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Many pre-retirees and retirees often wonder whether they're on track financially to retire. Do they have enough money to last a lifetime? Well, here to talk with me about that is Wade Fow. He's the author of the retirement planning guidebook on Bob Powell, and welcome to Decoding Retirement, Wade.

Thanks, Bob. It's great to be here. Oh,

it'sgreat to have you here and it will be great to have you sort of walk us through the framework for people to decide whether they actually have enough money to retire. Where to begin?

Right, right, I think that's the biggest question people have bringing up their retirement, so we do the retirement income challenge where we talk about a three-step framework, really, you, you need to quantify the financial goals for retirement. I call those the four L's longevity, lifestyle, legacy and liquidity, and this is really what you're seeking to fund in retirement, and that really translates into expenses for your retirement. So step one is figuring that out. Step 2 is thenReally being careful and thoughtful about what assets do you have available for your retirement, Social Security, investment assets, home equity, potentially part-time work, any asset which includes future income streams like Social Security or work, uh,assessing what you have there available to fund those liabilities, and then step 3 to figure that out is calculating your funded ratio, which is simply the ratio of the assets you have to your liabilities or expenses that you're trying to fund.Uh, using a relatively conservative rate of return assumption about what your assets will do in the future. And for me, I think that's really the best starting point for thinking about am I on track to being able to successfully cover my retirementexpenses.

Yeah, a couple questions, Wade, as you think about someone guessing, estimating what their expenses will be in retirement.Is there a point at which it's more reasonable to do that, say, at 55 or 60 or 65, given that you certainly don't know what your expenses will be over the course of, say, 30 or 35 years of retirement?

Oh sure, absolutely. I mean, I think it's useful on an ongoing basis to have a sense of how much you're spending from year to year. Of course, there's a lot of things that can change in retirement, but certainly, yeah, the pre-retirement expenses that you have are going to be the most useful for figuring out what that might translate into post-retirement. Some expenses may change, and especially if you're thinking to move in retirement, thatImpact a lot of your expenses, but probably in the 5 or 10 years leading up to retirement, you're getting a sense of what it costs to fund your lifestyle, and that becomes a really good starting point for them thinking about what might adjust or what might change, what do you need to plan and prepare for for your post-retirement spending plan. Right?

And so when you think about matching your assets to your liability.The, the thought is that you have lifestyle needs, whatever they might be, uh, you have, uh, discretionary expenses that you have, you have, as you mentioned, contingency or legacy, um, expenses, which might be your reserves, and then you have maybe uh legacy goals. How does one go about sort of allocating their assets to those different, uh, components?

Mhm. Yeah, yeah, so the four Ls that longevity is your essential spending lifestyle is more discretionary types of expenses that you view as part of having a good and successful retirement legacy goals, and then liquidity for the, the spending shocks, long term care, health care, that sort of thing. So that's then what you're trying to fund. And so with your question about linking assets to those expenses,When we think about retirement assets, I like to categorize them in three broad groups. There's reliable income assets, which are best earmarked to cover longevity expenses. These are the core fixed type expenses that you want to make sure you can cover no matter how long you live in retirement. So generally looking for some sort of lifetime protection, or at least some sort of contractual protection behind the assets that are part of your reliable income.Then second, you have the diversified portfolio, and that's really your investments where you're building that diversified approach, seeking a market growth as well as just trying to manage volatility for those assets, but looking for the risk adjusted return that you feel comfortable seeking, and then earmarking that more to the discretionary lifestyle goals, as well as potentially legacy. And then once you've figured out what you need to cover.Spending, that longevity and lifestyle, as well as any legacy goals, then other assets can be earmarked as reserves, where you actually can quantify and set aside whether it's the home equity, whether it is part of your investment assets because you have a surplus, uh, whether it's different insurance policies, whatever you have available that can then be earmarked to cover those unexpected spending surprises and retirement, that third category, that's your reserve assets. So it's reliable income.Diversified portfolio and

reserves, right, I want to go back to something that you mentioned earlier, Wade, which is uh the funded ratio and this notion of dividing your assets and liabilities to determine whether you have 100% of your liabilities covered by your assets. The thought is that this ratio is similar to what defined benefit plans use to determine whether they're funded or not to meet the obligations for their, uh, pensioners.And the thought is if you're 100% or above in terms of your funding ratio, you're fine, but if you're under 100%, things are less fine and perhaps you need to start thinking about maybe some adjustments, maybe trimming expenses or working longer or saving more or investing more aggressively. What advice do you have for people who are in that position where their funded ratio is below 100%?

