This week we’re talking about a cousin to the Retirement Rehearsal: the “Practice Retirement”.
I might refer to either back and forth throughout this post, in case there is some confusion. The retirement rehearsal is when you take a few weeks off of work and stay at home without doing anything fun. You can do some fun things of course, but the rehearsal is when you track your expenses, use up some of that vacation that you’re going to lose anyway, and apply reality to your hypothetical plan and to see how close you are.
That’s the retirement rehearsal. But here, we’re talking about the practice retirement. The practice retirement combines and rearranges a few aspects of retirement in an interesting way.
For most people the idea of retirement is taking one or two big trips early in your sixties, and then settling into an even keel spending lifestyle closer to your seventies.
As we discuss the practice retirement, we are operating on a few assumptions: Most people save for retirement based on a percentage of their income. The closer you are to retirement, the higher your income is, and because your retirement plan contributions are often based on income, your savings tend to be highest immediately before retirement. The last five years of work are your biggest savings years, and your first five years of retirement are often your biggest spending years.
When we sit down with clients who are ten years out from retirement, most people want to plan the things that are more tangible and easy to save for like the big trips, the family vacations, etc. These tend to be what people pursue right away when they first retire.
Now think of taking your last five years of work, (your biggest savings years), and your first five years of retirement (your biggest spending years) and think about living both of those at the exact same time.
What we’re talking about is cutting back hours, cutting back your retirement plan contributions, spending these accumulated vacation days, and also spending those newly liberated retirement plan contributions. We’re living the last few years of work and the first few years of retirement at the exact same time. We’re not going “all in” on retirement, but we’re trying to stretch out our career as much as we can by enjoying some of those big ticket fun things.
I came across a couple of interesting quotes when I was researching the practice retirement. The first is “Work, but start living some of your retirement dreams at the same time.” The other, “Yes, you are working longer but you are playing sooner.” I think these are interesting quotes that provide context on what we’re talking about with the practice retirement.
This is an attractive strategy for the right person, but any unique strategy that isn’t just a generic, by the books retirement requires plenty of planning ahead. While I was researching, I read every Google result I could find about the practice retirement. Most of them had roots back to a T Rowe Price article, whom I believe coined the phrase ‘Practice Retirement.’ Most sources had pretty similar definitions in what they thought the practice retirement was. There were articles from Forbes and many different financial publications that made the rounds a few years ago.
The basic idea of a ‘practice retirement’ based on these sources, is to stop retirement plan contributions and use those funds to start enjoying some of the fun aspects of quitting work, without actually quitting work. The theory behind practice retirement is that for the right person, you’re improving your retirement outcomes in several different ways. Rather than simply listing all the ways, I’ve decided to write a top 10 list and harness my inner David Letterman. I thought that might be more fun rather than just simply talking about some of the pros and cons.
1. The practice retirement takes away the financial temptation of early social security collection.
I know when I teach our social security planning classes at the local college, often times people have it in their minds that the day they quit work and the day they collect social security are the exact same day. They use the word ‘retirement’ and they apply it equally to quitting work and collecting social security. The practice retirement takes away the financial temptation of collecting social security early because you’re still working. You don’t have as much temptation to collect social security early at such a heavy discount as you would if you weren’t working.
Many people forget that every year after 62 that you wait to collect social security, you’re gaining an 8% increase to your benefit. If you’re married, that’s 8% that as long as you or your spouse are on the planet, you’re going to receive a direct benefit from waiting to collect. Deferring social security is a powerful part of financial planning, especially when we’re talking about retirement planning. I would prioritize that in front of just about any other investment that could be purchased for retirement. Deferring social security for one year 8% is tough to beat. That’s a big part of number 1.
Again talking about social security, if we can have a true practice retirement and get the full ten years out of it, we’re talking about waiting until age 70. That’s a 132% increase on your social security benefit. (We’ll take a look at some numbers later).
2. The practice retirement allows you to keep your employer sponsored benefits.
This is huge! When we have clients in our office here in Bismarck, the biggest hurdle I see as a barrier to early retirement is health insurance for clients not yet sixty-five years old. If a client retires at sixty and they have to make it until sixty-five on traditional 80/20 insurance coverage, it can be massively expensive. We’re talking $1,200 a month for a couple. Pre age sixty-five health insurance and a mortgage are two things that keep people working longer. If you can practice retirement, you can keep those employer sponsored benefits. It doesn’t help too much with your mortgage, (we’ll talk about that) but the employer sponsored benefits keep the company’s health insurance and keep it on their dime. Keep working, keep your benefits, but also have some retirement fun.
