EP 20: How to Estimate Retirement Spending, When to Stop Saving For Retirement, and Considerations for Refinancing in 2022

by | Nov 3, 2021 | Podcast

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Peter answers your questions in his latest mailbag episode. 

This episode covers reader and listener questions about:

  • How to estimate spending in retirement
  • At what point should you stop saving for retirement
  • Considerations for refinancing in 2022

Show Notes

Welcome to another mailbag edition of the show where I answer questions from readers and listeners.

As a reminder, you can submit YOUR questions for the show at the bottom of my podcast page. And if you’re signed up for my newsletter, which I send out twice a month, then all you have to do is reply to one of those emails and it goes right to my inbox.

Now let’s dive in…

Q: How to estimate spending in retirement?

The biggest financial question that I have, and one that doesn’t seem to get enough love in the world of internet financial advice (potentially because it is too personal/subjective) is how best should someone estimate their spending in retirement? 

I really liked your post about reverse budgeting but it seems like the hardest part about reverse budgeting is figuring out the end goal. 

It seems like there are many somewhat concrete goals, purchasing a house, college savings account, etc. but the most nebulous number to pin down is how much you will really need to spend in retirement, which particularly for younger folks is difficult to determine. Do you have any advice for estimating that dollar amount?

In my experience, I’ve always found the best predictor of future spending to be current spending, perhaps with an inflation adjustment. 

You can come up with all sorts of expenses that you view as “one-time” in your working years, and other expenses that you wouldn’t have in retirement (education is a pretty common one that comes to mind), but in my experience, most people tend to redirect spending to different categories rather than spending less. 

This isn’t 100% true, but it’s true more often than you’d think. Plus, it’s better to be conservative by overestimating your future spending than underestimating it.

Now, the closer you get to retirement, obviously the more accurate of a predictor current spending will be for retirement spending.

If you’re younger and haven’t reached what you think is going to be your peak earnings years, then you might have to get a little more creative.

By peak earning years, I mean the period where your salary is still going up by a few percentage points a year, but you aren’t expecting any double-digit percentage increases in a any longer. Most data would say this point comes in your mid-40s or 50s, but obviously it’s going to vary from person to person.

So one thing a person in their 20s or 30s might do is predict the age and income at which you are at a general earnings peak and then inflate that salary by 2-3% until the age you would retirement. From that number, you’ll want to back out taxes and planned savings (like a 401(k) or brokerage savings) because that gives you a more accurate picture of what you’ll be spending. 

Of course, anything you model out is going to be wrong, but that’s not really the point of the exercise. This part of the financial planning process isn’t about being precise, it’s about pointing your compass in the right direction. Think about following compass and walking for decades. Changing your path by just a few degrees will put you in a very different final destination. You mostly don’t want to be way off course — even being 30 degrees off course is dramatic over multiple decades. But you are undoubtedly going to be a few degrees off, so you plan make adjustments over time.

Financial planning isn’t a one-time exercise – it’s something that should be reviewed regularly and updated to incorporate the many changes you experience in life.

Working with an advisor can help you do a little more complex modeling on your future spending, too, but hopefully this gives you a good bit of insight on how to get started.

Deeper reading:

Q: At what point should you stop saving for retirement?

I am a widow at age 45.  I have 465k in IRA, 403B, 401K.   It has been suggested by one financial advisor that because they expect that to double every 7-10 years that I no longer need to save for retirement.  That sounds a little iffy to me.  Your thoughts?

A little more potentially relevant information: I will have combined pension income from my late husband and myself of about $1,300 per month, and I will also be eligible for Social Security. I’m currently investing 17% of my income into a 403(b). Thanks.

This is an interesting question. The Rule of 72 would suggest that a portfolio earning 8% a year would double every 9 years, so that part of the comment may not be terribly off base, but it’s not saving for retirement at your age seems iffy at first glance. 

Perhaps that is true if you’re spending is so low that’s the projected growth of your existing portfolio dwarfs whatever you can imagine spending beyond your pension income in retirement. If that’s true and you can easily support your spending to, say, age 95 or 100, then I guess the need for retirement savings is reduced.

But it also matters what the other option for your additional cash flow would be. If this person is trying to encourage you to buy a financial product like insurance or an annuity so that they can earn a commission, I’d say that is not a good use of the extra capital.

But let’s say you wanted to pay down your mortgage more quickly so that you ensure you are debt free heading into retirement: well, that might have more merit.

Or maybe you don’t have any sort of emergency savings to fall back on, so perhaps redirecting retirement savings to an emergency fund could make sense – again, this all depends a bit on the various nuances in your life.

But the idea of stopping all investment savings at age 45 – whether it’s for retirement or other goals — sounds questionable given the little context you’ve provided.

You might still benefit from investing, but perhaps you ought to look at investing in taxable accounts to better manage the tax liability you will have in retirement from your pensions and required minimum distributions from your retirement accounts.

It’s hard to know for sure, but those are the sort of things I’d be looking into with a new client in this situation.

It’s really a capital allocation question: what is the best place to put your extra cash flow?

It may be that some of that extra cash flow should be spent. If you’re living frugally and can afford a bit of lifestyle expansion, that’s a great alternative to saving more for retirement if the numbers work out.

Q: How to handle our Social Security when on the brink of retirement?

I am 66 and two months of November and my husband and I really need our Social Security as we are pretty much without income as of this month. We have approximately 1 1/2 million in 401(k)s… Never did a Roth conversion. My husband will start taking his Social Security at 66 and 2 months in January. We are invested in stock funds that produce income 60% stock 40 bond and others. Combine Social Security before insurance taken out is 5000 per month and we are taking 3000 a month from investments. Got any advice to offer on that snapshot?

