Last Updated: February 28, 2011 

For those thinking about retirement, choosing when to retire must be balanced with making sure you are able to stay retired. Actively managing your retirement expenses is just as important as managing your assets during retirement. At a minimum, retirees need enough income to pay for their base expenses.1 However, if a deficit exists, you only have two options: raise income or reduce expenses. The purpose of this article is to evaluate the impact of expense reduction on the retirees’ account balances. 

Would you rather have two $5 bills or one $10 bill? Most of us would say it does not matter because the economic benefit is the same. What if I told you that $200 per month in retirement expenses has a definable portfolio equivalent? This simple calculation could have profound implications on retirees spending habits, if the retiree will stop to consider the true total dollar value of their monthly expenses. By making this connection, retirees may be more motivated to reduce expenses in favor of sustainability. This perspective may also help the retiree calculate how much they need to have saved in order to generate enough income to cover on-going expenses.

In calculating the savings needed to cover a monthly expenditure, retirees should cover the base expense with income that has a specific set of characteristics. These characteristics ensure base fund expenses are covered with income that looks like the expense. If the expense is one that will last until you die and increase with inflation, then so should the income. Therefore, income should be characterized as being secure, stable and sustainable.2 

Let’s hypothetically examine meeting a monthly retirement expense by purchasing a no-load single premium immediate annuity (SPIA) and the amount of savings needed to meet an expense using this vehicle. With an immediate annuity, a retiree exchanges a lump sum amount for a series of regular payments that is guaranteed by an insurance company. Basically, the retiree could use a portion of their savings to get a steady, retirement paycheck in return.

SPIA payments typically represent a return of premium (retiree’s principal), interest on premium, mortality credits, and perhaps an inflation-adjusting factor. The highest possible payment from a SPIA would be for a term certain (limited time frame e.g. 10 years) or level income payments for life. If a retiree desired the highest monthly income payments, they could build a ladder of term certain or lifetime income SPIAs to offset inflation. Generally, the value of the mortality credits begins to make a noticeable difference around age 70.

So, what is the equivalent retirement savings value of a $200 per month after tax, inflation adjusting expense throughout retirement? The New York Life Retirement Income Annuity3 will be used in our example.

Our sample retirement expense is on-going throughout life, and increases over time due to inflation. Therefore, we will match this expense with an income source that will have the same characteristics of the expense — the income must be available for lifetime and inflation adjusting. The retiree should consider solutions that solve their longevity concern while keeping up with inflation. In our hypothetical example, by matching income to expense in this manner with New York Life’s Retirement Income Annuity, the retiree could get lifetime income that is inflation adjusting each year. 

EXAMPLE I: Male, Single Life, After Tax Income, 28 percent Tax Bracket


 Age   Inflation Factor   Monthly Expense   Equivalent Retirement Savings Needed 
 62  5%  $200  $66,391.44
 65  5%  $200  $59,780.91
 70  5%  $200  $49,192.38


EXAMPLE II: Female, Single Life, After Tax Income, 28 Percent Tax Bracket


 Age   Inflation Factor   Monthly Expense   Equivalent Retirement Savings Needed 


5% $200 $66,357.24
65 5% $200 $60,051.79
70 5% $200 $49,656.20


For purposes of these examples, a five percent inflation factor was used. Depending on the expense that needed to be covered, a retiree could choose two percent or three percent increases rather than five percent. You may think food costs will rise at three percent per year while healthcare costs will rise five percent. The inflation factor you select is important and can be tailored based on the expense or set of expenses you need to cover. Or, as mentioned above, a retiree could actively ladder SPIA income, which could result in higher payments in the shorter term.

Evaluating the equivalent retirement savings required to produce an inflation adjusting income stream for life may prove to be a wake up call of the importance of actively managing retirement expenses. It may also be used to help guide a retiree’s decision process about how much personal or retirement savings will be needed in order to meet their retirement obligations. 

Your retirement is personal and fact dependent, so please consult with a qualified financial planner that can help you evaluate the right course of action given your situation. 

Disclaimer: This information does not represent tax or legal advice or a recommendation or an offer to purchase any product or service, but is rather designed for educational purposes only.   

1 Base Expenses, as defined by Modern Retirement Theory, are mandatory living expenses of food, shelter, clothing, medical, transportation, and utilities.
2 Coverage Contribution, as defined by Modern Retirement Theory, is the contribution percentage that a guaranteed income stream covers relative to Base Expenses. Covering an expense with an income stream for the expense should be met using the 3-SModel which is secure, stable and sustainable.
3 This is sample information provided by New York Life Retirement Income Annuity, which is a no-load product. New York Life is AM Best A++ and Standard & Poor’s AAA rated company. Annuity rates displayed are as of 1/15/2011. Rates are subject to change.

FPA member Jason Branning, CFP®, is a fee-based investment adviser and financial planner with CS Planning Corp. in Ridgeland, Miss. He owns Branning Wealth Management LLC and serves on the FPA’s Journal of Financial Planning Editorial Review Board.


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