discussing this whole thing about retirement plans, sustainability, and people like you and me think a lot about how can we make sure this person doesn't run out of money. But you raised a really provocative point, which is that it's a big deal if someone way underspends during their spending horizon. So, let's talk about why you think that issue is under discussed.

Dickson: I do think there's been so much focus on the worry about not having enough resources during your accumulation years to then be able to meet a retirement approach, a retirement spending approach. And a lot of times, it's like, the headlines about people aren't ready for retirement, they're not going to be able to spend how they want, maintain their standard of living. And in many ways, I think that's overblown. Not to mean it isn't important! People need to think about, you know, what do I need for retirement. But where I look at it is that we have kind of the standard assumptions for how we define success and whether you will have sufficient resources to meet your retirement needs. And I think it's really important to look and understand what those assumptions are. And a big one in retirement is, the standard approach in advising around success and retirement: retire at age 65, plan for a 30 year or more retirement.

Benz: Right.

Dickson: And success is basically,do I run out of money by the time of the end of that planning horizon? So, for 100% of people, we are using a planning horizon of let's say, age 95 or age 100 to which less than 5% of people will probably actually survive--at least under current mortality assumptions. So that 5% case is extraordinarily, in some ways, conservative. Now, there will be people that make that…

Benz: Right.

Dickson: …that far and we need to worry about.

Benz: Right. Plus, there's a real connection with wealth and longevity, right?

Dickson: There is.

Benz: So, people watching us probably, I'm guessing have portfolios, they are wealthier individuals, they may be a little closer toward that 30 year time horizon.

Dickson: Yes, very much so, but at the same time, even to the extent let's even say it's 10% of people that make it that long. In many ways, you're going to have not so much of retirement savings crisis, but a retirement spending piece of, there's going to be money left over. Not a bad thing necessarily, but you know, it's more of, could you have enjoyed that during your lifetime, in a different way? And I think it gets back to working with your advisor or talking with yourself, your partner, and so forth about what does success look like in retirement? What is it that I want to accomplish and achieve? Because what I call the "bounce my check at the funeral" approach, which is, hey, do I run out of money by the time I'm age 95 or 100? And I'm just going to spend to that piece, right? Actually, it doesn't reflect how people have generally, at least how we've seen people spend money in retirement.

Benz: OK, so have that discussion about whether a bequest is a big deal to you. If it's not, then you may want to spend a little more actively from the portfolio, or how should you approach that?

Dickson: I think especially in the early years of retirement, those are the years that most people can enjoy the spending. There's often another part of the assumption in the whole planning process of, I have this 85% number of my final income, that I'm trying to target. And it's going to grow with inflation. You know, in terms of what I'm spending in retirement. What we see in terms of actual spending, all those things like healthcare spending, tends to increase over the retirement period. Overall spending tends to decline in inflation-adjusted terms. So, what we end up seeing is actually--and in part, my 80-year old parents are very much in this situation right now--it's not that they don't necessarily want to spend, but they don't really have the ability to spend on things, like they just can't go on trips in the same way they did or come visit the grandchildren in the same way that they did. And so those types of physical, mental limitations and so forth as we get older. One question is whether that spending can be shifted a little bit early. So maybe you spend a little bit more in early retirement years when you may be more able to do that, recognizing that your spending will probably adjust automatically or you may adjust it based on resources as well later in retirement.

Benz: Right. So one other complicating factor--and we could talk about this all day--if the market is not so great in your early retirement years, when you were hoping to really do a lot of your spending, that can be a problem, especially if you are needing to spend from an equity portfolio that's declining.

Dickson: Yeah. It's interesting because, this whole sequence of returns question, which is that point: Does it matter when the returns of the market happen in terms of your own retirement journey? I actually still see that as a longevity question not so much as a market question, which is that sequence of return only matters if you live a long time. If you only end up living to 85, then the sequence of returns if you have otherwise been said to be sufficient to age 95 or 100, the fact that you live to 85, probably that sequence of returns isn't as important. So, it's ultimately a longevity thing. And can you think about ways to protect against that longevity risk while still spending from your portfolio in a way that just doesn't say, I'm going to forgo spending now because I'm worried about potentially running out of money later.

And that's why things like, think about, we talk in a kind of a Vanguard global retirement framework standpoint, about different buckets of money--not buckets in the ways the same way, Christine, that you talk about it for investing. But in terms of things like your basic level of income or discretionary income or spending. We kind of bucket that all together when we talk about, oh, you have an 85% chance of not outliving your resources. But probably what most people want is 100% chance or as close as possible to being able to meet the basic everyday living expenses. Yeah, I've got some sort of roof over my head, I've got the food, I've got my basic medical needs taken care of.

Benz: Don't have to move in with the kids.

Dickson: Exactly. It's the "don’t be a burden," sort of, "I don't want to be a burden to someone else" piece. If the discretionary pieces now, on top of that, it's like, well, yeah, OK, I'd love to do it. But if I can't, I'm still not being a burden. That piece of it I think, thinking about it from that standpoint and focusing on what's the basic level of income that I really need to insure against, and that's being the first piece. And that may be covered by Social Security, it may be covered by you having defined-benefit income, you might even early in your years work part-time. There are any number of ways.

Benz: Use an annuity perhaps in that context.

Dickson: Use an annuity, exactly. Potentially also long-term care insurance in retirement to, I guess, again, managing some downside risks, although that market is complex and probably needs some guidance...

Benz: Right.

Dickson: ...In looking at that. But there are a number of things that, if we focus on what's the kind of basic level of income, that then frees up, kind of the flexibility in the discussion for other sources of income and how you then think about enjoying that, and maybe you can even then front-load some of that early in the retirement years.

Benz: OK, Joel, great insights. Always great to hear your perspective. Thank you so much for being here.

Dickson: Thank you, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.