Lordhenrivoton | E+ | Getty Images<\/p>\n<\/div>\n<\/div>\n<\/div>\n
When people think of how much to save for retirement<\/a> \u2014 and, subsequently, how to spend that money<\/a> wisely in older age \u2014 many worry about the risk of running out of money early. They fear the possibility of overspending. <\/p>\n But there\u2019s another less-appreciated danger, too, according to financial experts: The risk of underspending one\u2019s nest egg. <\/p>\n \u201cOverspending is risky. But underspending is risky too,\u201d said Zach Teutsch, a member of CNBC\u2019s Financial Advisor Council<\/a> and founder of Values Added Financial in Washington.<\/p>\n Data shows that it happens to many retirees. <\/p>\n About a third of retirees still have 100% or more of their initial savings remaining by their mid-80s, according to a recent study<\/a> by the Employee Benefit Research Institute, a nonpartisan research group.<\/p>\n \u201cWhen you see so many people into their 80s still at 100%, you see people who are being way too conservative [with their spending],\u201d said Craig Copeland, the director of wealth benefits research at EBRI. <\/p>\n<\/div>\n Of course, the opposite is true, too: \u201cYou also see some people with less than 20% [of their assets remaining] who are in the other situation: \u2018If I live five more years, I won\u2019t be able to do anything,'\u201d Copeland said. <\/p>\n About a fifth of people who entered retirement with more than $500,000 had less than 20% of their assets remaining by their mid-80s, according to EBRI\u2019s research. <\/p>\n \u201cThis will be the foremost challenge in retirement: figuring out how to maximize retirement but still have a buffer at the end,\u201d Copeland said. <\/p>\n<\/div>\n Vgajic | E+ | Getty Images<\/p>\n<\/div>\n<\/div>\n<\/div>\n The risk of overspending is straightforward: Running out of savings in older age may make it difficult to afford basic necessities, let alone enjoy one\u2019s later years \u2014 even more so if guaranteed income sources like Social Security aren\u2019t robust. <\/p>\n The risk of underspending may be less obvious. <\/p>\n But according to financial advisors, it ultimately amounts to something similar: not living as fulfilling a life as one could have. <\/p>\n \u201cIt represents a life not lived, the vacations you didn\u2019t take because you were afraid you were going to run out of money,\u201d said Marianela Collado, a certified financial planner and certified public accountant based in Plantation, Florida. She is also a member of CNBC\u2019s Financial Advisor Council.<\/p>\n<\/div>\n It\u2019s a difficult psychological leap for many people to go from a savings mindset, in which one\u2019s net worth is consistently growing, to one of drawing down that nest egg and seeing one\u2019s net worth decline, according to financial experts. <\/p>\n \u201cSome people spent all their life saving money, and it\u2019s very hard to switch then to spending their assets down,\u201d Copeland said. \u201cIt\u2019s not a comfortable feeling.\u201d<\/p>\n Many people who are retired today have also lived through \u201can era of very good capital markets,\u201d in which there have been many years of double-digit annual stock returns after the 2008 financial crisis, Copeland said. <\/p>\n That dynamic has made it easier to preserve or even build wealth throughout retirement, he said. <\/p>\n<\/div>\n Teutsch said he likes to use an analogy with clients to illustrate the risk of underspending: Imagine you\u2019re sailing a ship through a channel. Rocks on one side of the channel represent running out of money. On the other are rocks that represent the risk of missing out on experiences. <\/p>\n \u201cEventually, if you sail too far the other way, you end up ditching your boat on the shoals of regret,\u201d Teutsch said.<\/p>\n \u201cI hope people don\u2019t look back and say, \u2018I have more than I need, and it means I didn\u2019t need to work nights and weekends, I could have spent more time with my kids and family, or could have given more [money] away,'\u201d he said. <\/p>\n<\/div>\n It represents a life not lived, the vacations you didn\u2019t take because you were afraid you were going to run out of money.