This is the first of a two part series dealing 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.
Ten more solutions to the retirement cliff issue will be presented in Part 2 next time. Until then, let's hear your comments about these three. Are you in this situation or know someone in it? What are you (they) going to do about it? Comment below!
Grey divorces are hard. My brother is going through one. He plans to moonlight more.
Clicked on the cliff picture, love that it was full size so I could see the detail, but it was funny to see it coming up in sections. Felt like to AOL days!
On another note, I see a lot of my colleagues in this position. They haven’t lived extravagantly, but they just didn’t plan. Now they are close to retirement age and want someone to show them the magic investment that they can live off of principle only for the next 30 years. I think most of them will just keep working instead. Everyone really needs to think towards tomorrow and still live for today.
And it looks like the slow picture load was on my end (took 1 while to load the 3MB picture.) Monday computer updates are slowing up my computer, which I will also blame for my typos.
The future is going to be rough for everyone that thought the day would never come or just ignored it!
WCI,
I am 57 and I hear from my peers frequently that they can never afford to retire. I agree that things like inattention to starting some type of saving routine and living too large are big factors. I refer people to this blog and WCIs book when I am asked for advice on investing. I also think that really knowing what you spend is vital. Great post. I am looking forward to part 2.
A lot of places its mentioned try to save 20% of your salary. Being in 39.65 of the bracket, do we mean
1)20% of gross or 20% of Net.
2) Also are we supposed to include the 401k in this 20%?
First, it’s simply a rule of thumb. If you don’t like it, do the calculation yourself and figure out how much you need to save for your financial goals.
Now, your questions:
1) Gross
2) Yes, including any match. That’s all part of your gross salary in my view
But you’re right, as your income increases, the difference between gross and net gets larger and larger. But if you’re saving 20% of net, it’s probably still around 15% of gross, and you’re in the right range to be successful.
WCI, you’re right on the fact that in the early years retirees may actually spend more than when they were working. Many doctors have 5-6 weeks of vacation time while working, when these docs retire they end up with potentially 52 weeks. I show my clients 4x (todays dollars inflated at 3% until retirement) the amount of vacation expenses for the first 10 years of retirement, I also increase miscellaneous expenses and entertainment expenses in retirement. The decrease in taxes and retirement savings can be easily be eaten up by enjoying retirement.
What about doctors who go on vacation every month already? 🙂
Seriously though, I cannot imagine actually spending my current gross income without needing to pay a mortgage, save for college, pay for retirement etc. We/I went on A LOT of nice trips this year and bought lots of expensive stuff and still didn’t spend the half of it. But I’m well aware that any income can be spent. Remember that movie where Richard Pryor had to spend a bunch of money in just a few days to get his inheritance?
Patience is needed when saving for retirement. It takes longer to get to $1 million net worth than it does to go from 5 to 6 million. So for those who have saved from your first attending years you will see your accounts grow much faster, easier when you are in your late 50’s and 60’s than when you are 40. It’s like the Shawshank redemption, all or the sudden you will realize that impossible endeavor of saving for retirement is over and you come out clean on the other end.
I’m one of the authors of the book Jim mentioned, and the creator of The Cliff analogy.
In a good number of cases, the most powerful strategy is Jim’s #3, converting bad assets into good assets. For example, if you sell a $1.5 million trophy house at age 55, when you last kid moves out, and buy a $500,000 condo, you have up to an extra $1 million to invest, and you are probably reducing your upkeep by $50,000 per year or more. (If the mansion has a mortgage, obviously fewer investment $, but the upkeep savings are still powerful.)
I’ve seen this both work and not work with our doctor clients. The ones that work are bold and proactive, the ones that fail are reluctant and reactive. Bold means restructuring fundamentally right away, and reaping the benefits for decades. (Sell the mansion, sell the upside-down vacation property, invest the proceeds.) In the latter case, they hold onto the big house until they are forced to sell, and so on. They never get leverage to permanently improve their financial position.
It is quite natural (and necessary) for twenty-somethings to be fully occupied with important matters other than retirement planning. And, there is something about human nature that makes it hard to do something now that will benefit us only in the distant future. For these understandable reasons and others (how about huge education-related debt?) many start saving and investing for retirement too late.
It would be wonderful if just two concepts were successfully communicated to the young: 1) you will have to save enough money during your working life to live on during your retired life (which could last almost as long as your working life) and 2) the sooner you start taking advantage of compounding interest (the “eighth wonder of the world” per Albert Einstein) the better, or, in more concrete terms: “If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you’ll have around $560,000, assuming earnings grow at 8 percent annually. Now, let’s say you wait until you’re 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8 percent a year. When you’re 65 you’ll wind up with around $245,000 — less than half the money.” From Lesslie Haggin Geary’s article “Retirement Planning for 20-Somethings” on Bankrate.com.
The problem is, no twenty-something I know is aware that bankrate.com exists, let alone reads it. This stuff needs to be taught early and often.
That was unexpected and weird.
Isn’t there supposed to be some mention of a house wife making 10’s of thousands by working from home?
Welcome to my life. Occasionally one gets through the spam filter.