If Inflation Doesn't Get You, Forced Retirement Will

Price inflation, not poor returns, is the biggest threat to 4% rule for a sustainable withdrawal rate in retirement. We mentioned that a couple weeks ago when we looked at a podcast that William Bengen sat for with Morningstar. The point came up again in a Barron's article about five tips for retirees to protect themselves from price inflation. 

Here's what Barron's suggested;

• Delay Social Security as long as possible
• Own stocks
• TIPS not bonds
• Make sure cash is actually earning interest
• Own precious metals

The point about Social Security seemed a little odd because no matter when you take it, you get the annual cost of living increase. At this point, hopefully everyone has thought about the tradeoff of getting less money every month by taking it sooner and more money every month taking later but no matter what, you get the COLA.

Equity exposure is of course where a lot of growth will come from. Sizing the exposure correctly isn't always easy but for most people, something in the neighborhood of "normal" like 40-60% will be a good number even if not an optimal number. TIPS versus bonds, if you agree with the premise, own individual TIPS not TIPS funds.

The fourth one is sneaky. At Schwab and Fidelity, there are accounts where the default for uninvested cash pays essentially nothing. You need to proactively buy a money market that has a competitive yield. Schwab says they don't hide this fact but I am not sure they promote it either. The practice seems insidious to me but nonetheless, you need to be on top of this point. 

Precious metals, especially gold, should protect against inflation but gold can be a tough hold with any sort of large weighting. Gold can go a long time doing relatively little versus equities. My preference is think of gold as a diversifier, weighted accordingly as opposed to a core holding on par with equities in the manner that the Permanent Portfolio allocates to gold. 

A building block of understanding that gets some attention but not enough is the extent to which overall expenses can go down when you're older, retired or not. First is not having to save for retirement after you retire. If there is no earned income, then you're not paying 7.5% of income (W2 workers) to Social security. Can you synch up the final mortgage payment to coincide with retiring? Toyotas can pretty reliably last for 20 years so no car payments for a long time. Health insurance versus Medicare is trickier because of the amount that employers contribute to the cost. The thresholds for IRMAA are very high and just about anyone subject to IRMAA is spending a smaller percentage of their income on their coverage.

For most people, their incomes go down when they retire, so then do their taxes. If someone is paying more in taxes after they retire then they are either making more money (seems like a positive outcome) or they lose their spouse which is of course a negative outcome. 

Per a Google search, the median percentage of take home pay that people pay for their mortgage is 30-43%. That's kind of a wide range but it's a big number either way. For cars it's 15-20%. Using Gemini and Grok to try to assess health insurance versus Medicare, it might go up a little for W2 workers but go down for self employed people. Actual expenses could be a very different story. On the Google page with the search results was an ad for an article by Investopedia that said retirees spend $1 for every $6 they earn. That's more than paying Medicare, that would also include out of pocket for doctor visits and prescriptions.

People don't believe this so ok but the types of chronic maladies that people take prescriptions for can be reversed by cutting carb consumption and lifting weights. I can't say it is universally true but is often the case and there is no downside to eating less sugar and getting in better physical condition from exercising. It's a legitimate dollars and cents aspect that ties in with this conversation. 

What about discretionary spending? What does your typical month look like? Despite the word discretionary, how much of your discretionary spending could you actually cut back on if you had to? We don't eat out a ton, so hard for me to say but is it easy for couples to eat out less? Are there things you buy on some regular interval that may not be truly essential but still somewhat necessary that would be difficult to cut back on? My wife gave me a good example, ladies who get Botox. She does not, no judgment from me but how well would "honey, you need to cut back on the Botox" go in households where Botox treatments are a regular thing? What about a house cleaner? 

So maybe with some looking ahead, these sorts of expense reductions without sacrificing discretionary spending that isn't so discretionary can be put in place to help start retirement with a much lower base which would minimize the impact of inflation. If a $7000 monthly nut can be cut in half because there is no mortgage payment or car payments, then the impact of inflation on a $3500 monthly nut would be much easier to absorb. 

All of the above was about coinciding with a planned retirement date. What about those who end up having to retire sooner than they expect? Here's another Barron's article where the latest data says more than 40% of Americans retire sooner than they planned. That seems like a huge number but whether it is accurate or not we know it to be the case for many people. 

Someone who is 55 today, thinking they want to retire in 8-10 years should probably do what they can to move up the timetable on all the things we're talking about today. Health insurance stands to be a big threat but with incomes below $84,000 for a couple, plans on the government plan are very (fully?) subsidized. 

The solutions to planning and threats to whatever plans we make are up to us to figure out for ourselves. I find it easier to work on creating income streams to add to potential portfolio income I might take and Social Security when the time comes. I have general preferences of continuing to work, delaying SS until 70 or close to it and having a couple of small income streams for an extra margin of safety. I find it interesting that my preferences aren't really changing. I think these ideas go back to before I was 40, I'm 60 now. There's nothing truly enlightening there, just interesting.

I try to be consistent in not saying everyone should about when to take SS or the rest of it, I'm more trying to convey my thought process that gets me to a conclusion that is right for me. Certainly, everyone should understand tradeoffs but once you do, take the appropriate path for your circumstance and beliefs.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.