<\/p>\n Marianela Collado<\/p>\n certified financial planner and certified public accountant based in Plantation, Florida<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/blockquote>\n Retirees shouldn\u2019t be afraid to enjoy the money they worked hard to save for years \u2014 within reason, of course, financial advisors said. That\u2019s especially the case earlier in retirement, when retirees are more likely to be mobile and active relative to their later years, they said. <\/p>\n Ultimately, after death, the money will be spent on the retiree\u2019s behalf \u2014 perhaps inherited or donated to charity \u2014 but they won\u2019t get the chance to enjoy it, the advisors said.<\/p>\n \u201cAs long as the financial plan indicates it\u2019s a good idea, I encourage clients to give money to their favorite causes, to kids, to live well when they\u2019re alive and can enjoy it,\u201d Teutsch said. \u201cIf you help somebody buy a house [for example], you get a lot of enjoyment out of that.\u201d<\/p>\n<\/div>\n Assessing how to best spend one\u2019s nest egg from year to year is difficult because there are many unknowable factors that have a large bearing on success, advisors said. <\/p>\n For example, one\u2019s life span is impossible to predict, as are future returns on financial assets. <\/p>\n Retirees also must increasingly rely on 401(k)-type plans in which they\u2019re forced to manage their savings rates and investments and determine how to translate that lump sum into future income. Earlier generations were more likely to have a pension, which outsourced much of that complexity to employers. <\/p>\n<\/div>\n Momo Productions | Digitalvision | Getty Images<\/p>\n<\/div>\n<\/div>\n<\/div>\n There are some guiding principles for do-it-yourselfers, though, according to financial planners. <\/p>\n The 4% rule<\/a> is \u201ca really good starting point,\u201d for example, Collado said. <\/p>\n This rule of thumb gives an approximation of how much money retirees can withdraw<\/a> from their savings each year in order to give themselves good odds of not running out of money 30 years later. <\/p>\n Retirees would withdraw 4%<\/a> of their portfolio in the first year, then give themselves a \u201craise\u201d in the second year based on the inflation rate. Same in the third year, and so on. These funds would stack on top of other sources of income, such as Social Security. <\/p>\n For example, an investor would withdraw $40,000 from a $1 million portfolio in the first year of retirement, which is 4% of the total. If the cost of living rises 2% that year, the next year\u2019s withdrawal would rise to $40,800 \u2014 or, 2% more. Another 2% cost of living increase in the third year would translate to a $41,616 withdrawal. And so on.<\/p>\n One caveat: Retirees should ensure they\u2019re withdrawing at least enough to cover any required minimum distributions from their retirement accounts, advisors said. <\/p>\n<\/div>\n Buena Vista Images | Photodisc | Getty Images<\/p>\n<\/div>\n<\/div>\n<\/div>\n However, the 4% rule isn\u2019t perfect and, since it uses conservative assumptions, may contribute to underspending, advisors said. <\/p>\n Retirees can also consider a \u201cdynamic spending\u201d approach, in which spending isn\u2019t static like the 4% rule would suggest but is flexible according to market conditions, Teutsch said. <\/p>\n In a year of positive stock returns, for example, retirees could take out more money \u2014 perhaps a 7% withdrawal \u2014 and reduce that sum in down years, maybe to 2.5%, for example, he said. <\/p>\n Retiree spending tends to be more U-shaped than static, whereby retirees generally spend more early in retirement when they\u2019re more active, throttle back when they inevitably slow down a bit and then spend more in older age when they may have a greater need for costly long-term care<\/a>, for example, he said. <\/p>\n<\/div>\n A dynamic approach also helps to reduce something called \u201csequence of returns risk<\/a>,\u201d whereby retirees increase the risk of running out of money in retirement by withdrawing from their stocks when the stock market is declining. This risk is heightened earlier in one\u2019s retirement, advisors said. <\/p>\n Retirees might also consider a \u201cdynamic earning\u201d strategy in such years, Teutsch said. For example, people who are able to take on some side work might supplement their portfolio income by working a few hours a week on a consulting project or something similar, he said. <\/p>\n<\/div>\nRead more CNBC personal finance coverage<\/h2>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n
The risk of underspending<\/h2>\n
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Why figuring out retirement spending is difficult<\/h2>\n
How much can you spend in retirement?<\/h2>\n
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