Monday, November 30, 2015

5 Ways to Increase Your Near-Term Retirement Spending Budget

In our post of August 31, 2014, Managing Your Spending in Retirement—it’s Not Rocket Science, we set forth a simple four-step process for managing spending:

Step 1:  Develop a reasonable spending budget

Step 2:  Determine your spending needs/living expenses for the upcoming year

Step 3:  Compare results of Steps 1 and 2 and make necessary adjustments to bring them into balance (i.e., reducing expenses, increasing the budget or some combination of these two actions), and

Step 4:  Rinse and repeat at least once a year.

For purposes of this post, we will assume that you have crunched your numbers, the result of Step 2 is larger than the result of Step 1 and you would prefer to increase your near-term spending budget rather than decrease your current living expenses.  We will look at some of your options.  Remember, however, that since you can either spend more in the near-term or you (or your heirs) can spend more later, you may not be all that comfortable increasing your risk of possible real dollar spending reductions as you get older under some of the more aggressive approaches below.  You can use the spending spreadsheets in this website to quantify the possible effects on your current spending budget of adopting these approaches.

  1. Find part-time work or other sources of income.  Perhaps the best way to increase your current spending budget is to go out and find additional sources of income.   This can involve a part-time job such as becoming an Uber driver or additional income from renting out one of your rooms through an organization like Airbnb.  If you are lucky, it may involve an inheritance from one of your relatives or friends.  It can also involve reverse mortgages or funds you expect to receive in the future from the sale of your home or from other assets. 
  2. Defer commencement of Social Security and/or purchase immediate or deferred annuities.  As discussed in previous posts, implementing these approaches (which involve mortality pooling credits) can enable you to increase your near-term spending budgets because some or all of the future expenses you previously needed plan for will be covered by these lifetime guarantees.
  3. Use more aggressive assumptions.  The recommended assumptions for determining a spending budget for 2015 under the Actuarial Approach were:  4.5% investment return, 2.5% inflation and an expected age at death of 95 (or life expectancy if greater).   The rationale for selecting these assumptions was discussed in more detail in our post of February 14, 2015, but suffice to say that many investment advisers would find a 4.5% annual rate of investment return (2% real) to be relatively conservative for most investment portfolios.  Also, until you reach your late 80s, the recommended expected lifetime assumption is longer than life expectancy, which could also be perceived as a conservative assumption.  I stand by my recommended assumptions (for the reasons noted in the February 14 post), but if you are willing to increase your risk of future real dollar spending decreases, you can develop your budget by running the spreadsheets in this website with higher assumed real rates of investment return and/or lower expected payment periods.
  4. Use more aggressive assumptions only for non-essential expenses.  This is a variant of item 3  for individuals who aren’t comfortable taking the risk of being too aggressive for all expenses, particularly essential expenses, but are more comfortable assuming an increased risk of declining future real dollar non-essential expense budgets.  Some experts believe that such expenses generally decline with age.
  5. Increase your budget by X%.  This final option is equivalent to making a conscious decision that you are going to spend what you want as long as it is within x% of your calculated budget.  Clearly if you do this on a consistent basis, you are more likely to experience decreases in future real dollar spending budgets, but this may not be a significant issue for you.  

Of course it is also important to remember that in addition to increasing the risk of declining real dollar spending later in retirement as a result of too much spending early in retirement, spending budgets can also go up or down temporarily as a result of investment performance.  If you want to stress test your spending budget for variations in investment performance, you can model future experience with the 5-year projection tab in the “Excluding Social Security V 3.0” spreadsheet.