Scott Burns

In Retirement, Should You Eat Dessert First?

Play now, die later?

Most new retirees face that vexing question. They've got their bucket list of things to do. They want to do it now. But each item on their list will require spending more money than they can do safely. This is a real rock/hard place dilemma.

"I want to do these things now, while I can," reader letters say. "I don't want to have some future disability make it impossible."

Well, maybe you can do just that: budget an additional amount in the early years of retirement and spend less later.

One framework for thinking about this is the new taxonomy of aging. Where once turning 65 made you "old," demographers now identify three groups.

-- The "young-old" are those between 65 and 74;

-- The "old" are between 75 and 84;

-- The "old-old" are 85 and older.

The faces of the "young-old" adorn the covers of magazines for active retirees. Pictures of the "old-old" are found in the cautionary pamphlets in doctor's offices. The reality is that the young-old tend to have few disabilities; rising disabilities mark the period of being "old"; and being "old-old" is defined by living with disabilities.

And let's not forget the inconvenience of death.

While our financial planners are urging us to plan for a 30-year retirement, the actuarial tables give a much darker message. Take a broad group of 65-year-old Americans: 76 percent of them will be dead in 30 years. Does it make sense to live frugally for three decades to prepare for something that has only a 24 percent chance of happening?

To explore what more spending today costs in reduced spending later, I used a "consumption smoothing" program called Basic ESPlanner. The program allows you to enter your household and financial information, assumptions about inflation and return on investment, etc. It then calculates a smooth standard of living until you die at an advanced age, such as 95 or 100. The program calculates your annual Medicare premiums (which are rising faster than inflation), your annual income tax bill and other non-discretionary spending such as the cost of operating your home. Then it figures out a level amount of discretionary spending for the rest of your life. Here's a sample:

Pete and Pam Prudent have just turned 65 and retired. They have a combined Social Security income of $3,000 a month, $600,000 in retirement accounts, $100,000 as a reserve fund, and own their $250,000 house free and clear. Their house costs $13,000 a year to operate -- taxes, insurance, and $8,000 for utilities and other expenses. They assume a 6 percent return on their savings and a 3 percent inflation rate. If they aim for a level standard of living for the rest of their lives, Basic ESPlanner tells us they will have $46,062 a year -- after they've paid income taxes, Medicare premiums and shelter expenses.

If Pete and Pam decide they want to spend extra money each year traveling while they are still "young-old," how much will it reduce the amount they have to spend for their other expenses? Here is what the program tells us:

Level living standard.. $46,062...$0 reduction...No percent

reduction

$6,000/year for 10 years...$43,450... $2,612/year 5.7

$12,000/year fund $40,841 $5,221/year 11.3

$18,000/year fund $38,234 $7,828/year 17.0

$24,000/year fund $32,668 $13,394/year 29.0

$30,000/year fund $26,490 $19,572/year 42.0

$36,000/year fund $20,311 $25,751/year 56.0

A do-it-now fund of $6,000 a year required only a modest 5.7 percent cut in lifetime discretionary spending. The figure that got my attention, however, was the $18,000-a-year fund. That will buy a nice amount of travel every year for 10 years -- at the price of a 17 percent cut to their ongoing discretionary spending. Not bad.

Why did a 17 percent cut catch my eye? Well, it just happens to be the probability that a 65-year-old will be dead in 10 years.

Needless to say, all these figures will vary with the amount of Social Security income, retirement savings, pension, mortgage debt, etc. If you're trying to get a handle on spending in retirement, Basic ESPlanner is a really useful (and free) tool.

On the Web:

-- Basic ESPlanner website: basic.esplanner.com

-- Consumption smoothing column collection: assetbuilder.com/blogs/tags/Consumption+Smoothing/default.aspx?GroupID=6

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