Avoiding A Stressful Retirement By Understanding Household Cash Flows

by: Bruce Miller


Retirement is recognized as one of several "Life Changing Events".

Entering retirement can be stressful for many.

A firm understanding of household income and expenses will go a long way towards relieving financial stress.

In their 1967 landmark study on life events and stress, psychiatrists Thomas Holmes and Richard Rahe developed a stress scale for adults that show which life events occurring within the past year are the most stressful to individuals. Of the 43 studied life events, the following represent the top 10 most stressful.

  1. Unexpected death of a spouse
  2. Divorce/marital separation
  3. Imprisonment
  4. Death of a close family member
  5. Personal long term injury/illness
  6. Marriage
  7. Job dismissal, unexpected
  8. Marital Reconciliation
  9. Retirement
  10. Illness of a family member

It is interesting that retirement is, by this scale, considered more stressful than the death of a friend, bankruptcy, job change, long distance relocation and pregnancy. So why is a recent or soon-to-be retirement so stressful? A March 2015 article in Financial Advisor Magazine points to lack of knowledge as the primary stressor, which is to say, not understanding how personal finances are going to be managed when there is no longer the security of a regular paycheck. Will the retiree deplete savings prematurely? Will lifestyle cut-backs be necessary? Can the house be kept or will it have to be sold? I'd add to this that being later in life than most of the stressful life events, compound this. It is hard enough when our brains are young and elastic to deal with stressful life events, but doubly hard when our brains have lost some of this elasticity.

Understanding how household bills will be paid in retirement

For planning purposes, the best way to help allay the anxiety and stress associated with having sufficient retirement savings to meet household income needs over the years ahead is to actually map out the sources and amounts of known income and compare this with projections of household expenses. This is the bread-and-butter of true financial planning and makes up a sizable chunk of the Certified Financial Planning course curriculum. Short cuts to this kind of planning will typically estimate some percent of pre-retirement income as the household income requirement, usually a wage replacement between 60% and 85%. But as Michael Kitces March 2012 article finds, this percentage will depend on multiple factors and is at best an approximation. The CFP® Board requires its certificants understand how to use this important measure by actually calculating it. Michael Dalton, author of 'Personal Financial Planning: Theory and Practice', the primary text for most CFP course curriculums, an individual arguably worthy of the title "Mr. Financial Planning" (and with more letters after his name than will fit on a signature line), uses two approaches to doing this calculation: The Needs Method and the Continuation Method.

Needs Method

Sometimes referred to as the 'fundamental cash flow need' or the 'bottom-up' method, it begins with a blank piece of paper (or blank Excel Spread Sheet). At the top of the page are listed out all sources of income in the first year of retirement. Below this are listed household uses of cash, broken down into three categories: Fixed, variable and discretionary, showing monthly and annual expense amounts.

The following is an example of the "Needs" method of the first year retirement household cash flow for Lee and Ariel Owenski :

Click to enlarge

This couple has elected to retire early, beginning Social Security and Ariel's pension before full retirement age thus taking a reduction in benefits. Their employment provided moderate middle-class income although they both were diligent savers in their employer retirement plans and their own Traditional IRAs (TIRAs) for which annual contributions have always been deductible to them. After employer plan rollovers, total TIRA holdings for 2016 are $524,000 in Lee's TIRA and $196,000 in Ariel's TIRA for a total of $720,000.

Notice that the 'Needs' method does not consider past earnings, only future projected expenses and known sources of income. Future expenses are based on past expenses or on the current cost of an expense if it is new to the household. It is important to project tax as an expense, something relatively easy to do in the case of the Owenskis, as all income will come from TIRAs, a pension and Social Security, all of which are treated as ordinary income.

It will be important to adjust household cash flows for future known changes. For the Owenski's, the changes will be the change in health insurance as they each move from a pre-Medicare health plan to Medicare parts A and B and, for the Owenski's, Medicare Advantage Plans at age 65 and older. Note that they have been saving in a Health Savings Account over the years using little of it due to their good health, with the plan to use these tax free savings during Medicare years to cover out of pocket expenses.