Mhm, yeah, you did touch upon really, there's only a few basic options about what to do. You need to either increase your asset base, which implies potentially working longer, or you need to decrease your retirement liabilities, which just means cutting expenses, uh, whether that's just trimming some of the discretionary expenses or maybe reducing the legacy goal, just reducing what you're trying to fund helps to get the funded ratio in alignment.And then the uh the other option that you mentioned is seeking that higher investment return, that would be just using a higher interest rate to calculate your funded ratio. Now that's a risky approach, uh, if you're, the funded ratio is different from the Monte Carlo financial planning that we hear a lot about.But if you're using a conservative rate of return to estimate your funded ratio, that would correspond to a high probability of success. If you're assuming you're going to earn a higher investment return and use a higher interest rate to calculate your funded ratio, uh, that can make your plan look more funded, but it would correspond to a lower probability of success because there's less chance that you're going to outperform.That return assumption that you're using. So I do suggest using caution by by going the route of assuming a higher investment return. But, but yeah, at the end of the day it's either increasing the asset base by potentially working longer or reducing expenses to decrease the liability that you're funding,

right? And so when I think about the funded ratio too, I also think about it as a point in time estimate.And that it could be, it could change depending on factors. So for instance, if you reduce the time horizon from say 35 to 30 years or you increase the time horizon from 30 to 40 years, that funding ratio changes. So I often think about using that ratio in a best case, worst case, probable case, as opposed to maybe one number. What's your thought about that?

Mhm. Right, right, as you, so the other part of risk, so that you're trying to manage retirement risk within your funded ratio, longevity risk, what planning age do you use? The longer you assume you're going to live, the less funded you'll be because you'll have more expenses to fund over a longer retirement. So, yeah, you could play around with that number. Uh, market volatility, which you manage by assuming a conservative rate of return, and then the uh the spending risk, the spending shocks the different big expenses outside of your budget.Uh, you manage that by including those contingency liabilities in the plan. And so at the end of the day, it's really developing assumptions that you feel comfortable. If, if I can have a funded plan, assuming I'm going to live to 95 or assuming I'm only going to earn a bond like rate of return on my investments or assuming I could fund a couple of years in a nursing home.Then I'm gonna go ahead and proceed with my retirement because things could get worse, but I hope they'll be in a good place. And, and it's also true that your funded ratio would fluctuate on a daily basis as the value of your investments, investment accounts fluctuate. Uh, that's where with the funded ratio, you're assuming a simple fixed rate of return that hopefully you'll outperform over the long term, but on a daily basis that can fluctuate andAnd that's something to certainly keep in mind and monitor, and if, if things are going well and your funded ratio keeps improving, it might even point to spending a bit more, but if your funded ratio is decreasing over time due to market losses.Then you might want to revisit whether you need to reduce expenditures to help get that funded ratio back into alignment,

right? So the funding ratio may be something new to most people who are planning for living in retirement. Many times people are told a common rule of thumb when they're planning for retirement is to to plan for replacing 70% to 80% of their pre-retirement income in retirement to fund their desired standard of living.Uh, any thoughts about that rule of thumb and whether people should use that as they're sort of determining whether they have enough money or not?

And it's a really simple starting point that could be a way to define what your longevity and lifestyle goals that your retirement budget would be 70% to 80% of your pre-retirement spending. But as you really start digging into in any depth, that rule of thumb starts falling apart because if 70 or 80% of what is a big question, it's really implicitly assuming you always have the same salaries. So if you'd say, I'm going to replace 70% to 80% of my pre-retirement salary.Kind of have a sense of what that is, but the reality is people's salaries fluctuate quite a bit and so then it, it's really, what am I replacing? Is it just a salary right before I retired, but if my salary had been declining as I start to cut back on work pre-retirement.Uh, I might need a higher replacement rate, or it's, do I do it based on the peak earnings over my lifetime, which might have happened in my 50s or, or my average lifetime earnings, uh, it quickly, I mean, the, the basic idea makes sense in terms of if you tend to spend most of your income other than maybe saving 10 to 15%, uh, paying taxes and so forth.That guideline of 70 to 80% could make some sense. It's just in practical terms, you're probably better off spending the time figuring out what your budget is and then using that as a baseline for figuring out what you're, whether you're potentially able to fund that in retirement.