3. The practice retirement turns a thirty year savings dependency into twenty.
Living off your savings is harder to do for thirty years than it is to do for twenty. Every year that we can cut down our savings dependency, we’re increasing the probability of success for our retirement by a substantial amount. You don’t have to save as much; obviously the price tag for a thirty year retirement versus a twenty year retirement is much lower.
Keep in mind that the only new dollars going into the retirement plans that we’re talking about with the practice retirement, are dollars being used to get the company match. If your company is saying that they’re going to match you, the idea is not to save more for retirement, but we also don’t want to leave anything on the table. Any new money in the company 401(k) is just to get your company’s match.
4. You can partially fund any big ticket items through vacation pay and newly liberated 401(k) contributions.
In The Retirement Rehearsal, we discussed that a substantial amount of vacation pay is lost at retirement. When we’re thinking about the practice retirement and taking those big trips without quitting your job, your vacation pay (that you’re probably going to lose anyway) could be a huge ticket to being able to afford those trips. Let’s not leave any money on the table and instead look at using vacation pay to fund some of those things that we’ve been saving up for.
5. There could potentially be several more years of compounding in retirement accounts, even without new contributions.
The growth might surprise you. If there is a 10 year practice retirement window, and we can earn a 7% rate of return through the magic of compounding interest, we would actually double our nest egg over that time. Ten years at 7% return, doubles your retirement funds. That’s not any kind of guarantee of return of course, that’s just the simple trick of compound interest.
6. You can plan for longevity and health.
Think about what a five or ten year difference health consequences can have. A normal retiree’s plan says, “I’m going to retire at sixty,” or, “I’m going to retire at sixty-five and then I’m going to take trips.” I know this only plays itself out well in hindsight, but think about if your parents would have retired and took that big trip five or ten years sooner. How that would have impacted the success of that trip from a health standpoint? If you attempt to have a practice retirement, that’s what you’re affording yourself: a five or a ten year younger version of yourself going on that trip. Depending on your health, that could be pretty impactful.
7. If your parents are in declining health, traveling earlier before they’re more dependent upon your care could actually prove itself to be a once in a lifetime opportunity.
This is anecdotal evidence of course, but it is very common for clients of ours to retire specifically to take care of their parents.
8. If you are more of a homebody and big vacations are not appealing to you, think about swapping those newly liberated 401k contributions for a super sized mortgage payment.
Let’s say you meet with a financial advisor and they say you’re very close to retirement – within a few years. Maybe you stop the 401(k) contributions and you make double-sized mortgage payments? Like I said earlier, along with health insurance, keeping the mortgage around is a big reason why people keep working. If we can get that mortgage out of the way, that’s all the smoother the sailing will be when you’re actually living off of your nest egg.
9. You get to test drive your ideal retirement and the associated costs.
This is where we take theory and turn it into reality. When we’re doing our practice retirement we get to actually take vacations, visit the grandkids, go on a cruise – all while working. We can compare the results of what these things actually cost to what we had forecasted in our original retirement plan. Are we on track? Are we off track? Is this more expensive or less expensive than we thought it originally would be? We’re able to take real numbers and plug them into the plan. Thus, we can be even more sure of our plan once we decide to put it into motion completely.
10. You get to try leisure activities that you’ll finally have time for.
Leisure is not always what it’s cracked up to be. If I had a nickel for every time a retiree came into my office and told me that they were absolutely sick of golf, I might be retired by now. Sometimes you’re in your cubicle thinking you’d rather be playing golf, and then you finally retire and go out on the links every day, and end up sick of it. In the practice retirement, you’re able to find that out before you’re 100% fully retired. If that happens to you, how is that going to change your plan? Maybe you need to find a new hobby? Maybe you need to budget for less tee time? It’s going to be different for every person, but you’ll be able to test drive some of those leisure activities and find out if they’re actually a good fit for you and something that you’re going to want to do for the next twenty or thirty years of your life.
Bonus. Find your retirement “WHY”.
