I was talking to a client who was living the good life in Florida. Julia owned a beautiful penthouse condominium, drove a sporty car, traveled frequently with friends, and wore ultra-stylish clothing. Looking at her, you would have thought everything in her life was going well. Underneath the surface, however, lay the nagging question of whether Julia's assets could support her extravagant lifestyle forever. Condominium fees and real estate taxes were upward of $100,000 per year, and her travel expenses typically amounted to about $10,000 per month. She was enjoying life, and why not? This was the way she had lived when she was married, so why should things change?
In her divorce, Julia received a generous settlement, which included her luxury condominium. Of course, she felt her home needed to be thoroughly renovated postdivorce, to reflect her new outlook on life. Essentially, Julia was spending money like she had no financial constraints whatsoever. The divorce agreement did not include lifetime spousal support, however, so she needed to make sure she could live on the assets she received in the settlement.
After a candid conversation with Julia, I realized that she needed help organizing her finances and then gaining control over her spending. She needed some guidelines for setting an appropriate monthly spending limit for herself.
My suggestion that Julia downsize her home to get out from under the large housing expense did not go over well initially. But she came to understand the potential crisis looming and began looking at other housing options. That was the first and most important step: Getting her to recognize that her spending issue was real and that she needed to change certain habits if she wanted to continue enjoying some of the other things that were important to her, such as traveling. Sometimes we have to start with baby steps, even when a big change is ultimately required.
As financial advisors, we see situations like Julia's – in which people are living a lifestyle that outstrips their means – more often than you might imagine. You read celebrity versions of these stories in the press sometimes. The front page will be emblazoned with a headline about a major sports star or movie actor who retired several years earlier and now is declaring bankruptcy. From Jerry Lee Lewis to Gary Coleman to Lenny Dykstra, we've seen dozens of formerly wealthy celebrities file for bankruptcy over the years. Because these celebrities made millions of dollars at the pinnacle of their careers, they think they are eternally rich and can live the high life forever. They forget that their stratospheric income is no longer coming in and they need to live off the assets they've already accumulated.
Your Retirement Spending Picture
How do you envision your life as you grow older and begin working less or retire altogether? Will you travel the world on luxury cruises? Spend half of every year on the white sands that stretch in front of your new beachfront home or Caribbean bungalow? Or perhaps you plan to buy that picturesque horse farm you've always yearned for and occupy your time cultivating the next Derby winner. If you've built up your wealth and planned for this future, these dreams may well be within reach. But it's also possible that unrestrained spending could lead you down a path that will ultimately crack your nest egg. Which scenario comes to pass depends not only on your level of wealth and on how many hefty expenditures you make, but on what you want to accomplish in retirement and the trade-offs you are willing to make to achieve your goals.
Imprudent spending is one major reason people fail at retirement – and it lies at the root of many of the other potential pitfalls I talk about in this book, from the purchase of vacation homes to overgenerous support for adult children. So how can you tell the difference between a luxury (or a lifestyle) you can happily afford – or are willing to make reasonable trade-offs for – and an indulgence that will ultimately undermine your retirement goals? What separates a hard-won dream from a serious mistake? Before we can examine overspending, we have to look at broader spending philosophies and at some of the ways that spending in retirement differs from outlays you make while you are still working at full capacity.
When evaluating retirement plans, nearly everything centers around spending, either directly or indirectly. Most people are, in fact, overly cautious, so the number of people who jeopardize their retirement due to extravagant purchases is not large by percentage; but overspending is a significant problem for those who have it. And sometimes a pattern of free spending is enough to raise caution flags, even if no single expenditure is outsized.
When you are working full time and have a healthy income, it is easy to develop lavish spending habits. Nice vacations, meals out at upscale restaurants, frequent shopping trips, and other treats are among the ways people reward themselves for a productive week's work and cope with the stresses that come with a busy life. In retirement, people may have the same desires for material possessions and entertainment that they had before they stopped working, but now they have more time – more time to travel, more time to shop, more time to pursue potentially expensive hobbies or interests like collecting cars, starting a winery, enjoying multiple homes, or indulging in large-scale boating. And in retirement, their income is a fraction of what it once was, so it's easy to overspend assets.