One may think that with all investable assets providing retirement income in TIRAs, in 6 years at age 70 ½ the Owenski's will experience a hike in their Fed income tax bill thus increasing their tax expense. However, because their current yield on these investments will likely exceed 4% of their portfolio value at that time, this will itself meet the Required Minimum Distribution (NYSE:RMD) for several years. By my calculations (not shown), the Owenskis will not have to withdraw more due to an RMD than they are already withdrawing in dividends until they are into their late 70s, and thereafter will be a gradual annual increase in their tax bill, although this will depend largely on the valuation of their income portfolio in their TIRAs.

The continuation of Income Method

One of the significant drawbacks to the "Needs" of 'bottom-up' method of determining income need from life savings is that most coming up on retirement don't really know where they are spending their money. At this point in their lives, the Owenskis, (to continue using them as an example), are at the height of their earnings years with fewer expenses than in their early years and so considerably more discretionary income (income remaining after paying all fixed and variable household expenses), and so have not tracked very well what their expenses have been over the past several years….they just pay them. So to do diligence on determining monthly expenses would require carefully tracking all monthly disbursements along with other non-monthly payments, such as property tax, quarterly estimated tax payments, semiannual and annual insurance payments and so forth. This would be very time consuming for most households who do not already carefully track month-to-month expenses leading up to retirement. Most professional financial planners will instead simply look at current household income and adjust it for those household cash flows that will change, both positive and negative, DUE to retirement. This 'Top Down' method of determining the first year's retirement household income requirement assumes that most household expenses will remain as they are due primarily to retirees at this point in their life having developed routines that will not change by very much. Unlike the 'Needs' method, this approach does not consider ongoing household expenses but instead considers only the adjusted household income. Here is an example using the Owenski's pre-retirement household income:

In the case of the Owenskis, the first year income requirement is close to the same in both the 'Needs' and 'Continuation' methods of calculation ($93,623 - $92,971 = $652/year difference). However, the difference between these two methods is rarely this close….at least in my experience. The 'Needs' method will usually produce a lower household expense projection than the 'Continuation' method will project income need. But whichever method is chosen, this is a vital first step in getting a firm understanding of the retirement household's ability to generate the income necessary to sustain the lifestyle the retired household wishes to sustain.

The Next Step

Once it can be clearly seen how much of retirement savings will be required to be withdrawn each year to safely support the retirement household, the next question will be how to invest these savings. The Owenskis have chosen to invest in dividend paying stocks and perhaps ETFs, whose combined income portfolio annual yield will meet the 3.85% withdrawal required from their TIRAs. They are very confident they can achieve this income need, and that it will grow with inflation over the years ahead in order to sustain their household purchasing power. Another option would be to hold a mix of stock and bond funds (open end or ETF), periodically rebalance and withdraw the 3.9% from it, growing the withdrawal each year by inflation. How this is done is the logical next step to be covered in another article.


Anticipating retirement or being in retirement without understanding if sufficient income exists to meet lifestyle expenses, will indeed be stressful. Careful analysis of the sources of retirement household fixed income and the expected household expenses will give a clear picture of how much of the retirement savings will be required and if there is sufficient savings to meet household income need over the years ahead. This necessitates doing the actual calculations, whether the calculation begins with a blank piece of paper (or spread sheet) and builds up the projections of planned household expenses…..or…..begins with the household income just prior to retirement and adjusts this for the changes in household expenses due to retirement. Either way, calculating income need and comparing this with savings will go a long way towards making retirement a less stressful experience.

A Personal Note

I have been doing household cash flow analysis for clients for many years and taught it in a local university based CFP® course. But other than calculating our own need, I had never personally experienced a household cash flow crisis until a family member passed away last year, leaving his wife of 50 years with no understanding of household income or expenses. The months following his death saw the widow becoming increasingly anxious and at times despondent. A closer query by a sibling found that her concern was financial. She was afraid she would not have enough monthly income to pay her bills or to buy enough food to live on. A few hours of listing out her sources of income (Survivor's Social Security and Joint Survivor benefit from husband's pension) and her regular monthly expenses showed that with modest withdrawals from her now inherited IRA, she is well covered for sustaining her retirement lifestyle. It was as though she had been a cancer patient and was just told she is now cancer free. She became her happy former self and has returned to the retirement lifestyle that she had so enjoyed.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.