What I want you to do is test drive some volunteer opportunities, or maybe rent a house in a different state closer to your grandkids. Dip your toes into retirement with this practice retirement and find out why it is you want to retire. What is going to be your new purpose in life outside of work? There’s nothing worse than being in retirement and being completely bored, because we know what that does to our budget.
We wouldn’t be approaching this practice retirement evenhandedly if we didn’t talk about some of the cons of the practice retirement. Perhaps you had children later in life. Most of the time when we’re talking about practice retirement, we’re talking about funding some bigger ticket items like vacations. If you had children later in life, child care could be a concern. This is something to think about when we’re pre-planning the practice retirement. Now if they’re old enough perhaps you could take them with you on vacation, but it is something I think about when I’m role playing in my mind clients that this would be a good fit for. For clients that had children later in life who have kids that are a little bit younger, this plan could be a bit of a stretch of them.
This strategy only works if you already have significant assets by normal retirement age. Once you begin your practice retirement, you are no longer saving into those retirement accounts. Unless we’re talking about 401(k) matches, and that’s going to be to a smaller extent. If you feel like you are behind in your savings, the practice retirement isn’t going to be a good fit for you. If you are unsure, there’s really only one way to find out: visit with a Certified Financial Planner(TM). Besides myself, there are literally thousands across the country that could help you discover if you’re on or off track or from a math standpoint, if this is even something that you should be considering. If meeting with someone in person or virtually is too intimidating and you’re leery of your numbers, I’ve found Vanguard’s online tools to be very helpful. If you Google ‘Vanguard retirement calculator’ you’ll be able to easily find these tools.
What’s the point of all this? We are trying to increase our positive retirement outcomes with the practice retirement. The Retirement Policy Center at the Urban Institute estimates that for every year that you work past age sixty-two, every year that you execute this practice retirement, you’re going to increase your eventual retirement income on average of 9%. If we use our compounding interest calculator and can increase our average by 9% every year, working eight years longer would double your retirement income. Here’s why: the rule of 72 that I mentioned earlier on in this list.
(I call it the rule of 70 just because I don’t like that extra pesky 2 in the 72 as it makes the math harder.)
The rule of 70 (or 72) says ten years at 7% will double your money. The reverse is also true: seven years at 10% will also double your money, but since we’re talking about being very close to retirement goals, we’re being a little bit more conservative in our portfolio. A 7% return assumption is much more conservative than a 10% return assumption. That is probably the more prudent option but let’s talk about a mini case study here.
Let’s assume a person at age sixty with $300,000 in assets, doesn’t have a pension and they aren’t yet old enough to collect social security. On $300,000 they can expect around $12,000 a year using the 4% safe withdrawal rate. $12,000 per year income or $1,000 a month. Now the 4% safe withdrawal rate isn’t perfect by any means and it shouldn’t be used as any kind of a guarantee, but it’s a rule of thumb when doing the math in your head. The 4% rule, $4,000 per $100,000, $12,000 a year is a reasonable rate of withdrawal. That’s going to be $12,000 a year for the first two years, and then when you hit sixty-two and collect social security early, you’ll probably be able to increase that $12,000 to $26,000, once social security starts.
Generally speaking $26,000 a year isn’t really enough to pursue some big ticket, bucket list items that we talk about and save towards when we’re doing our retirement planning. Now let’s turn that plan into our practice retirement plan and see how it changes the numbers. That same portfolio, the $300,000 at 7% return, executing a practice retirement for ten years. Think about that, ten years at 7%, no additional savings because we’re spending those hypothetical retirement plan contributions. We’re funding those big ticket bucket list items. That $300,000 at 7% for ten years has now grown to $600,000, which will not kick off $12,000 at 4%. That’s going to kick off twice the amount, $24,000. Now we can combine that with social security at age seventy, and that will be 132% more. So we can quit work completely and enjoy $40,000 per year of income.
Additionally, a thirty year retirement is now a twenty year retirement, which astronomically increases our probabilities of success. It makes a huge difference! Take the exact same person with the exact same risk tolerance, the exact same return, the exact same age, portfolio, everything. The practice retirement allows them some of those big ticket items because you’re funding it through their normal earned income. The practice retirement is able to afford them a substantially different retirement, just by re-ordering and rethinking how to approach this quandary of retirement.
In summary, this is an attractive strategy for the right person, but it requires a lot of planning ahead. This isn’t something you can read about on Monday and implement on Tuesday. This requires a substantial amount of planning ahead.