The demographics of family life have changed a lot in recent decades. Young people are marrying less and later in life when they do. The number of young people interested in having kids is in decline. And older folks are finding themselves less happy at home and exploring whether there are “other options.” All of these decisions have financial effects and what is remarkable is how few people have the tools to understand them.
In the various newsfeeds I read today I saw statistics about the decline in U.S. interest in having children in response to an inquiry by a young couple whether they could “afford” to have children when their household income exceeded $200,000. Meanwhile, I regularly see efforts to respond to questions about whether people can afford to retire.
Today brought a cogent response from a website called “Moneywise.” The article was not divorce specific but suffice to say that if you and your spouse divorce, your assets will be cleaved and each of you will live on your share. In community property states, the asset division is easy; each person gets half. But in equitable distribution states the percentages typically range from 40-60%. What drives that is each spouse’s ability to build new wealth after divorce. Take the couple with $500,000 in assets where the husband makes $100,000 a year and the wife $30,000. If they are age 50 at divorce the wife could get closer to 60% of the assets because she has little ability to save for retirement on a $30,000 income. Husband is in a much better position to save with his $100,000 wage. But take the same facts and change the ages to say both are age 60 and the percentages move closed to 50/50. Most courts assume that people will retire at 65 and in that case while husband does have a 3:1 advantage in earnings he will retain that for a short time before retirement. These “rules of thumb” are themselves being challenged as more and more Americans don’t plan to retire at 65.
Now…back to our example and the Moneywise article. Let’s take our couple, leave them at age 60 and assume $1,000,000 in assets to divide. In my world, that’s going to yield close to a 50/50 split with husband to pay alimony so long as he is working. Husband will be netting about $78,000 on his $100,000 wage and wife will be netting about $24,000 on her $30,000. There is no alimony formula but my educated guess is a court will make husband pay about $1,500 a month while he continues to make the $6,500 in net wages. Both spouses needed to be cautious because while husband might want to work indefinitely, his health and his employer’s needs could change that. But for now, wife can expect to have $3,500 a month to consume until age 65; husband will have $5,000 after he pays his taxes and his alimony.
Now back to the long term picture. To keep life simple let’s assume it’s 50/50 + the alimony. Thus each spouse as $500,000, hopefully with some investment gains once retirement occurs. What next?
First is to assess what defined benefit money is around. That includes social security. Here, wife needs to explore whether she is better off claiming on her own work history or taking a derivative benefit based on her marriage to higher earning husband. It is also worth investigating whether there are pension benefits that may have accrued with former employers back in a day when these plans were fairly common.
Once we know these periodic sums, it is time to look at the $500,000 in investments or other assets. If value is trapped in illiquid assets such as a house we need to evaluate whether the house makes economic sense. Home prices have appreciated nicely since 2020 but when you look at returns over a decade or more, other investments have generally outperformed residential real estate. Residential realty also presents liquidity problems when markets slow. Homes also require capital expenses like new windows or roofing. On the other hand, we live in an environment where rents are rising quickly.
Returning to the Moneywise model for now, let’s just assume that the $500,000 is either in securities or retirement mechanisms like an IRA or 401K plan. Moneywise and a number of other advice platforms promote what is termed the 4% rule. In a word, you can afford to take 4% of your principal each year to supplement social security. That amounts to a $20,000 a year draw on the $500,000 fund. The average social security benefit in 2022 for a fully retired worked was $1,600 per month. Applying the 4% rule on $500,000 amounts to a suggested draw of another $1,666 per month for a total of $3,266. There will be some income tax due on this, but it won’t be a lot.
The 4% rule is merely a conservative estimate. A broad measure like the S&P 500 over the last century indicates the average return is 10% a year but lots of people in the investment community view that as unsustainable. Realize as well that returns are not consistent. Look at the past five years the S&P 500 is up an average of 8% per year. But look only at last year and the S&P 500 was down 12.6%. While it would be preferable to cut costs when markets are down, that may be tough to do when the “budget” is $3,266 per month. It is painful to draw money to meet expenses when the assets you are selling have declined in value but realize that over time those assets have increased immensely by the same market that suffered in 2022.
Now comes the hard part and one where most financial advisers seem to offer little help. You need to figure out “How do I live on $3,266 a month or 4% of my portfolio plus social security. The starting point is to look at current expenses. What does housing cost when you factor in not just mortgage but real estate taxes, utilities, cable and insurance? Our pre divorce couple had gross income of $11,000 a month, or $8,500 net. They shared expenses. Now they are separated and living in two households with prospective retirement income of $3,000-$4,000 a month after tax. This is going to require adjustment or additional income through post retirement part-time employment. An inheritance may come to the rescue at some point. But this is the point where the prospective retiree needs to be the realist rather than the optimist. Things like auto, vacation, clothing and other expenses will probably have to be pared. Realize as well that while you might want to work forever, the human body is not always accommodating to that demand. The Moneywise article suggests that retirees should have $1 million in the bank, That number is illusory unless you know what expenses your retirement will need to fund. For that subject the best expert is the person who will be living on the retirement fund: you.
Here’s the Moneywise article: https://moneywise.com/retirement/rules-of-thumb-to-decide-if-you-can-retire-now