Retirement Roulette

Jonathan Clements  |  Nov 25, 2023

IT’S HARD TO OVERSTATE how challenging it is to generate retirement income: We need our money to last at least as long as we do, and yet we don’t know how financial markets will perform, what the inflation rate will be, whether we’ll get hit with hefty long-term-care costs and how long we’ll live.

Moreover, the generic advice offered inevitably doesn’t work for many—and perhaps most—folks because we all start retirement with different attitudes, goals and financial resources. For proof, consider seven issues.

1. About the kids. If our retirement needs and wants were relatively modest, and hence we could cover all expenses with our monthly Social Security check, we’d be in great financial shape. After all, we’d have a government-backed inflation-indexed stream of income that’s paid until the day we die—and that, arguably, is as good as it gets.

Yes, even Social Security has drawbacks. First, Congress could cut benefits, though I can’t imagine that ever happening, given that politicians have a fondness for reelection. Second, the national standard of living rises not with inflation, but slightly faster, with per-capita GDP. That’s why many retirees feel financially pinched, especially later in retirement.

But there’s also a third key drawback: Even if Social Security could cover our entire retirement costs, there’d be nothing left for our children, nieces, nephews and charity—and bequeathing money is an important goal for many. Where we position ourselves on the spectrum from “strong bequest motive” to “die broke” can make a huge difference to how we manage our retirement finances.

2. How optimistic we are. If we knew our end date, managing our retirement finances would be a cinch. The reality: Unless we’ve lived a life of total debauchery or our current health is downright awful, it’s hard to know how long we’ll live. What about family longevity as an indicator of our own life expectancy? We might imagine our parents and grandparents are a great guide to our longevity, and yet genetics might explain just 25% of the variation in lifespans—and perhaps as little as 7%.

The bottom line: It’s awfully hard to know how long our retirement will last. Like saving too much for retirement, there’s no financial harm in assuming we’ll live to a ripe old age. By contrast, there’s great risk in assuming a short retirement. What if we do just that? Before we start spending merrily, we should at least have a backup plan in case we live longer than imagined. Did anybody say “reverse mortgage”?

3. Risks we hate. The biggest risk in retirement is running out of money before we run out of breath. But that’s hardly the only financial danger. Every key financial decision in retirement involves risk. The question is, which risks are we willing to take?

For instance, if we delay Social Security, buy income annuities and take any pension as a monthly payment, we run the risk of dying early in retirement and leaving big money on the table. Meanwhile, if we claim Social Security early and take our pension as a lump sum, we’ll have a fatter nest egg, at least in the initial retirement years. But there are also dueling risks—the risk of sharp short-term losses if we favor stocks and riskier bonds, and the risk we’ll lose ground to inflation if we’re too conservative.

4. Income we want. The popular 4% withdrawal rate is based on withdrawing 4% of our nest egg in the first year of retirement, and thereafter stepping up the sum withdrawn each year with inflation. Is 4% the right number? Those of us without a crystal ball have no idea.

More important, we should be skeptical of the notion that steadily growing lifetime income can be generated from volatile investments. And even if it’s doable, most retirees won’t do it. Instead, faced with a market crash and accelerating inflation, their instinct will be to spend less—and that’s a good instinct, I’d argue. My advice: Treat the 4% rule as a guideline and not a withdrawal strategy to be followed robotically.

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