One of life’s under-appreciated pleasures is the “ah ha.” It is that lovely moment when the mists clear and the truth that was lurking behind the clouds emerges in full clarity. I always feel terrific when things come together, and I can say, “Ah ha, now I get it.” I often find myself working with things that are not completely clear. I may have enough knowledge to achieve useful results, but still feel myself struggling with the big picture and the broader implications. Sometimes I am rewarded with a little “ah ha” that brightens my day and makes my path a little clearer, but really big “ah ha’s” are rarer. Recently, someone¹ gave me a whopper of an “ah ha” about retirement planning that I’d like to share.

The idea is simple, but for me it has changed the entire structure of my understanding of retirement planning. The idea is this: “There is a ten-year period, the five years just before retirement and the five years just after retirement, that is critical to the success of any retirement.” I think I always understood that there was something like that, but stated with such clarity, this concept has transformed my thinking. It’s similar to when I finally understood what the ski instructor meant when he said, “Keep your weight on the downhill ski.”

The more I reflect on this concept, the more wisdom I find in it—in other words, the more I find it reflects ideas that I have talked about, written about and tried to work with for many years, but which never came together with such clarity. There is more to say about this than I can cram into this column, but let me try to pull out two of the most important ideas, one from the five years before retirement and one from the five years after retirement.

Before Retirement: Lifestyle Creep

The first idea is what I call “lifestyle creep.” More and more, people find themselves in a pretty comfortable situation as they approach retirement. They are earning more money than they ever have. Frequently, the second spouse has gone back into the workforce, and as that spouse moves from entry-level positions to more responsible roles, the earnings increase dramatically. The primary earner has achieved senior status and the compensation that comes with it. Meanwhile, many of their key expenses were fixed in earlier years when they were earning less, and for many, university tuitions have finally been paid. The result is that the gap between earnings and expenses is widening rapidly. For many families, the funds available for savings and investment may increase by five or even ten times in the five years just before retirement.

Imagine a family where the principal wage earner was making $60,000 in 1995. The spouse was managing the home while the last of their two children was still in high school. The mortgage on their home was ten years old, and had been fixed in 1985 when their income was $45,000. The monthly mortgage payments were about $600 a month. They were saving $3,000 into a 401(k) and paying tuition for their oldest child of $7,500 a year, $2,500 from current income and the rest from an educational savings fund that they had set up years ago.

Today, tuition for their children has ended. The spouse went back to work five years ago and is now making $30,000 a year, and the principal wage earner is up to $75,000 a year. Their lifestyle has improved a little in the last five years, and their after-tax budget has gone from $45,000 to $57,000, but their margin for savings and investment has grown from $3,000 a year to more than $30,000. In the next five years, they could conceivably save about one-third of all the money they are going to need for a comfortable retirement. They are looking forward to a prosperous retirement, a pleasant lifestyle, some travel and the security of knowing that their needs will be met.

These are indeed the good times. But just barely visible behind the mists of euphoria, there is a potential problem—lifestyle creep. Suppose the happy couple decides to spend that surplus instead of using it for savings and investment. They decide to make dramatic improvements in their lifestyle: better home, new wardrobe, new cars, and a country club membership. It’s not hard to spend $30,000. In the typical cycle of retirement planning, this gets translated into an imperative to postpone retirement for a few years.

The bad news is worse than that. Lifestyle creep not only reduces or eliminates the ability to make dramatic additions to retirement capital, but it also increases the cost of retirement. The goal of modern retirement is to have a lifestyle in retirement that is similar to the lifestyle enjoyed just before retirement—not to make it better but certainly not to have it worse. If lifestyle expenditures increase dramatically in the years just before retirement, they tend to increase the budget throughout most of retirement. In fact, in the case just described, if the funds available after their usual expenses are used to increase lifestyle, it will increase the cost of retirement by almost 50 percent.

So here is the happy couple: empty nesters, looking forward to retirement with more cash available than they ever had, and they have a serious decision to make. How will they allocate these surplus funds between savings and investments on one hand, and improved lifestyle on the other? To make the “right decision,” they need to understand the full implications of their decisions. If they take these dollars for improved lifestyle, they also are increasing the cost of their retirement. Thus, a seemingly Solomon-like decision to put half into savings and half into lifestyle is actually a decision to spend most of the funds on increased lifestyle. Half of the available cash that they have decided to put into lifestyle will also increase the cost of their retirement by about one-third, and the amount that they are putting into savings will increase their retirement capital by only about eight percent. They need your help, as a planner, in getting to an “ah ha” in these critical years just before retirement.

After Retirement: Second Childhood

Now, let’s shift our focus to the first few years just after retirement. With your help, our happy couple made the right decisions in the years just before retirement. They saved the great bulk of those extra dollars, invested them wisely, and now have a nest egg large enough to provide a prosperous retirement—one in which their lifestyle is very similar to their lifestyle before retirement. But they are retired, and this is the period of retirement that has the potential of being “a second childhood without parental supervision.” Whoopie! School is out and it’s time to play. Now the trick is to help these folks plan the rest of their retirement in a way that deals realistically with their needs, but still frees them to shift financial resources into this active phase of their retirement. There are issues that need to be dealt with: longevity, medical care, the possible need for nursing care, changing requirements for their residence, their desires to leave an inheritance, investment returns, inflation and so on—all the familiar retirement planning issues. When all is said and done, however, the question remains, “What is the purpose of having saved all this money for retirement?” The quick and easy response is, “To provide financial security,” but this is not a time of subsistence living. Financial planners are trying to respond to their clients’ desire to capture the full potential of modern American retirement—not just to keep the wolf away from the door.

The trick to capturing the full potential of this complicated, very long and expensive retirement is to create a comprehensive financial plan that shows the retiree exactly what is available for grasping the fun and excitement of the first few years of retirement. These first few years are the time when their health, vigor and enthusiasm are likely to be at a peak, and capturing the full potential of those years is at the very top of the list in terms of important retirement decisions.

The role of financial planning has never been more important as millions of Americans reach out to grasp the reality of modern retirement. It will help them understand just how to do that if we can get them focused on the important decisions that tend to cluster in the Decision Decade.

Endnote

1. This comes from my friends at Delaware Investments who have dubbed this concept “The Delaware Decision Decade.”

Michael K. Stein, CFP, is vice president of EMSTCO, LLC, in Boulder, Colorado, and author of The Prosperous Retirement.