Spending shocks in retirement.

The Society of Actuaries (SOA) Committee on Post-Retirement Needs and Risks has a number of reports from last year that offer insights into some rarely explored sides of retirement planning.

Whenever we do our simulations or come up with spending plans we always assume that the future is basically unchanged. We spend a lot of time worrying about sudden inflation or sudden stock market crashes.

I’ve slowly been coming around to the belief that once you have any reasonable asset allocation (basically any of the ones listed in White Coat Investor’s “150 portfolios better than yours”) and have a withdrawal rate that is under 5 or 6% or so…whether your plan succeeds or not is largely up to whether you are lucky at avoiding spending shocks or not. It won’t be about stock market performance or whether you’ve figured out that a 3.25% withdrawal rate is safer than 3.8%.

We spend almost no time worrying about spending shocks. Yet…

  • 72% of retirees experience at least one spending shock during retirement.
  • 19% of retiree experience four or more spending shocks.
  • An unexpected home repair was the most common spending shock.
  • An unexpected major dental expense was the second most common spending shock.
  • More than one in three who experienced shocks had their assets reduced by 25% or more because of the shock.
  • More than one in ten who experienced shocks had to reduce spending by 50% or more because of those shocks.
  • Long-term care, divorce, and long-term help to children were the spending shocks that were hardest to adjust to.

Some of the quotes (from actual people) in the report show exactly how impossible it is to plan a bulletproof retirement:

  • “In 2013 I got colon cancer…The medical cost and stuff like that was unreal. I’ve had to spend $3,900 right off the top.” (Compare that to the usual simulations that expect a constant $40,000 a year in expenses…)
  • “Dental…I mean, you get into thousands of dollars sometimes and no insurance.”
  • “My daughter lives alone…She was on her way to a teacher’s meeting, and she crossed the street and was hit by a car. Since then she has MS and they did not pay anything. We got nothing and now she has no job…It’s very expensive.”
  • “House upkeep. Furnace, driveway. In the last month I have spent $2,500 on one expense, $3,600 on another. That’s in one month.”

72% of retirees experience at least one spending shock during retirement.

While there are some obvious steps all of us can take to deal with spending shocks the report makes the point over and over again that two factors conspire to make shocks hard to deal with. It is difficult for us to manage our exposure and the timing is completely unpredictable (meaning we may not have sufficient cash reserves on hand).

I came away from the report thinking a few different things:

  • When looking at simulations the difference between 92% success and 96% success (just to make up two numbers) is probably meaningless when there’s a 75% chance you have some unplanned spending shock that the simulation isn’t taking into account.
  • Some of the spending shocks can be planned for now that we know about them. The dental one wasn’t one I had thought of before, though it seems obvious in retrospect. Dental insurance is pretty useless — when you can even get it — and it seems like all of my grandparents had dentures, implants, and other expensive sounding dental work.
  • An early retiree may have difficulty forecasting house maintenance costs if they haven’t been living in the house for a few decades already. And those costs can arrive suddenly — even in the bottom of a market crash.
  • There’s just a ton of things that there’s nothing you can really plan against. Divorce happens, even for people who were happily married for decades. Children and grandchildren get into accidents. Cancer is a nearly omnipresent risk as we age.
  • I think all of this underlines how much unappreciated risk people take on when they try to do leanFIRE.

Many planning tools ignore shocks. They can provide misleading results.

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