I Forgot to Save for Retirement!

By Dr. Jim Dahle, WCI Founder

This deals with the high earner who finds himself just a few years away from retirement with not nearly enough money to have the retirement he would like. This could be for many reasons. It could involve a late entry into medicine, a costly personal or professional divorce, making poor investment choices, having your money grow too slowly due to an incompetent or overly costly advisor, poor savings habits, an unrealistic view of what retirement should be, or more commonly, simply living too high on the hog for too much of your career. Essentially, many of these folks put off saving for a rainy day until the storm clouds appeared on the horizon. It isn't too late, but it's a much different situation from a doctor who gets his ducks in a row in his 30s.

The Retirement Cliff

A concept I really like, which I first saw expounded in Jim Hemphill and David Burd's soon to be published volume Changing Outcomes, is this idea of a cliff at retirement. This is the difference between spendable income during the earning years, and sustainable spending income in the retirement years. I've hand-drawn a copy of their concept below:

If you look closely at this drawing, you'll see that during your working years your income gradually goes up with inflation/raises (I know, I know, that isn't what it looks like for many doctors.) Then, at some point, you retire and go off the cliff to the point where you start living on cash flow from your investments and Social Security. The goal of good financial planning and investing, of course, is to minimize the size of that cliff. As a strong saver who started as a resident, my goal is for there to be no cliff at all. I don't want my lifestyle to change when I finish working. In fact, at least early in retirement, some people may even want to spend more as they now have more time for travel and hobbies.

However, those who arrive at retirement age with inadequate savings, for whatever reason, are faced with a choice. They can have a cliff that looks like the one above, with a small drop-off right at retirement, or they can have one that looks like this:

In this example, the retiree maintains his spending for a few years in retirement, but then runs out of investments and is forced to live on Social Security alone, a dramatic decrease in lifestyle from that enjoyed during his working years. Obviously, this is a scenario that most of us would like to avoid.

Retired and in Trouble?

If you have found this post at or after your retirement, or if your retirement was forced due to job loss or health issues, and your personal graph is starting to look an awful lot like that second one, the sooner you cut your lifestyle to a sustainable level, the better off you will eventually be. There is not a lot you can do at that point. It might be possible to go back to work, at least part-time, and perhaps not even in your original career field. But we'll assume that isn't an option. So cutting back your lifestyle right away is the most important factor, such as downsizing your home, moving to a less expensive or income tax-free state or country, or simply going on fewer trips. You might be able to trim a bit around the edges with some other factors, such as converting some of your non-income producing assets (second car, second home, boat, airplane) into income producing assets (rental properties, stocks/bonds.) You can also take a lump sum and annuitize it with a Single Premium Immediate Annuity (SPIA) to maximize your guaranteed income from it, at the expense of losing the lump sum for later spending, gifting, or inheriting. You might also simply adjust your view of what you were planning to leave to your heirs or charity.

The Pre-Retiree in Trouble

However, this series is primarily aimed at the person who, although clearly behind, still has a few years to make some adjustments. In that case, it is important to consider the reason why you're behind where you need to be. If you're behind in your savings because of a late entry into your professional field or because you lost half your assets in a divorce, you may not need to make huge lifestyle adjustments compared to someone who has simply had too low of a savings rate for far too long. If you've been saving enough, but your money hasn't been doing its share of the work due to low returns or high investment-related expenses, an adjustment in investing strategy is certainly part of the solution.

Most of the pre-retirees in trouble are going to have to make some hard decisions about their lifestyle which are going to require some serious motivation and discipline. The remainder of this post and the next one are a list of possible solutions. Some of these will give you more bang for your buck, depending on your personal situation. Most likely, you'll need to use several of these to get to where you want to be. Even if it is impossible for you to eliminate the retirement cliff completely, the smaller you can make it the better.

