Will You Run Out of Money in Retirement?

Everyone wants to know if they’ll have enough money to last through retirement. So, how can you tell?

The true value of a financial plan comes from testing its resistance under difficult conditions. To do this, financial advisors often conduct a financial “stress test.” The test examines how a financial plan will fare during a significant future event, such as a recession or major geopolitical crisis, and allows you to adjust accordingly.

Based on our experience conducting these tests, here are four areas to discuss to ensure your plan will hold up:

1. What’s the growth rate you’re using in my stress test?

Many financial advisors build a conservative growth rate into their projections—5% annual growth is commonly used. While changing the growth rate by even a couple of percentage points may seem irrelevant, it can monumentally alter the trajectory of your projection.

A 5% annual rate of return is generally feasible for a financial stress test, but we believe anything significantly higher becomes unrealistic for many investors. Research has shown that investors often lose a significant chunk of their annual returns as the result of mistakes such as poor investment selection and emotional trading.

Even if you’re working with a wealth advisor who can help steer you away from these common pitfalls, we believe it’s best not to risk inflating your projected future assets, which could ultimately leave you with a financial shortfall.

Our approach: Lean toward conservative growth assumptions to ensure a financial plan can withstand the unpredictability of future returns.

2. How are you accounting for inflation?

It’s not surprising that $100,000 had greater spending power in 1950 than it does today. This can be seen in something as simple as the price of milk, which in 1950 was about 83 cents per gallon. Today, the average price per gallon is around $4.00.

Some expenses experience higher inflation rates than others, such as health-care or education, so accurately projecting inflation is important when developing your financial projections. Otherwise, your financial plan may misrepresent your future reality.

Our approach: Since the cost of living will rise in the future, we account for inflation in our financial projections. While we recently saw a rapid increase in inflation, historically, it has ebbed and flowed with underlying economic conditions. To adequately capture purchasing power risk in our projections, we typically assume an annual inflation rate of 2.0% to 4.0% for most general living expenses.

3. Are my annual spending plans in retirement accurate?

Let’s assume a client reports to her advisor that she’s been spending around $120,000 annually, or about $10,000 per month. When this client is asked to map her annual expenses, the advisor discovers that it was actually closer to $140,000.

The additional $20,000 per year came primarily from home improvement costs, roughly $500 a month on takeout orders and online shopping, and other miscellaneous expenses that were overlooked. Everyone will have their own “hidden” or unaccounted-for expenses, but you get the point.

If the client took no corrective action, this higher spending rate would’ve severely affected her income in retirement. Rather than lasting through age 95 (as many financial plans target), her assets could be depleted at a much younger age. Using this information, a Corient Wealth Advisor would work with the client to try to find ways of getting her back on track toward meeting her financial goals.

Our approach: Overestimate annual spending levels in anticipation of future unknown costs. While everyone’s lifestyle choices and spending situations are different, projecting an extra 5% to 10% in annual expenses allows the plan to cover unexpected costs down the road.

4. A whole array of other uncertainties

Stress testing your financial plan will help you plan for other uncertainties in the future. We know the stock market has been volatile in years past and will likely continue to be in the future. There will be future recessions, and there will be future geopolitical events that will impact the global economy. We may not know when these events will occur, but we do know they will occur. And when they do, they will impact your financial plan.

Our approach: Build flexibility into your financial plan to account for various uncertainties. This includes considering different market scenarios, potential changes in tax laws, unexpected health-care expenses, and other life events that could affect your financial situation.

The future may be unpredictable, but your plan doesn’t have to be. A Corient Wealth Advisor can help you stress test your retirement income strategy under real-world scenarios and adjust course as the economy, the markets and your life evolve.