Here’s the story of a couple who actually did a “dry run” to test how their retirement might work. In this post we’ll explore the why and the how with them.
What’s a retirement dry run? It’s not the real thing, but a sort of practice run to prepare for the real thing. And I know a couple who have done exactly that. Call them S (for She) and H (for He). They’re an interesting couple.
S works with a firm of financial planners, and is happiest when she is helping a client make a success of things. She isn’t a mathematician, but lives with numbers. She comes from a family that takes responsibility seriously, and to which responsible young people are attracted as role models. You know that when any member of that family commits to doing something, it will be done and done well.
H is a down-to-earth, practical guy, a lover of old cars. He is one of the wisest people I know, though his wisdom comes from life experience rather than book learning. He sees straight through to the heart of a matter, and brooks no nonsense. And, like S, when he gives you his word, you can bank on it.
The idea occurred to S, and it was accidental. A friend of their daughter’s was living with her parents and had just qualified as a teacher. She wanted help to plan for buying a house, but had no idea at all about managing a budget. S suggested continuing to live with her parents for the following year, and paying an amount to them every month that they could save for her, equal to the costs of food and other expenses that the parents were happy to meet, plus the monthly payment on a mock mortgage of an amount that a bank could tell her she could qualify for. Either the friend would cope, and find that she had enough saved for a downpayment, or she might be able to save less, in which case it would take longer. Whatever the outcome, it would be a simultaneous learning and saving experience.
That’s when it occurred to S that this was an equally good idea for retirement. What if she and H tried a retirement dry run? It would help them answer the question: what would we do if our income dropped 40%? At least they’d realize what they needed and what they could afford.
But the idea didn’t come to life until a few years later, when H suddenly asked S one day: “When will we be able to stop working?” His job was necessary for making a living, but unrelated to his passion for fixing and running old cars.
S replied: “I have an idea. Stop me immediately if you think it’s dumb or if there’s something you think won’t work.” And she explained the idea, which involved tracking (for the first time) everything they spent. She would do the analysis; H’s responsibility would simply be to hand her all the receipts for everything he spent money on, every day. And that’s what they did.
Her analysis consisted essentially of recording payments under two headings: expenses that would continue into early retirement, and expenses that would stop at retirement. Some had to be split across both categories, of course, like the expenses for their second car, which they anticipated wouldn’t last too long.
Experience eventually caused her to make some changes. First, they awarded themselves a weekly allowance, and skipped recording those expenses. (They didn’t cheat. They’re not the type, and anyway there was no point fooling themselves when the whole point was to make an honest assessment.) Second, they realized that there would be new expenses in retirement, for example when their work-related healthcare benefits stopped. (And they added the cost of replacing the second car with a used one.) And third, there were expenses that were occasional rather than repetitive, like home repairs; S added them all up and converted them to an average monthly amount. With these simple but tedious tasks, she compiled a post-retirement monthly budget.
Would it be enough?
She went to an expert at her firm and took all her information: her (and H’s) latest Pillar 1 pension income projections, and their tax-sheltered and other assets. Question: if the expert projected everything to age 65, how much would she and H be able to spend (after tax) each year after 65?
It turned out that the answer was: roughly 60% of what their current aggregate spending amounted to. Coincidence: there would indeed be roughly a 40% reduction. But, more important, that 60% was pretty much what S, after her analysis, estimated would be necessary after retirement.
What, I asked her, was her reaction? Lots of emotions!
First, huge relief! “It’s within reach!” They’re a modest, modest-earning couple, and it was very satisfying that their frugal past lifestyle had helped get them to the point where their current lifestyle was essentially fully funded in retirement.
Second, surprise. S had expected the process to reveal flaws in their planning. Maybe, she thought, it would turn out that they didn’t have enough, or she hadn’t anticipated X, Y or Z. Those didn’t happen.
And they also learned a couple of lessons.
One was that the process would never have worked in reverse. If they had started with the assumption that they would have to cut 40% from their current spending, it would have caused panic to estimate their current budget and then adjust it to 60% of its current size. But the simpler opposite approach worked fine – first see what you’re actually spending money on, and then the comparison (60%) with total current spending is an incidental and interesting number, rather than the one that dominates everything and dictates what action should be followed.
The other was that nobody else she knows does this. She was now more sensitive to hearing others talk about retirement: “We’ll do A, B and C,” “We’ll cut back on expenses” and so on. But it’s clear that those others have never given any serious thought to what they’re saying, they’ve never actually done it, and they simply assume all will go well.
I had a few more questions. One in particular. She had asked the expert to project essentially to the first year of retirement. What allowance was made for post-retirement inflation? What if the same spending cost 20% or 30% more, 10 years after they retired? Answer: they hadn’t thought that far ahead, yet. It was enough just to know that retirement is already within reach. For the long-term future, there are two possibilities.
In one scenario, slow but steady inflation is the big issue. They anticipate that their spending will gradually decline over time. That alone could solve the problem: reductions counteracting inflation. Or they could downsize from their current home, which is itself modest.
In the other scenario, something serious changes everything. In which case they have already gone though the planning exercise, and will be better prepared than most to adjust their lifestyle to cope. The learning experience has been tremendous, and gives them lots of confidence.
I also asked H about the experience, to see what it added to S’s perspective. And he had two very practical observations. The first is that instinctively it put his back up, until it became clear that his only responsibility would be to put his receipts in the folder, and there would be no analysis of spending. This is what subsequently became the weekly allowance, no longer recorded as individual items. His second observation was that it won’t work for couples who have something to hide from each other, and conceal some of their spending. Very true! But it needs to be noted explicitly.
Meanwhile, let me just complete the story, as of the date of my writing it. They’re still working (and their retirement dry run continues, in an even more sophisticated mode). They know they can retire. S enjoys her work, but will be happy to cut back to part-time status, something her firm will be equally happy to accommodate (and which will create an additional margin of safety).
When? That call will be made by H. He was the one whose question triggered the dry run. His will also be the call that triggers the real thing.
A retirement “dry run” is unusual, but it could be a great learning experience.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.