A Backup Plan is Mandatory for Most Would-Be Retirees

As I mentioned last week, I recently read Darrow Kirkpatrick’s new book Can I Retire Yet. One of the things I most enjoyed about the book was its stressing of the importance of “lifeboat strategies.” Kirkpatrick writes:

When I retired at age 50, I couldn’t really be certain that we would have enough money to live comfortably for the next 30-40 years, or longer. Yes, I ran a bevy of retirement calculators. But that’s a long time into the future for any prediction to hold true. So, what really gave me confidence to retire early was not the calculations, but having a backup plan. I knew if things didn’t go as expected, there would be something I could do about it.

The lifeboat strategies are backup plans that can generate the baseline income you need to cover your essential living expenses. That’s the minimum you need for food, shelter, utilities, and medical care and not much else other than free, frugal fun. You hope retirement never comes to that, but, as we’ve discussed, it’s virtually impossible to achieve complete certainty about life decades down the road.

To back up a step, broadly speaking, there are three ways to retire without putting yourself at significant financial risk:

1. Arrange a situation such that your super safe sources of income (Social Security, inflation-adjusted pensions, and inflation-adjusted annuities) cover all of your needs,
2. Save so much money that you can get by on an very low withdrawal rate (e.g., less than 3%), or
3. Save enough money that you can get by on a roughly 4% withdrawal rate and be willing to make adjustments (i.e., implement what Kirkpatrick refers to as a “lifeboat strategy”) if things go poorly.

For many people, option #1 isn’t very appealing because (given how few people have pensions and given the limited income that can be provided by Social Security) it often means using a significant part of the portfolio to purchase one or more annuities. And most people don’t like annuities. (For the record, I do like them.)

And for many people, option #2 is similarly unappealing, because it means keeping spending low during working years (in order to save a lot) and/or keeping spending low during retirement years (so that a modestly sized portfolio can last a long time).

In other words, most people gravitate toward option #3.

But option #3 is only appropriate if you really are willing to make changes when necessary. And, not coincidentally, those changes look a lot like options #1 and #2 in the first place — only more severe, because you’re now in a worse position than you were in when you chose to retire.

As Kirkpatrick stresses in his book, it’s important to spend time thinking about what exactly your backup plan will be — downsizing your home, taking out a reverse mortgage, moving to a less expensive town, etc. If you can’t come up with a specific plan that you would be willing to implement (i.e., you can’t significantly cut back spending or free up additional liquid assets), and you cannot satisfy your desired level of spending with a very modest withdrawal rate from your portfolio, then you probably need to keep working.