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How a Back-of-the-Envelope Plan Can Reduce Financial Anxiety

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How can a few numbers, calculated on the back of the envelope, help a retired couple overcome their fear of running out of money?

Like many retired people, money has been an ongoing source of anxiety for Sam (age 80) and Diane (age 70) (not their real names). Living on a limited nest egg, social security and a modest annuity, they are unsure how long their money will last. Rapidly rising medical costs and an uncertain health outlook created a set of unknowns that caused them to delay known expenses, like dental work and painting, which could cause the ultimate costs to be higher. They knew they needed to look at their situation and do some careful planning. However, negative emotions, including anxiety, fear, uncertainty and doubt caused them to procrastinate.

With Sam turning 80 and Edna 70, we leveraged the fresh start effect to change their behavior and make the most of their future. In addition, my promise of a quick, painless and easy-to-understand accounting reduced some of the friction involved. Here’s how we figured on their finances in less than an hour and on a scrap of paper:

  • We added up all their sources of liquidity (money that can be spent easily), including bank accounts, IRAs and an unused home equity line of credit.
  • Next, we subtracted outstanding bills, the taxes they’ll have to pay on their future IRA withdrawals as well as their deferred, but unavoidable expenses including dental work, painting and an expected HOA assessment. This left a total of about $80,000 of net liquidity.
  • To estimate how long they need to make their money last, we needed to have an awkward discussion about their health and expected longevity. Helpfully, one of their doctors had suggested planning on ten years of living. In this scenario, and as a preliminary estimate, they should be able to draw about $8,000 per year or $675 per month. (This doesn’t include interest they earn on the balance, nor does it include general inflation. For simplicity, we assumed they canceled each other out.)
  • Besides longevity, other unknowns include health care inflation and unexpected expenses. We agreed that about $150 per month should handle these, based on history. That left a reasonably safe monthly draw of $525. They do some informal budgeting and felt the $525 was feasible based on current spending.
  • We discussed having an automated transfer from their IRA to their checking account that would function like an allowance. Automating this way acts as a commitment device, reducing the temptation to withdraw more than $525 per month when things get tight.
  • Their budget already includes a small amount for fun and entertainment. Sam has a little eBay business, which occasionally generates income. We agreed that, when he makes money, so long as they’re otherwise living within their allowance, they could splurge with this income. This is important to motivate the couple to stick with their commitment.

Longevity risk is an issue because they could run out of money if they live longer than ten years. It’s partially mitigated because Sam has an annuity that pays him monthly as long as he lives (as does social security). We discussed a contingency plan should they live longer than ten years: They could sell the apartment and use the equity to pay for a rental. If either dies first, the other could move closer to children and grandchildren.

I had to resist the urge to follow up with a sophisticated financial economic model that more realistically project inflation, investment returns, taxes and more. We could run a Monte Carlo simulation of thousands of potential futures to give them an idea of risk. However, this could confuse and overwhelm the couple. Also, the uncertainties and guesstimates involved would offset the greater precision, while not necessarily providing a clearer picture of the future.

Both Sam and Diane were reassured by our work that afternoon. They’re not free from worry but have moved from “very concerned” to “less concerned.” Sam has an appointment to get the dental work done and they are happily spending occasional small windfalls from the eBay business. They are living within the allowance and “trying to find the balance between having the best quality of life now and not running out of savings before age 90.” We hope that a little less money anxiety will help them find the creative solutions to make this possible.

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