Here's a question I get asked from time to time, "Why do I need a a plan? If I’m 65, expecting to die at 85, why can’t I just put everything in cash and spend 5% a year until I die?"I call this the “‘No Plan,’ Plan.”
I'll admit, the sheer simplicity of this plan has a certain appeal. Why not go this route, particularly if you've accumulated a healthy nest egg, have minimal debt, and an affordable lifestyle? The problem though, is that this "Plan" is subject to several important risks, any one of which could ruin your financial independence and quality of life.
Let's say you $1,000,000 of assets in your 401k. You figure you can live on $50,000 a year (or roughly $4000 a month). At the same time, you might not be very comfortable with the volatility of the stock market. On the surface, this plan looks like it could work.
Inflation is the most obvious problem with this plan. Even over a 20 year retirement, 3% inflation leads to a 45% loss of purchasing power. That means 45% less groceries, gas, electricity, travel, and healthcare. Does that sound like a dignified way to spent the final years of your life? God forbid you live into your mid-nineties and witness a nearly 60% loss of purchasing power.
Statistically speaking, if you've made it to 65, you have a 1 in 4 chance of making past 90. If you are part of a couple, there is a 50% probability that you or your partner will live past 90. This poses a problem for the idea of spending one twentieth of your assets each year.
What if you live to be 90 years old? A 25 year retirement means you can only take 4% out each year. In dollar terms, with $1,000,000 in your 401k, you can only draw $40,000 of income, not $50,000. That's an immediate 20% cut in your lifestyle spending.
It only gets worse the longer you live. If you live to 95, that dwindles further to 3.33%, or $33,333 per year. 100? Just 2.86%.
To me, the sheer uncertainty is one of the worst parts of this plan. Because you don't know exactly when you'll die, you don't know what you can spend today. That makes it really hard to enjoy your money without fear or guilt, doesn't it? You might live in extreme frugality throughout your retirement for fear of running out. And you still might not have enough!
The other obvious problem is that this "Plan" ignores taxes. Even in the relatively low income brackets, you'll still be paying 15-25% taxes depending on where you live. So $50,000 of income is really just $40,000 of spendable money . On a monthly basis, $4167 of income becomes $3,333 of cash.
By the way, this still assumes you're dying at 85. Taxes, combined with living longer, really decimates your spendable money.
This plan also does not account for late-in-life expenses. For many couples, one or both members will need assistance with the activities of daily living. This may mean in-home care, or an assisted living facility, or even a nursing home. Whatever option you choose, this help is expensive. It is important to set aside resources today to make sure that you can cover these expenses. But the "No Plan, Plan" makes no such provisions. If either partner needs help, they will be dependent on government programs to get it. This is usually not anyone's first choice.
"The No Plan, Plan" does not guard against external risks. If you forget to block the wheels on your RV, and it rolls out into the road, causing damage and injury to multiple people, how much damage does your insurance cover? What if it hits a prominent (and litigious) attorney in your town? Does your basic insurance cover it, or will this one event destroy your financial security completely?
Lastly, let's talk about estate planning. An estate plan isn't absolutely necessary for you during your life. But if you could see what happens after you are gone, your failure to draft an estate plan could be a major regret. Failing to draft an estate plan ensures that you will leave behind headaches for your descendants. Without proper planning, you risk unnecessary fighting and conflicts, you might even accidentally disinherit the people you care about. Too, the weeks and months leading up to your passing are likely to be filled with added tension that comes from your failure to designate power of attorney for medical and financial decisions. This is a big gap to leave unattended, and it could cause tremendous strife and suffering for your family.
To recap, under the “No Plan, Plan,” the biggest risks to your retirement finances are: losing your lifestyle to inflation and taxes, being unable to pay for major end of life expenses, lack of asset protection, and inadequate estate planning. Any one of these risks could destroy your financial security. In conjunction with one another, they virtually guarantee disaster. Please don't let this happen to you.
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