Retirement ruin isn’t something that’s pleasant to think about. But unless we have a high enough guaranteed income for life, funding our lifestyle depends on maximising the probability of success. Old-fashioned retirement calculators ignored uncertainty, and predicted exactly how long your money would last. Modern approaches are based on Monte Carlo simulation; they typically tell you the probability that you’ll run out of money within a set timeframe, or (better) within your lifetime. If you’ve played around with such calculators, you’ll be quite familiar with the idea of probability of success or failure. Success means we have enough money to fund our lifestyle into the future. Failure means retirement ruin; but what exactly do we mean by ‘ruin’?

## What is retirement ruin?

The simplest way to analyse retirement finances is to base it on a ringfenced invested retirement fund: you can draw down from this fund during your estimated lifetime, or until the fund runs out. If it runs out, then this is considered to be retirement ruin. Whilst this scenario is (relatively) straightforward to analyse statistically, it’s too much of an oversimplification. One reason is that it ignores how close you came to success. Let’s say you expected your portfolio to last 30 years, but it ran out after 29 years. Then this is obviously better than if it ran out after only 20 years. In the years leading up to year 29, you may may well have seen the writing on the wall; you could then have made some adjustments, which would hopefully have avoided ruin. So treating retirement ruin as black and white may be misleading.

Another thing to consider is that life expectancy is not a number, but a range of probabilities. Making the assumption that you (and your partner, if any) will live to (say) 95 might be playing it safe, but might cause you to unnecessarily reduce your discretionary spending. Your portfolio wouldn’t need to last 30 years if you only lived for 20 more years. On the other hand, simply using your average life expectancy means there’s a 50% chance of exceeding it. So you need to factor in life expectancy uncertainty into any projections.

## Assets outside your retirement fund

Maybe you have other assets that you don’t count as part of your retirement fund. If you have a large enough retirement fund, or a generous defined benefit pension, this may not matter. However for most people, it’s essential to factor in one’s entire net worth when planning for retirement. Otherwise, if you ringfence assets so that you can’t use them for funding your cash flow, then you increase the chances of retirement ruin.

For example, let’s assume you own your home. If you’re very attached to it, the idea of downsizing to help fund your retirement may be unappealing. That could be because you love living in it, or because you want to leave it to your heirs. But compared to someone who lives in rented accommodation, you have a security buffer against hard times. If you were to hit a major cash flow problem, you’d have far more options than a renter. In fact a cash flow crisis during retirement wouldn’t necessarily mean retirement ruin. Other than downsizing, you’d have the option of equity release via a reverse mortgage.

No doubt part of the reason you decided to buy your home in the first place was that it seemed a better investment than renting. in fact, any assets that sit outside of what you might think of your retirement fund are relevant to financial planning. Even if you have a strong desire to leave a legacy, the very presence of additional assets acts as a potential cushion against retirement ruin. The greater your desire to leave a legacy, the lower you’d like the probability to be that you’ll need to tap into your additional assets; but they’d still be there as a potential cushion.

## Essential versus discretionary spending

Here at EvolveMyRetirement® we put spending firmly at the heart of retirement planning. Your income and assets are obviously important, as are your efforts to mitigate tax. But spending is the ultimate reason you accumulate wealth. The better your financial plan, the more spending you should be able to afford, with less risk of retirement ruin.

There are two categories of spending: essential and discretionary. It’s important to understand your spending, and to group it correctly into those two categories. By definition, you won’t be able to flex your essential spending, other than via a major lifestyle upheaval. Not being able to afford essential spending is retirement ruin by definition. On the other hand, you can flex discretionary spending if need be. Most people in pension drawdown would instinctively cut back on their discretionary spending if the market crashed; and they’d start increasing it again if a new bull market materialised.

A good plan avoids retirement ruin by starting with a sustainable level of discretionary spending, and not taking risks in excess of your risk tolerance, and taking into account your desire (if any) to leave a legacy. But your plan is never set in stone. The unfolding of events mean it’s essential to update your plan periodically. When you do so, you need to treat today as the first day of the rest of your life; what’s happened up till now can’t be changed.

Retirement Ruin: It’s Not Black And White
Tagged on:

This site uses Akismet to reduce spam. Learn how your comment data is processed.