Wade, we're going to take a short break and when we come back, we're going to talk about how youManage and mitigate the risk that you'll face in retirement. We'll talk a little bit about inflation and interest rates, and we'll also talk about the newest version of your book, Retirement Planning Guidebook. So don't go away. Stay tuned. Welcome back to Decoding Retirement. I'm Bob Powell, and I'm speaking with Wade Fowle. He's the author of the retirement Planning guidebook among other things. Wade.Uh, before we took a break, I promised that we would talk about the ways in which people can manage and mitigate the many risks that they'll face in retirement. Uh, the Society of Actuaries lists 15 risks that people will face in retirement longevity, inflation, spending, health shocks, divorce, death of a spouse, change in living conditions, etc. etc. etc. Where to begin? Longevity and inflation seem to be like the big two, the twin pillars of risks that people face, andThe tools that you need to use to manage and mitigate longevity are different from the tools you might need to manage and mitigate inflation. So eager to hear what your thoughts are.

Right, right, it's really about building an overall plan that has aspects that will manage the different risks, but yeah, longevity is just, it's great to live a long time. It's just financially more expensive and so longevity risk is the risk you live longer than expected and outlive your financial plan. If you're retiring in your 60s and your life expectancy is your 80s, there's a 50% chance you live beyond your life expectancy. So then you may start, well, what if I outlive my assets? What if I have to plan the age 95 or plan to 100 or whatever the case may be.And then with an investment strategy, that means spending less to make sure you can stretch those assets out over a long term horizon. So with managing longevity risk, the key things you have available, delaying Social Security helps to provide a lot of longevity protection, especially for the high earner in a couple whose benefit will become a survivor benefit potentially as well, and also using risk pooling type products such as annuities as part of the planning process can help manage that longevity risk as well.Uh, on the inflation side, annuities may not be the the best approach for managing inflation specifically. Uh, that's where Social Security also shines for managing inflation because Social Security does have a benefit that's linked to one of the major consumer price indexes used in the United States. You also have tips, Treasury inflation protected securities, which are Treasury bonds that actually give you a real rate of return plus whatever inflation ends up being.And then also, if you have your reliable income that we talked about earlier for your core expenses in retirement, that can provide the capacity to invest other assets, your investment assets for long term growth, with the idea that there's no guarantee behind it, but typically over a long time horizons, a diversified investment portfolio can also grow beyond the inflation rate and give you a real rate of return beyond inflation as well.

Yeah, I'm curious, Wade. Many people often say that people have to be worried about sequence of returns risks, especially if they're using their diversified portfolio to generate income in retirement using the 4% withdrawal rule or whatever the case may be. And I'm curious if, if, if one is using reliable income to fund essential expenses, you may not be exposed to sequence of return risk because you're not depending on your diversified portfolio to generate the income that you need to live on. Is that fair to say?

Right, right. So sequence of returns risk is in retirement being forced to sell assets at a loss to meet expenses. And so if you have reliable income that's not exposed to losses, uh, those assets are not exposed to the, the sequence of returns risk, and so if you have your basics covered,And, and you're not having to take, at least you can cut distributions for discretionary spending. Being able to reduce your expenditures after a market downturn is another way to manage sequence risk. So right with reliable income for the basics and then with some flexibility about how much you spend for discretionary, that can be a really powerful one-two punch for helping to manage the risk of having to sell assets at a loss and then seeing those assets disappear from the portfolio so that even if the market subsequently recovers,Whatever you sold from the portfolio to meet expenses doesn't enjoy that subsequent market recovery.

So one thing that people need to plan for and fear the most are healthcare shocks, the possibility of having to spend hundreds of thousands of dollars on medical expenses, on nursing homes, on, on home health aids, etc. etc. How do you plan for the possibility where half of the people may have a healthcare shock and and may and half may not?

Right. So when we talk about like there's the idea of long term care insurance, but insurance works best for low probability, high cost events. Long term care is not a low probability event, so you can't leverage your dollars as much through insurance. At the end of the day, it's either self-funding that you have enough reserve assets to manage a significant long-term care event.Or for many people, it may ultimately mean if you do, if you're part of the population that experiences a long-term care spending need, eventually as you spend down assets, Medicaid may become an option at some point, or there is still different long-term care insurance policies, whether it's traditional insurance or insurance linked to life insurance or an annuity.To help support spending when a long term care event takes place, you really have to think through which of those three approaches do you feel most comfortable with for your own retirement.

Yeah, another risk that people don't talk often enough about, especially if they're, you know, a couple, is the death of a spouse and the sort of the ramifications that happen.Uh, tax bombs, etc. etc. etc. I mean, what, what it's a, it's going to happen for most couples, right, that there's there'll be a death of a spouse.