While conventional wisdom dictates that people need 80% of their preretirement income to maintain their lifestyle in their post-work years, recent research has shown that spending patterns are actually quite variable – while some households do indeed reduce their spending considerably, nearly half spent more in the first two years of retirement than they had while working.1 And 28% of the retirees surveyed spent more than 120% of what they'd spent in the years preceding retirement, with the majority continuing that pattern of increased spending into their sixth year of retirement.2 So, while 80% may indeed represent an average, the spending picture is uneven, with some households cutting spending by a sizable amount and others actually increasing their outlays rather dramatically. According to the data, most of the increased spending was discretionary in nature, used either for travel or for home expenses.
In retirement, you may not be taking a hard enough look at your household spending. As an executive you might have been brilliant at developing business strategy, assessing corporate cash flow, and understanding the company's financial health, but it's possible that you do not take the same clear-eyed view of your own finances. It's much more difficult to see your personal spending rationally, particularly when what you should do and what you want to do are in conflict.
In the corporate world, you are playing with other people's money; when it comes to personal finance, you are, of course, dealing with your own, and your spouse has a say in how the money is being spent. Once you're retired, you are unlikely to be adding to your retirement bucket. You have a finite amount of assets to draw from over an uncertain period of time. For most people, living within one's means requires careful thought and planning.
We find that, for most people, managing their personal finances has never been their strong suit. If you are a person whose career success has come in law, business, sports, or entrepreneurship – or if your money has come to you through an inheritance – you may not be attuned to the details of cash inflows versus outflows and how they relate to your lifestyle and investment assets. You were bringing in more than enough money, so there was no need to pay close attention to what was gushing out.
When you are used to having money in the bank, you may be inattentive to your spending habits. And as long as cash is coming in at a brisk rate, that approach may work. But what happens when your income slows or stops, either because you've decided to retire or because your circumstances change? How will you make the transition from an income based on full-time work to an income based primarily on your investment assets' performance, which is often much less than what you'd been bringing in? How will you decide what “appropriate” or “lavish” spending is, and how will you reset your habits if you need to?
Priorities, and Who Decides Them
One of the difficulties is determining who decides what lavish spending is. Is it the husband or the wife? Do the in-laws, children, friends, or neighbors influence spending decisions? It is easy for people to make judgments about excessive spending when critiquing another individual or family – typically, the definition of excessive is “more than I would spend” on any given item or category.
But people see life differently, and their priorities and spending patterns often originate in their upbringing. Growing up in a family that was either financially stressed or spent extravagantly, hearing frequent parental arguments about finances, and suffering childhood trauma of various types can lead to a complicated or unhealthy relationship with money. Sometimes a person's individual temperament and/or the financial behaviors he or she learned growing up contribute to spending patterns that later cause conflict with a spouse.
Husbands and wives very often have different money personalities. They simply look at money and what it means differently. One spouse might think buying a new car every three or four years is unnecessary and wasteful, while the other considers it a normal and appropriate expense. One partner might view the kids' private school tuition as an extravagance, while the other sees it as an essential investment in their children's future. Who decides, and what impact will those decisions have on the couple's retirement goals?
According to a 2016 Ameriprise survey, approximately 31% of couples disagree about finances at least once a month. The most common points of disagreement are major purchases (34%), decisions about finance and children (24% of respondents who have children), a partner's spending habits (23%), and important investment decisions (14%).3
I was working with a husband and wife, Mark and Teri, both of whom had great jobs, but, based on our financial analysis, were not saving appropriately for their retirement. These two were setting aside money in their 401(k) plans but, given their income level, they needed to save a lot more if they wanted to generate a retirement income in line with their lifestyle.
The biggest obstacle to saving was that Mark and Teri had two children in private middle school at a cost of $30,000 per year, per child. That meant they needed $60,000 in after-tax dollars for tuition. In their tax bracket, the first $110,000 of their income ($60,000 after taxes) was going toward schooling – and this expense was going to continue for five more years before the children were off to college. And, of course, it was likely these kids would be attending private colleges at more than $50,000 per year, per child.
I knew that the neighborhood the family lived in had fabulo...