Solution # 1 Decrease Spending

The first, and most obvious solution, is simply to reduce spending now. Just like early in your career, every dollar you don't spend can be redirected into income-producing assets. For some doctors, that might mean budgeting for the first time in decades. Taking a serious look at where your money is actually going is the first step to any budget. If you're spending it on vacations, remember that you can go on just as many vacations, they just have to be cheaper. There is a big difference between a week camping in the National Park a few hours away and a week in Paris. If you're spending it on expensive cars, pay your car off and keep it for at least a decade. If you're spending it on interest payments, pay off the credit cards, car payments, and home equity loans. If you have expensive hobbies like boating, flying, or antique cars, consider swapping them out for running, reading, other other inexpensive hobbies you enjoy just as much or nearly as much.

Solution # 2 Use Your Tax Money To Increase Savings

If you're getting close to retirement and finding yourself with inadequate savings, there's a good chance you never installed the habit of maxing out all possible tax-advantaged accounts. By maxing out your 401(k), 403(b), 457, profit-sharing plan, defined benefit plan, and HSA, you may be able to reduce your tax bill significantly. Those tax savings go straight into your nest egg. Pre-tax retirement savings accounts are even more beneficial for a retiree expecting a large retirement cliff, since his post-retirement tax bracket will likely be dramatically lower than his pre-retirement bracket. To make things even easier, as you get close to retirement those tax-advantaged accounts allow for “catch-up” contributions (extra $5500 for 401(k)s starting at age 50, extra $1000 for IRAs at age 50, and an extra $1000 for HSAs at age 55.)

Solution # 3 Turn Non-Income Producing Assets into Income Producing Assets

Most docs in their 50s, especially those with inadequate retirement savings, have some assets sitting around that are worth something. It might be an expensive boat, airplane, or automobile. This can be sold and the proceeds can be used to purchase stocks, bonds, or real estate. If you have a vacation property, you can start renting it out (or rent it out more often) so it at least covers its own expenses. You can rent out the mother-in-law apartment in the basement or the guest house. Selling an asset is especially useful for an asset that was sucking up a lot of your income previously. Not only do you get the cash out of it, but you can quit feeding it every month.

Solution # 4 Move!

This one seems dramatic, of course, but can be very beneficial, despite the cost of moving, especially if you're moving to a community you'll stay in after retirement anyway. You can move to a community with a lower cost of living. You can move to an income tax-free state that allows you to save what you were previously paying in taxes. You might also be able to move to another area of the country with higher reimbursement. Most physicians have realized that cost of living has very little correlation with physician pay. Selling a half-paid-for $2 Million dollar home in California and buying the same home in Texas for $300,000 cash gives you $700,000 to add to the retirement portfolio and eliminates that massive monthly payment. Insurance and tax costs may also decrease significantly.

Moving also allows you to change your lifestyle and social group with much less pain. You don't have to explain to the guys why you're no longer in the country club or why you're selling the boat. It's obvious- you're moving. Then, at the new location, you can buy a smaller home in a less expensive neighborhood and avoid making friends with the Jones.

Solution # 5 Work Longer

This solution may sound just as unattractive as moving, but it is so beneficial that it is the main solution that most undersavers utilize. It is helpful for six reasons. First, you earn more lifetime income. Second, you don't need your nest egg to provide for as many years. Third, you can delay taking Social Security, allowing for greater payments later. Fourth, you can delay purchasing a SPIA, getting a higher rate when you do so. Fifth, and perhaps most importantly, delaying retirement gives your nest egg more time to compound and perhaps even recover from a recent bear market. Lastly, if you're working longer, you can be more aggressive with your investments, hopefully producing a higher return.

Solution # 6 Work Part-Time

This is really just a toned down version of working longer. Physicians of many specialties and similar professionals can often decrease how much they work. They may be able to support their lifestyle on just 5-10 days of work a month, especially given the reduced tax burden. While they might not be able to do that and still make big retirement contributions, they do get the other five benefits of working longer while still having time to enjoy retirement activities and travel. Sometimes, it can be tough anyway for a doctor to stop doctoring and going part-time is a good compromise.