Yeah, um, unfortunately, it's inevitable, but it can still be a significant retirement risk in that it's unexpected, but with the death of the spouse, the, uh, Social Security benefits to the household will probably decline if that spouse had any other pensions or things that were based just on their own lifetime, those will be gone. Now household expenditures may decrease, but not necessarily by as much as the the lost income sources that we're talking about.And then also there's a tax hit because single filers are not treated as well as married filing jointly and so in the year after the death, when you have to switch to single filer status, you might find that your tax bills are going up quite a bit as well. And so between theWell, having some reduction in expenses that higher taxes and losses of other income sources, the death of a spouse, in addition to the emotional and non-financial considerations, can also have a significant financial impact as well.

Yeah. So wait, I want to turn my attention to the newest edition of your book. There's some highlights in here, things have changed, uh.The Social Security Fairness Act has eliminated the uh windfall elimination provision and the government pension offset. Uh, talk about a little bit about how that will affect people for whom this was a problem.Mhm. Yes,

so most Americans are spent most of their careers in work covered by Social Security, but with some state and local employees and in some other cases, federal employees and things, they spent part of their careers in work not covered by Social Security because Social Security had progressive benefit formula, made them look poorer from a lifetime basis, and they would have then got a higher amount from Social Security. So the, the windfall elimination provision and government pension offset.Reduced benefits to individuals that spent part of their careers outside of the Social Security system and had pensions coming from that work outside of the Social Security system. Those provisions are gone. So if you previously had your Social Security benefits cut, either your own primary insurance amount reduced to the windfall elimination provision, or any spousal or survivor benefits you are entitled to from someone else's record through the, the government pension offset.That's now gone and, and you'll see a big boost in your Social Security benefits.

So Congress also did something else uh recently where they clarified the rules on inherited IRAs and RMDs. Tell us what we need to know about that.

Right, with, with the cure Act 2.0 and andIt's or was it 211 of them, uh, we, we got this new 10 year rule where individuals who were, did have a lifetime stretch when they had the inherited IRA, they could stretch distributions out over their lifetime.If they were not otherwise an eligible individual or a spouse, they now had 10 years to distribute that account, and the initial thought was, well, they could just wait to year 10 to take it all out if they want to. Now that might not be wise from a tax perspective, but that was the assumption that that would be the option. We now have received clarification and it's not for everyone, but it's first, if, if the owner of the account.was past their required beginning date, which is April 1st in the year after uh their R&Bs began. So if they're already passed that date, and they died after 2020, well, in 2020 or later, so after the very end of 2019.Then you do have to follow those lifetime stretch rules and take a distribution in years 1 through 9, and then take the remainder of the account out in year 10. And there's been an exception for that, so that in 2021 through 2024, you're not penalized if you didn't take those RMDs, but you do have to start doing that if you're, if you're required to starting in 2025.Uh, there is still annual R&D requirements only in that case.

So Wade, last question quickly. In your new book you increase the interest rate that you're using to 2.25%, and I'm wondering if you could just touch briefly on the notion of where we stand with respect to inflation and why you're using a higher interest rate now.

Absolutely, and that's the real interest rate. So that's, that's like based on treasury inflation protected securities, uh, then you add inflation on top of that. Real interest rates had been close to zero for a long time, had it even been negative at some points, but they keep going up now, and that makes it much easier to fund a retirement. So if you're running a funded ratio analysis with a 2.25% real interest rate compared to in the previous year I used 1.75%.And in the year before that, I think I was still at 0% real. That really makes it easier to fund the retirement because the cost of funding your liabilities will generally speaking decrease by more than the the impact on any cash flow based assets that you may have. And so it's, it's great news for retirees, it's easier to fund retirement now.We used to talk about things like is the 4% rule safe and it wasn't for the very low interest rate if you were trying to just build a 30 year ladder of tips bonds, uh, but today, if I wanted 30 years of safe inflation adjusted spending with where tips are right now, we're talking more about like a 4.6%, uh, initial withdrawal rate is sustainable.because of that higher interest rate environment. All

right, Wade, I'm afraid we've run out of time. I want to thank you for sharing your knowledge and wisdom with us. It's so greatly appreciated, and I can't wait to have you come back on a future episode of Decoding Retirement. If you've got a question about money or retirement, we're here to help. Email me at askbob@yahoo Inc.com, and we'll answer your question in a future episode.So that's it for this edition of Decoding Retirement. We hope we provided you with some actionable advice to help you plan for or live in retirement. And don't forget, for the latest retirement news and expert analysis, check out yahoo Finance.com.