Oops, I did it again. I need some extra money out of my nest egg because (select all that apply):
- I have to repair the roof
- I’m buying a new car
- Travel, travel, travel!
- I underpaid on my taxes
If you’re retired and your nest egg is an important source of your day-to-day spending, you might be finding that those recurring distributions don’t end up being enough after factoring the lumpy and unexpected expenses that life throws at us. If you find yourself “ATM’ing” your nest egg for one-time distributions every year, here’s a way to help make sure those expenses don’t sneak up on you and put you at risk of outliving your wealth.
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During the Career Years
When you had years or even decades of work ahead of you and didn’t know exactly when you wanted to retire, you probably worried less about the consequence of big-ticket surprise expenses as long as you were able to pay for them from somewhere (bank, investments). If you wanted to repaint the house, you could treat it as a goal and save for it. Or just withhold saving to your nest egg for a short period. But once you stop working and saving, you’re essentially locking in on a portfolio balance that will become the foundation for your spending. From that point, the only levers you have any real control over are with your spending (unless you create some other new income source).
Your System for Retirement Spending
Imagine two scenarios. You’re 40 and your financial planner tells you that because you built a pool in your backyard, you might need to work until 63 instead of 62. Now imagine you’re 70 and you spontaneously spend an extra $30,000 on a new primary bathroom and closet. Your planner tells you that the odds of you running out of money just jumped from 10% to 30% because that expense was never baked into your financial plan. Failing to plan for the lumpy and unexpected expenses in retirement may have significantly worse consequences than it did during the work-and-save years.
How to Project the Lumpy and Unexpected
Here are the most common offenders when it comes to sneaky expenses that we’re used to having, but don’t always know when they will happen or how much they’ll add up to. The ferocious four are:
- Travel
- Car purchase
- Taxes (higher than expected)
- House (renovations or large sudden repairs)
For illustrative purposes, and using simple numbers, let’s assume you’re retired, and you agree with your financial advisor that $8,000 per month is an appropriate recurring distribution from your retirement portfolio. It’s assumed that you need to cover all of your expenses from this, but you’ll be able to give yourself annual cost-of-living-adjustments (COLA) as inflation increases (just like what happens with your social security checks). You need to be ready for those four types of expenses, but how?
You might want to travel a lot more in the first few years of retirement. You might need a new HVAC six years from now. How can you predict what these will be over the next 3 decades and is that really a necessary calculation to compute when you retire? There is an easier way that could help.
First, you can try viewing these in terms of five-year windows. Let’s use the house renovations and large repairs example. You can start with some rule of thumb, such as 1% (or higher) of the home’s value towards maintenance or repairs. Next, add in any specific renovations you are committed to doing in the next five years. Lastly, are there any big-ticket replacements you think you’ll need, such as an HVAC? If the total costs add up to $50,000 over the next five years, then convert that into a monthly amount, $834 in this case ($50,000 divided by 60 months).
Bucket Saving
Now, how do you practically integrate this into your portfolio withdrawals system? You could set up a monthly auto-transfer of $834 into a savings account that is earmarked just for this home expense category. You could schedule this to happen within a few days of receiving your $8,000 monthly distribution. Leave that savings account alone to grow until the expenses are needed, then reimburse yourself (your checking account) from that savings account.
Let’s say that over the next five years, you only spend $30,000 of that $50,000 leaving you an extra $20,000. You could go through the same exercise, estimating what the next five years may look like. The only thing that matters is that you leave yourself enough room so that you’re only pulling from that account for these types of expenses. You can adjust your monthly transfers downward for the next five year period if you think you’re adding too much. The important thing here is that you’re not “ATM’ing” your portfolio on top of the $8,000 you’re getting every month.
For the car category, you may have more options. If you tend to lease or finance (when you buy), those costs can be treated just like other monthly recurring costs (no need to create a special savings account for this). If, however, you buy a car with cash every 8 to 10 years, make sure that’s accounted for in your financial plan. In the same example, it would mean that the $8,000 would need to be lower to account for those large portfolio withdrawals every 8 to 10 years.
If you have trouble not spending excess cash in your checking account, you could also set up another savings account. While it may be overkill for some, I personally do this for my property taxes as well. This way I can keep my checking account balance low since I know that there are almost no lumpy expenses that will ever surprise me in that account.
Let’s Not Forget about Long-Term Care
The topic of long-term care (LTC) was excluded from this article because that is a beast that should be planned for separately, not from your normal annual spending assumptions. It’s also potentially the biggest financial planning landmine. I recommend doing your research early so that you can explore the best options to be ready for this. The majority of senior citizens will incur at least some type of LTC costs, and they can easily rip through your nest egg in a short time in a worst-case (expense) scenario.
Closing
Feel free to pick whatever parts of this resonate for you and to customize your own version. Some people have more savings buckets (I use one for charitable giving) and some don’t need any, because they’re good at keeping guardrails on their bank balances (allowing them to drift higher while being ready for surprises, and then lower when they happen). It also gives you some freedom in choosing how and where to treat yourself. If you don’t touch the home-renovations fund in the first few years, maybe you take that money to book an extra special vacation for next year. Instead of “oops, I need more money” it could be “oops, I have too much money over here, what do I want to do with that surplus?”
Happy planning,
Barrett
