The other day a dear family friend asked me if she was able to retire. After reviewing the person’s retirement plan I came to some interesting conclusions. I do not plan to normally do case studies on this blog, but I thought this one was interesting enough to be of some benefit. So without further ado, a case study in early retirement planning.
Jane’s Retirement Assets
My family friend, we’ll call her Jane to allow her to remain anonymous, is in her late 60s and single. Jane has worked an average career over the last 40 some years and is nearing the end of the road. Jane has not been particularly financially focused up until now. She has some legitimate concerns on whether she can retire. So let’s first look at Jane’s assets.
- A pension worth a lump sum of : 500K or 38K a year in non inflation adjusted payouts
- A Roth IRA worth: 300K, 90% in bonds.
- A paid off home worth: 180K
- Social Security Payments worth about $2,788 at 66 or another 33K a year.
Jane’s Health In Retirement
Jane is in decent health and will have a company provided retirement healthcare plan. After much arm twisting I managed to determine she spends about 70K a year, though she has never controlled her spending or had a budget. Jane has no debt. Knowing all this the first thing is to determine what to do with the pension and how that factors into her retirement plans.
Jane Does Not Know Her Spending: Pension Ramifications
Normally I would recommend a person decent at investing take the lump sum. When invested the lump sum will undoubtably return more than if she took the annuity. In fact if she lives 20 more years and averages the S&P 500s average return of 7%, she will come out nearly 50K ahead in NPV. You can use this nifty calculator to evaluate a lump sum versus pension. So clearly mathematically the Lump sum comes out ahead. I have almost never seen it not. After all the stock market has a risk premium over a riskless annuity.
Jane Does Not Know How To Budget or Invest
But, Jane has no experience with budgeting. She has 46 years of fly by the seat of her pants spending. In fact she could not tell me how much she spends a year. I had to calculate it using her checkbook. If she were to take a lump sum, she would have only her own self control to ensure the money lasted through the remainder of her life. Also Jane has been 90% in bonds since the financial crisis of 2008. Even if we remove this investing error, this still indicates her risk tolerance adjusted return It would be far below that of the market. Given the personal history of Jane with money I’m going to have to recommend she is better off with the pension payouts.
Jane’s First Year of Retirement is Covered By Social Security and Pension
What this means is she will receive $71K a year in pension and social security payments a year if she pulls the plug after turning 66 in 2018. This is more than her current spending of $70K. So at least for the first year she has enough to support herself.
What about future years?
While her social security is adjusted for inflation her pension is not. As such she will need a way to cover inflation for the majority of her income. Her social security does this partially but her pension does not.
Roth As A Legacy
In talking to Jane she is convinced the Roth IRA is her legacy to her children. As such she does not plan on touching this account in retirement. Given it’s size it would not add sizably to her number of years of retirement coverage, but it would offset the missing inflationary aspect of her pension. As such I recommended an allocation such that the equivalent of one year of expenditures from the pension is in a cd ladder. The goal would be to cover inflation on the pension over time (if needed). The remainder I had her invest in large cap index funds for future generations. This should ensure she has enough to cover inflation while maximizing her heirs inheritance. If needed for inflation adjustments she can touch the gains on the cd ladder only to pay for the needed funds.
Auto Pilot Retirement Accounts
I also had her put the account on auto pilot and forget the password for now such that she does not adjust the investment allocation due to market swings. Honestly I doubt she will need to touch this money as most studies indicate a decline in spending in retirement. That being said giving her the piece of mind to allow the remainder of the funds to sit in stocks is a tradeoff worth taking.
Her home is paid off, and other then maintenance, taxes, and other such things does not factor into the equation. She should not need to touch her equity for the foreseeable future. There may come a time when she needs assisted living or such. If ever needed her home can help with this potential added cost. Alternately it can be passed to her heirs. I did not recommend any type of additional life or long term care insurance for her as a result of this and the Roth IRA.
So is Jane Ready to Retire?
The answer from a financial analysis screams yes, Jane is ready to retire. She can cover expenses now and for the foreseeable future using her pension and social security. But… Ultimately the answer is no, Jane is not ready to retire.
The Really Important Question: What is Jane Retiring To?
I spent hours with Jane talking through her finances and ensuring she had sufficient funds. I figured out exactly how much she spent a year, helped her with investing her Roth, obtained her social security payout information, and even evaluated her pension payout options. But initially I missed the most important question, if she were to retire what did she plan to do.
Jane couldn’t answer the question. Most of her friends would still be working. Jane does not have a lot of on her own hobbies or goals. At the moment Jane has no idea what she would do in retirement. And that’s a bigger problem then the finances frankly.
Retire To Something
We all have seen it. The person that retires and is bored out of their mind. Or worse, the person who retires and then kicks the bucket a few months later. The sad thing is a lot of these people have a similar thing in common, they didn’t retire to something. No, they don’t need to plan every day out. But everyone needs a reason/purpose to get out of bed in the morning.
Retiring because you are tired of work or it is time because society says it is will end up in a very poor retirement indeed. Retiring to practice your hobbies, spend more time with family, travel, or whatever is what will result in a higher quality of life. As I probed deeper I determined that Jane was not retiring to something, but instead doing so because it was the social norm. In fact in some ways Jane was more looking forward to her work activities over the next year then her time off.
Spend Some Time Finding a Retirement Purpose
Ultimately my advice to Jane was to not set a retirement date just yet. Instead spend the next few months determining a series of hobbies or goal she might want to pursue during retirement. Only once she has something of a purpose post retirement should she consider pulling the plug. Jane is working on that what as we speak. For now she will give one more year while she figures out how to maximize her life with or without work.
Remember, life is a journey. Work or no work, we all need a reason to get up in the morning.
What do you think? Should I have given Jane a different feedback? Do you know your something in retirement?