How Retirement Spending Works in the Real World

On this episode of The Long View, Dan Haylett, financial planner and head of growth for TFP Financial Planning based in the United Kingdom, discusses financial planning, retirement planning, and his podcast The Humans vs. Retirement.

Here are a few excerpts from Haylett’s conversation with Morningstar’s Christine Benz and Jeff Ptak:

How to Figure Out Annual Spending Levels in Retirement

Ptak: How do you help your clients figure out their annual spending levels? What sort of system do you use to determine how much they can spend from their portfolio per year?

Haylett: I’m trying to think about how we’re wired to think. I don’t think most people entering into retirement like the word “budget.” It feels quite restrictive. So, we get them to create a spending plan, and that spending plan is broken down into basics—leisure and luxury expenditure—and we get them to think about the big-ticket items over the next 12 months, and three years as well, and that can be anything from new cars or house repairs or gifts or weddings or big birthdays or milestone moments. We get them to craft out that, as well as getting them to really think through those three phases: What does it look like immediately after retirement? What does it look like from the ages of 72 through to 82? And what does it look like from ages 82 onward? And I say to them, “Look, I have no idea what your heating bill is going to be like in five-and-a-half years’ time; neither do you. I’m not trying to crystal-ball this.” But I do know that our clients have a sense of direction when it comes to their spending patterns. You are going to be spending less on leisure activities in your 70s than you are in your 60s and less in your 80s than you are in your 70s. So, getting them to start to think about how spending changes through those phases is a really, really important part of understanding the annual spending levels now and in the future.

So, we then overlay that with forward-looking cash flow where there are some deterministic numbers around growth and inflation, which we are very, very prudent on. And I think it’s very dangerous to start chucking in some of these growth rates that I’ve seen on forward-looking cash flow because false confidence and straight-line certainty isn’t the thing that I’m into. We just don’t know. We use a backward-looking stress-testing system where we look at 108 years’ worth of economic data and investment returns and overlay what they want to do and then have a look at the success rate of those plans. I’m not a massive fan of Monte Carlo if I’m honest with you. I think the backward-looking stress-testing paints a better picture of how their plans fared during some of the worst and best times over the last 100-odd years.

And then it’s starting to educate them about evidence-based retirement timelines, that the concept of retirement spending falls naturally over the period but by about 1% a year. So, although inflation is obviously the silent assassin, I think that if we understand that our real-time spending falls in retirement, then we get much more comfort about what we might need going forward, understanding the concept of health span versus life span and the three phases of retirement. And how all the evidence supports that most retirees leave quite a big chunk of their money on the table and start to bring that to life through some of that cash flow planning, just to make sure that they understand what they can spend. And from a spending point of view, it’s entirely flexible. I’m not a believer of this 4% rule, 8% rule, 12% rule that’s been in the news lately as guardrails and all this stuff. I think there are some frameworks that you can put around things. But I’ve got clients that are spending 10% of their portfolio at the moment, and it’s not unsustainable because they’re not going to spend it forever. They’re just going to spend it for the next two or three years before Social Security or our state pension kicks in. So, it’s flexible spending based on what they want to do now, given that they understand that spending falls in retirement. I try and bring as much evidence to that as I do to my investment philosophy.

Worried About Running Out of Money in Retirement?

Ptak: Many preretirees are worried about running out of money later on in life. What steps do you take to try to allay those concerns to ensure that they spend appropriately during their retirement years?

Haylett: I think it comes back to the evidence-based retirement timelines. It’s making sure that there’s some evidence and factual stuff that we can present to them about what happens. And I know everyone is unique, and therefore we build standard “what-if” scenarios into our plans around investment declines and investment valuations, upticks in short- and medium-term inflation, the death of one of the spouses, and that kind of thing. So, we build in standard “what-ifs.” But then, it’s about listening to them. It’s about understanding what their fears are and how we can show them that through some of the planning work that we do.

And some of these don’t necessarily paint a pretty picture. I will always try and break the plans because the plans are wrong. We all know that. The plans are wrong at the moment created. So, I try and show them what breaks them. And more often than not what will break the plan is something they’re never going to get anywhere near, and so that gives them comfort. But I will say that this is not a money thing. I’ve got people that have got much more than enough, and they’re worried about running out of money. So, it’s a human problem, not a money problem. I think that by listening and building these “what-if” scenarios but making sure they understand that these are big-picture things that we have very little control over, but we can make some short-term decisions if the direction of travel doesn’t quite go to plan, then that concept really helps.

One other thing that I do to encourage them and people love is that I say to them, “Would you rather be in a position that I’m having a difficult conversation with you when you’re 78 to cut your spending?” Surely, that’s a better conversation. You’re in your late 70s, early 80s, and you’ve done some wonderful things over the last 15 years with your family. I would rather be having a conversation with you then about releasing some equity in your house or spending a little bit less on this and that. And I think putting that into perspective really helps.

Misconceptions About Retirement

Ptak: What would you say are some of the other big misconceptions that people embarking on retirement have? What do they get wrong?

Haylett: There’s one big thing for me, actually. I think the amount of time they have to truly enjoy their hard work. I think the longevity thing has been rammed down people’s throats to think that they are going to be alive for 40 years and need all of their money to last and they’re going to spend 20,000 pounds or dollars a year on leisure forever and we’re going to be alive longer. To take advantage of those go-go years and understand that our health span is different from our life span, I think that they definitely get that wrong. The misconception around health and life and the fact that they should always try and front-load the fun, and while we’re active and we can enjoy the time that we have whether it is big-ticket items or simple things like walking the grandchildren to school or being able to go for a nice walk and have a pub lunch. That time is not always given to us. It is borrowed. And our health, both physically and mentally, will absolutely decline and probably decline sooner and quicker than we all are going to plan for. So, I think they do have a real misconception of time when it comes to planning their retirement.