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Before we begin, know that these seven conversations are based on the book “The 7 Most Important Equations for Your Retirement” by Moshe A. Milevsky. You should definitely check it out!
Now, let’s dive into the key conversations to get your retirement planning started.
1) How Long Will My Money Last?
Given a specific interest rate, a starting principal amount, and a fixed monthly withdrawal amount, you can estimate how long it will take your balance to drop to zero.
A lot of people walk into our office with an Excel spreadsheet where they project their future retirement income with the help of interest rates.
Although that’s a decent starting point, it’s not enough to build your entire retirement plan.
You can never know, with full certainty, how interest rates will fluctuate in the future or for how long you expect to live.
So, you cannot base your retirement decisions on a single Excel spreadsheet — at least not without running through the next six conversations!
2) How Long Will I Spend in Retirement?
This is just another way of saying, “How long do I expect to live?”
As Moshe has rightly said, “One thing is clear: Your remaining lifetime is a random variable. It’s impossible to predict with certainty how long you will live.”
But you can always look at the estimated life expectancy rates. Actuaries Longevity Illustrator is a great tool to help you do so. If you’re entering retirement as a couple, make sure you look at your joint life expectancy i.e., the probability of either one of you making it to a certain age.
There are also two risks you need to consider:
- Passing away too soon: If you don’t make it to your estimated life expectancy, a lot of your money might remain unspent. It’s important to plan for what happens to that money. You might also need to think about the surviving spouse benefits if you’re a couple.
- Living longer than expected: If you live longer than expected, you might face the risk of running out of money.
Thinking about longevity is a critical part of making smart financial decisions.
3) Is a Pension Annuity Worth It?
When it comes to pension, you often have two huge decisions to make:
- The timing of your pension: This doesn’t have to be the same as the time you retire. For instance, you can retire at 55 and let your pension payout grow until you’re 60. The timing of your pension is crucial. Even one month can make a huge difference in some cases, such as taking it before your birthday vs. immediately after your birthday.
- Lump sum vs. monthly payout: Comparing a lump sum with a monthly payout is not a suitable comparison. It’s like comparing apples with oranges! You need to first convert both into monthly terms (or both into lump sum) to identify the better option.
4) What Is My Proper Spending Rate?
Clients often ask us, “How much can I withdraw every year without the risk of running out of money?”
A lot of people simply go with the general 4% rule of thumb.
However, taking a fixed amount every year might not be the best strategy. As time passes by, you might need to withdraw more to account for inflation.
Plus, it also depends on what Moshe likes to call “your rate of patience.” It refers to your willingness to delay your withdrawals.
Some people prefer to take the money upfront while others patiently wait for the money to grow over a period of time. The earlier you choose to take it out, the lower you might receive. This is because of a concept in finance called the “discount rate.”
For example, $100 after one year might be worth only $50, $75, or $99 today depending on the discount rate.
Your spending rate might also be affected by the probability of you surviving to the next year. Most people forget to factor in this probability. We would love to see a client spreadsheet that accounts for this!
In addition to the longevity uncertainty, your attitude towards such uncertainty is also important. This means choosing between “I might not make it that far, so I better live now” and “I’d hate to run out of money later, so I better save now.”
Finally, it’s likely that you’ll need to spend less during the later years of your retirement. During that time, your biggest spending needs might arise from health expenses or long-term care, both of which can be addressed through insurance.
Based on all of the above factors, it’s prudent to adjust your spending rate with time during the different stages of your retirement.
5) How Much Should I Set Aside for the Risky Stock Market?
If you’re consumed with the thought of how much money you have in your bank account or stock investments (your financial capital), pause for a moment and think about your “human capital” — a concept by Paul Samuelson.
It’ll make you realize that you’re wealthier than you might think!
You might have a salary, a pension, and Social Security to your name, all of which goes away after you pass away. So, they can be said to be part of your human capital.
If you have a large human capital, the short-term ups and downs in financial markets should not be of a big concern to you. As a result, you might be able to take more risk in stocks.
The “stocks vs. safer investments” decision also depends on your personal risk tolerance. The more risk tolerant you are, the more risk you might be willing to take.
6) What Is My Financial Legacy Today?
This is a good time to have a conversation around insurance.
Ask questions like: What is the present value of the death benefit your beneficiaries might receive 20 years from now?
In the life insurance world, this is called the “human life value” i.e., your personal value today as a financial instrument. Don’t simply say, “I want to leave money for my kids.” Think about exactly how much money you want to leave them. This will help you determine your ideal life insurance policy.
7) Is My Current Plan Sustainable?
Here, you tie all of the above conversations together.
Consider all of the potential causes of uncertainty from previous conversations and compute the probability that your plan is actually sustainable.
However, don’t get carried away with minimizing the “probability of ruin” i.e., the probability your plan will not succeed. The outcome of a retirement plan is not a pass/fail binary.
For example, if a software tells you that there is a 20% chance of failure for your retirement plan, it does not necessarily mean a complete bankruptcy. Even if you overspend or underspend by a dollar, it might be considered a failure!