Personal Finance

Retirement Readiness: Underestimating Your Retirement Cash Flow Can Have Severe Consequences

People preparing for retirement often think that investment returns are the biggest factor in retirement success. Returns are an important factor, but cash flow is the #1 driver of a retirement plan’s success.

If you are approaching retirement, it’s important to take these steps in understanding the risks of underestimating your retirement expenses.

Underestimating Your Retirement Lifestyle

A lot of pre-retirees assume that retirement expenses will be lower once they retire. In reality, unexpected expenses can destroy a retirement budget. Hobbies and traveling are often a much larger part of the retirement budget as more free time leads to a more active lifestyle. You may also want to contribute more charitably or help out grandchildren, but often assets used for these purposes are not allocated before retirement. Another common pitfall is forgetting to add expenses that are currently covered by an employer or your small business. Car allowances, cell phone bills, fuel, travel expenditures, medical premiums, dental costs, and dining are often overlooked. It is important to think not only of your current lifestyle, but to envision what retirement means to you.

Underestimating Unexpected Expenses

Another important factor to consider before retiring is how unexpected expenses will be handled in retirement (e.g., a new car purchase, home improvements, health expenditures, etc.). Before retirement, when an unexpected expense occurs, you usually have time to build your investments or cash back up and recuperate. In retirement, it can be much more stressful to have an unplanned expenditure because you don’t have the inflow of income to recover as easily. Poor market performance and a market downturn can make unexpected expenses even more challenging because you could be forced to sell from an investment account at an inopportune time.

The Impact of Underestimating

Underestimating your expenses can have a devastating effect on your financial plan. For every $5,000 per year you underestimate, you will need an additional $100,000-175,000 of assets to cover the mistake. This assumes you are using a 3–5% withdrawal rate from your portfolio.

Take These Steps Before You Retire

Pre-Retirement Cash Flow Analysis

Prior to retirement, you should go through an exercise where you evaluate your cash flow. The best way of doing that is by looking at your prior year’s expenses to see what might be added to your current expenses based on employee benefits and your retirement lifestyle goals.

Pre-Retirement Budget Stress Test

Budgeting can be helpful, but it can be an arduous process. If you’re thinking “This isn’t for me,” I would encourage you to stress-test your budget. The best way to do this is by putting an estimated budget amount in your checking account on the first of the month and seeing if you need to add money to your account before the end of the month. Continue this test for at least three months. Many find that their expenses are higher than normal during the holidays, so keep those months in mind. If you’re adding money to your checking account consistently, it is safe to say you’re underestimating your monthly expenses and should reevaluate your retirement income goal.

Plan for the Unexpected

Make sure you have enough cash on hand to comfortably handle future lump sum expenses. If it’s not possible to build up your cash reserves, consider leaving some cash on the sidelines in your investment account or taking out a home equity line of credit as a backup before retirement as an alternative.

Finally, have a plan for long-term care expenditures. Even if you have a sound, realistic monthly budget and a plan for unexpected expenditures, long-term care expenses can add up quickly. Speak to your advisor about how you can leverage your assets to cover long-term care expenditures.

Many Ways We Can Help

Our My Net Worth online budgeting tool is available to any Janney client. It can help you track your savings and spending on all of your financial accounts. You can set savings goals and track your budget with this easy-touse online tool. My Net Worth can also be the first step toward a retirement income evaluation or financial plan provided by your Janney advisor.

Your advisor can also help create a retirement income plan or a more comprehensive financial plan. Understanding cash flow and budgeting are critical for anyone approaching retirement. It can help you avoid the consequences of underestimating expenses and help you plan for a comfortable retirement.

Jessica Landis
Director of Financial Planning

Jessica Landis is Janney’s Director of Financial Planning. In this role, she is responsible for the day-to-day management and operations of the internal Wealth Planning team. In addition, she plays a critical role in process improvement initiatives focused on enhancing Janney’s financial planning offerings. 

Jessica recently joined Janney after serving as a financial advisor with Legacy Planning Partners. During her seven-year tenure at Legacy, she was part of an advisory team with a focus on comprehensive financial planning. Her role included designing financial plans, determining product solutions, and educating clients on the most suitable options. She specialized in working with pre-retirees and on multi-generational plans, with a focus on strengthening the customer relationship through the financial planning process. 

Jessica graduated West Chester University with a Bachelor of Arts in Communication Studies and a Bachelor of Science in Finance. She holds her Series 7, 66, and Life Accident and Health licenses, and is also a CFP®.

This is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within.

Share this article