Posted by Tim Stobbs on August 10, 2012
In the typical obsessive compulsive theory of retirement planning I’ve heard of a few people suggest that I should attempt to ensure I have everything shiny and new prior to actually quitting my day job. The idea is if you spend an extra year working you can afford to replace your appliances, car, upgrade your computer and anything else you might want and can afford at that time.
The upside of this particular method of planning is you can hopefully avoid the problem of having a really bad spending year within your first five years of retirement. If you ever had a bad spending year you know what it can be like. As an example, you might need a new furnace, new singles for your roof and you car dies all in the same year. Depending on how much of this you need to contract out and your particular tastes in cars you can be looking at an extra $15,ooo to $40,000 in spending for that year.
While this can feel like bad luck there is an additional issue with retirement to consider, you don’t want to drawn down your capital if at all possible during your first five years of retirement. Why? Well in a nut shell you can potentially send you portfolio into a tail spin from which it will never recover. How? Well for example, if you plan on taking out 4% of your portfolio a year and your average five year is only 3.5% you have a problem. Next you add in your bad spending year and before you know it you have spent too much of your money upfront in your retirement. Now you have to either go back to work for a while to replace the lost cash or accept you will run out of money sooner than you expected.
So on the risk planning side of the equation, I understand the logic of this idea. Yet there is a big downside as you can be setting yourself up for a big spending year further down the road. Let’s say you do replace all your appliances in the same year. The odds of all of the breaking down around the same time increase by a fair bit or you might shift it into the same year as some major work that needs to be done to your house. So yes you avoided the big spending year during your first five years, but you might get nailed hard about year 25 of your retirement. This again could cause a problem by taking too much cash out at once (not to mention the issue of taxes owning if all of this had to come out of your RRSP in a single year).
So while I like the idea I personally won’t do everything prior to quitting work. Instead I will replace stuff that is close to being required anyway, like singles for my roof if I’m within a 2 to 3 years. Yet beyond that I will only setup a bit of slush fund for things to go wrong during those first five years of around $25,000. That should absorb the majority of any big costs that come up and also means I can continue to use what I already own to the end of its useful life.
How do you plan to deal with unusual expenses during your first five years of retirement? Are you going to do everything shiny and new or not?