My first instinct is to look into tapping the retirement accounts to cover cash flow in the near term instead of tapping Social Security. Every year you delay Social Security, the payment goes up 8%. That’s a pretty great return. Could your 60/40 portfolio earn 8% a year, sure it could. But it’s far less of a certainty than the Social Security payment rising 8% a year.

As a rule of thumb, you should wait to tap social security until you get the maximum payment. In terms of the total dollars you would receive from Social Security if you take it early vs full retirement age vs age 70 is really dependent on how long you live. The break even point for taking social security is age 84. So if you think you will live beyond age 84, you are going to earn the most lifetime dollars delaying social security to age 70.

The other thing that sticks out to me about your situation is that even though you haven’t ever done a Roth conversion, this might be the absolute perfect time to do so. Once you start taking Social Security, your taxable income will be higher, making the cost of a partial Roth conversion higher. 

While I don’t have all of the information, delaying Social Security and doing some partial Roth conversions could save you quite a bit on taxes. For compliance purposes, I want to make it clear that I’m making a guess here, but I would think you’re talking about 10s of thousands of dollars in lifetime tax savings.

Q: Does refinancing in 2022 make sense for our mortgage?

My wife and I moved into a bigger home three years ago and financed using a jumbo 30-year fixed rate mortgage. While everyone else was refinancing the past year or two, we found that rates weren’t as attractive for jumbo loan refinances, but now I’m seeing the amount that qualifies for a regular, non-jumbo loan is going up to the point where we would qualify.

With normal loans now covering a larger dollar amount, is there any reason someone with a jumbo loan wouldn’t refinance? 

The “normal loan” this person is referring to is a “conforming loan.” It used to be that conforming loans were $548,250 or less. Beginning in 2022, that amount will be $625,000 – so as of this recording, you still have to wait a little longer for loans of that amount to fall into the conforming loan definition.

To answer the question, though, there is nothing wrong with being in a jumbo loan, so you wouldn’t refinance just to be in a conforming loan. Whether it makes sense really depends on the specific terms of your refinancing.

Obviously you’d want the loan to have a lower interest rate so that you are realizing savings from the transaction.

There are also costs to consider with refinancing, which is fine, but the rule of thumb we use at Plancorp is to make sure it takes no more than two years for the monthly mortgage payments savings to cover those costs. 

Figuring this out is pretty simple. You start by subtracting your expected monthly payment from what you currently pay – which is what you would save per month. Next, add up the total cost of the fees associated with refinancing. Then you divide that total amount by the monthly savings.

The result tells you how many months you need to stay in the home to make up the cost of the refinancing. If, for example, your break even number is 18, it will take you 18 months to recoup the refinancing costs and actually start realizing the benefit of the mortgage payment savings.

Again, our rule of thumb is it should take no more than two years for you to break even on a refinancing.

One final thing that is less of a consideration for you, but might be for someone listening….How far you are into your current mortgage can change the math behind the choice to refinance. For example, if you’re more than 10 years into a 30 year mortgage, then resetting the term by refinancing into another 30-year mortgage might actually increase the interest you pay over your lifetime on the home.

One final thing to consider is that prior to refinancing, you might want to call the bank servicing your mortgage and tell them you are going to refinance unless they lower your interest rate. Sometimes they will change the rate on your loan without evening resetting the term. I’ve never seen this happen firsthand, but I’ve spoken to people who insist it happens occasionally. What I have seen happen is the bank sometimes responds to this request by essentially refinancing the loan at market rates, but with less cost and hassle than a traditional refinancing.

Q: Where do I begin with an Health Savings Account (HSA)?

This is the first year I’ve had access to a Health Savings Account (HSA), but I’m not entirely sure how or where to invest the funds. You seem to be pretty bullish on these accounts, so I was hoping you could point me in the right direction.

In order to have access to an Health Savings Account (HSA), you must be in a high deductible plan and that isn’t necessarily for everyone.

Choose a High Deductible Health Plan (HDHP) if:

[Expected Medical Expenses] < [Savings in Premiums + Employer Contributions + PPO Deductible]

While investing HSA dollars isn’t a strategy for everyone, it is a valuable retirement savings tool for higher earners because of the triple tax benefit:

  • Tax deduction on the contribution
  • Tax deferred growth
  • Tax free withdrawal for qualifying medical expenses 

But to answer the question at hand, if you are going to invest your HSA like a retirement account, you should look for providers that…

  • Don’t have maintenance fees or additional one-off fees
  • Offers reasonable interest and FDIC insurance on deposits
  • Has high-quality and inexpensive options in core asset classes
  • Low investment fees (nobody does it free to my knowledge)
  • You don’t want to be required to keep money in a spending account before investing

If you really want to geek out, Morningstar does an annual report on HSA providers.

For what it’s worth, Fidelity and Lively get the top two rankings from Morningstar out of 11 different offerings. I use Lively myself and like it. I’ve only used one other option and that was Optum and I really wasn’t a fan.

From an investing perspective with Lively, your assets get custodied with TD Ameritrade, so investing on Lively is basically like having a TD Ameritrade account where you can invest in whatever you want. Because Charles Schwab bought TD Ameritrade, I don’t know how that will impact Lively going forward, but for now, I like their HSA functionality and user interface.

Deeper Reading on HSA’s:

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About the Podcast

Long term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence. 

Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.

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