Solution # 7 Get a Real Investing Plan

If you do not already have a finely-tuned investing plan, I would suggest you do so, either on your own or with the help of a competent, fairly-priced advisor. Many doctors are investment collectors and have no investing plan. Others have terrible returns due to market-timing or stock-picking schemes. They may be invested in high-expense mutual funds. They may also not be taking an adequate amount of risk. There is nothing quite like understanding your shortfall risk to encourage you to take an appropriate amount of market risk.

Solution # 8 Fire Your Advisor

Obviously, if you have an incompetent or overly expensive advisor you should fire him. However, even firing a competent, low-cost advisor does save you some investing expenses that can be redirected toward portfolio growth. Those expenses get larger every year if you're paying via an Assets Under Management (AUM) fee. Now, I'm hesitant to recommend this approach to someone who is behind on their savings. If they were really the competent do-it-yourself type, they probably wouldn't be in this situation. Nevertheless, there is no reason you cannot learn to do your own financial planning and investing in your 50s just as easily as in your 30s. But remember, it does not help you to avoid advisory fees you were paying a competent advisor unless you actually perform the tasks your advisor was previously doing. Selling low in one bear market late in your career is a financial catastrophe from which there may be no recovery. If the advisor can prevent you from doing that, he is well worth the fees you are paying.

Solution # 9 Eliminate Economic Outpatient Care

Standard financial advice is a lot like that safety speech the flight attendants give before the plane takes off. If the oxygen mask drops, put yours on first, then help your kid. In the same way, you need to take care of your retirement first before worrying about your kids. That might mean they have to take out more loans for college. It might also mean cutting them off if your income is supporting them post-college. You can't afford to help them with a downpayment on their home, cover their medical bills, or pay off their credit cards.

Solution # 10 Give Less to Charity

Physicians are well-known for their charitable inclinations. But just like helping your kids out, you've got to take care of yourself first. Besides, in retirement you can switch from supporting charities with money to supporting them with your time.

Solution # 11 Get Lucky

The safe withdrawal rate is generally considered to be in the 4% rate. However, if you look at what is usually okay, it's possible to get away with withdrawing 5-6% a year. A $1 Million portfolio may only be the equivalent of a $40,000 per year of income, but if you hit a reasonably good period of returns early in retirement, you may be able to get away with $60,000 per year. This good period of returns is far more likely if you had relatively poor market returns the last few years of your working career. For example, someone who retired in early 2009 would have a much smaller amount of money than someone who retired in early 2008. However, the guy who retired in 2009 who would have enjoyed a much better average return his first 3 years of retirement than the guy who retired in 2008.

Solution # 12 Rob your Heirs

Many people wish to “leave a legacy” to their heirs. However, that money can be used to support your retirement lifestyle instead. There are two ways you can do this. First, if you have cash value life insurance, you can exchange it to a SPIA instead of leaving it for the death benefit. You can also simply do a partial surrender (amount equal to premiums paid comes out first tax-free) and then borrow most of the rest tax-free (but not interest-free.) Even if you don't have life insurance, you can use a large chunk of your nest egg to purchase a SPIA. That money won't be available to heirs, but it will maximize your guaranteed retirement income, probably allowing you to spend more than 4% of it a year.

Solution # 13 Roll the Dice

This isn't the same as get lucky, in fact, it's an awful lot like getting unlucky, but the truth is that most people aren't going to enjoy a 30 year retirement. The life expectancy for the average 65 year old male is 19 years. That means half of those guys are going to have a life expectancy less than that. Only a small percentage of them will actually live the 30 years the safe withdrawal studies are based on.

Each of these 13 solutions, if implemented, are likely to reduce the size of the retirement cliff. Those who find they have undersaved for retirement should not necessarily feel guilty, as they are actually quite normal. Most Americans have trivial retirement savings and live mostly off of social security. However, if they wish to avoid a huge retirement cliff, they need to become a bit abnormal, implement several of these solutions, and boost that nest egg prior to retirement.

What do you think? Are you or anyone you know in this situation? What have you/they chosen to do about it? Comment below!