Friday, January 13, 2017

The Opening Game

In my previous post, The Opening, the Middle Game and the Endgame, I compared retirement to a game of chess that can be broken down into three distinctive game phases. Like the three stages of chess, the three stages of retirement have different risks and opportunities. It is very difficult in either chess or retirement to predict what your position will be at the beginning of the next phase until you are almost there.

The opening game typically begins around age 65 to 70, depending on when the worker retires. It can begin earlier if the retiree is one of the 50% or so who reports that they were forced to retire earlier than planned (see The Risk of Retiring (or Being Retired) Early ). About 7 in 10 Americans born in 1952 have lived to reach age 65 in 2017, according to the Social Security Administration [1].

The opening game lasts until about age 75, though this is my own somewhat-arbitrary break point and depends on individual household situations. The beginning and end of the three games are fuzzy ranges, not specific ages.

The table below shows the median remaining life expectancy in 2017 for a male, female or at least one spouse of a couple, all age 65. The second column shows the 5% probability that these will live even longer. For example, about half of females age 65 today will live to age 86 and about 5% will live to age 99.

The opening phase of retirement is when retirees tend to be most physically active. For example, as I have mentioned previously, airlines report that Americans stop traveling internationally around age 70 and domestically around age 80. This decline in activity may also mean a decline in spending.

David Blanchett and Sudipto Banerjee have reported in multiple studies that spending typically declines about 1.5% per year throughout retirement and that spending late in retirement is typically lower than that at the beginning of retirement even when large end-of-life expenses are experienced. So, the opening of retirement may be the most expensive of the three games. Not all households will experience this decline, however, and it is very difficult to predict for an individual household.

Key risks of the Opening Game include forced retirement, the “Tax Torpedo”, and sequence of returns risk. (For other risks, see Why Retirees Go Broke).

The three stages of retirement have different opportunities and different risks.
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About half of recent retirees report that they were forced to retire sooner than they had planned to take care of a relative, as a result of age discrimination, as a result of layoffs or for other reasons. The decade before retirement has a large impact on retirement finances and retiring sooner than planned can be devastating.

The “tax torpedo” [4] is the name given to the scenario in which other income, like Required Minimum Distributions (RMDs) from your retirement accounts, forces more taxation of your Social Security benefits. Depending on your income and marital status, up to 85% of your Social Security benefits can become taxable. These RMDs must begin at age 70½ and this tax increase can take a substantial bite out of your Social Security retirement benefits.

Sequence of returns (SOR) risk is the risk that a series of poor market returns early in retirement can result in a retiree's savings being depleted earlier than planned. Poor returns later in retirement have less impact on the survivability of invested retiree savings and this risk declines exponentially throughout retirement. That means that the Opening Game is the phase of retirement when a series of poor portfolio returns can have the greatest negative impact on future retirement finances.

A retiree who experiences these poor returns early in retirement isn't likely to deplete her savings during the Opening Game. In fact, my SWR studies show that portfolio depletion with a reasonable spending rate of about 4% or less rarely occurs before the retiree's median life expectancy at age 65. (See Death and Ruin.) In other words, a series of poor returns that occurs in the Opening Game won't deplete savings until the Middle Game, assuming spending is somewhat reasonable. Spend 10% of your savings annually, however, and you can deplete your portfolio pretty quickly.

Sequence risk is also very high during the decade preceding retirement. Many households who believed they were all set for retirement in 2000 to 2006 encountered a dramatic setback when the Great Recession hit in late 2007. Many had to postpone or scale back their retirement plans. In my previous post, I mentioned the transition into the Opening Game (obviously not a feature of chess). That's a good time to reduce equity exposure to mitigate the risk of losing capital with little time to recover before retirement – you probably should have reduced your equity exposure before the Opening Game.

Several key decisions in the opening game also affect later games including claiming Social Security benefits, spending a reverse mortgage, purchasing a fixed annuity, and purchasing long-term care.

Claiming Social Security benefits is an excellent example. Claim benefits early and you increase Opening Game income but decrease income in later games – should you live that long. Likewise, borrowing from a reverse mortgage in the Opening Game will increase spending immediately but you might have an even greater need for that spending in later games – should you live that long.

Purchasing a fixed annuity will cost more in the Opening Game because you have a longer life expectancy. On the other hand, delay too long and you may have significantly less capital with which to purchase an annuity. At some age approximately halfway through the Middle Game, buying a fixed annuity may no longer be economically sound.

Long-Term Care insurance policies require that you qualify medically. Wait too long to purchase one and you may no longer qualify.

These decisions have both “expiration dates” and impacts on future games that are both good and bad in addition to the immediate impacts they have on the Opening Game. Decisions need to consider the impacts on all three games in a good retirement plan.

The following summarizes the salient characteristics of retirement's Opening Game:

The Opening Game has its own risks and rewards and decisions made in early retirement can have a dramatic impact on later games. A good retirement strategy will not only consider the impacts of decisions on the Opening Game but also impacts on later games. Plan with the understanding that the three games are different, that each may require its own strategy, that decisions may affect more than the current game, and that you won't know what pieces are still in play until you almost reach the next game.

In my next post, I'll move on to the Middle Game.


[1] Life Tables for the United States Social Security Area 1900-2100.

[2] Blanchett, D. (2013, November 5). Estimating the True Cost of Retirement. Morningstar.

[3] Banerjee, S. (2012). Expenditure patterns of older Americans, 2001-2009. EBRI Issue Brief, (368).

[4] The Tax Torpedo explained, Kiplinger.