Retirement Spending Is Not a Straight Line

The standard method of projecting a client’s spending pattern may have them saving too much – 

The standard formula starts with replacing a certain amount of pre-retirement income – generally 75 percent to 80 percent – and adjusting that for inflation annually. Yet a growing body of financial planning research questions that approach by demonstrating that retirement expenses rarely move in a straight, inflation-adjusted line – and often declines sharply at advanced ages. The implication: clients may not need to save as much for retirement as traditional planning theory holds.

Retirement researcher Wade Pfau recently analyzed U.S. Bureau of Labor Statistics Consumer Expenditure Survey data and found that retirees age 65-74 spend 20 percent less than those who are 55-64; 75+ retirees spend 40 percent less than those who are 55-64, and 26 percent less than people age 65-74. That’s because discretionary consumer spending tends to fall off in advanced age; healthcare spending tends to rise, but with the exception of long-term care, the spending tends to be stabilized by Medicare insurance coverage.

Pfau, a professor at The American College in Bryn Mawr, Pennsylvania, thinks the jury is still out on the issue. “Some of the studies worry me, because they are based on surveys of the non-institutionalized population,” he says. “Any nursing home or assisted living can cause you to underestimate the spending. But if you’re insured for a long-term care need, you probably don’t need as much money for retirement as we’ve been saying.”

“Planners should think about each of their clients individually,” he adds. “If he looks like someone who will have declining discretionary spending with age, and he’s properly insured, you can build that into the budget.”

Even healthcare spending can vary widely, depending on your client’s longevity, health conditions, and even location. I illustrated this in my April column, with help from Boston-based Healthview Services, which provided projections showing that out-of-pocket spending in retirement can vary by hundreds of thousands of dollars.

Stephen Utkus, director of Vanguard’s Center for Retirement Research, thinks the evidence to date points toward a need for much more research on what he calls “the second half of retirement.”

“The standard model in the actuarial world is that if your income was $100 before you retired, and you want to live on $60 or $80, then every year in retirement your basic risk was to hedge some kind of cost-of-living adjustment. You can do that using Social Security, but not a corporate pension. So, you’d use some of your savings, and hope that you have investments that beat inflation over time.”

“But the first half of retirement is different than the second half. In the first half, that model works really well. You’ve downshifted to a retirement lifestyle, adjusted your expenses and adjust your drawdown for inflation every now and then. But the second half of retirement, assuming you make it that far,  has many more paths. As an industry, we need to do more to understand those different paths.”

“As seniors get to an advanced age and become more frail, people make decisions to either move in with their kids, where the cost of living falls dramatically because they are sharing costs. On the other end of the spectrum, you have people who need nursing care and pay $120,000 a year. So, we need to think more about the breadth of outcomes.”

Utkus, who recently wrote a blog post on his own experience with this, helping his mother, who is in her mid-eighties, with her transition to a retirement community, also thinks the uncertainty of later-life spending needs goes a long way to explaining the annuity puzzle – the fact that so few retirees purchase income annuities to protect against longevity risk, despite arguments by many retirement researchers that they can be a very effective hedge against longevity risk.

“When you talk to households and ask why they don’t annuitize more of their wealth, they say they are worried about locking up their money. But at heart of that is a fear that they may need to draw down those assets quickly late in life for catastrophic health need. So, it’s a very practical reason that people are reluctant to annuitize.”

The emerging thinking on spending also echoes recent research questioning the standard four percent drawdown rule of thumb. Recent Morningstar research concludes that an initial four percent withdrawal rate — in today’s low interest rate environment — leads to a 50 percent probability of success over a 30-year period. The authors concluded that a 2.8 percent target is much safer.

Article provided by John Caffery, CFP

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6 years ago

We moved frpm Va to Fl 4 years again. Our cost of living is consistantly going up and up for everything. Just 1 example is eating at the same restaurants we used before we left Va, and the same restaurant we go to here in Florrida. I can only assume that the chain restaurants will have the same prices for their menus across the board. But, the same meal that we paid for in Va 4 years ago costs approximately $8-$10 more now. An $8 increase for the same food in 4 years. We are paying much more for utilities… Read more »

7 years ago

I was ask some question before, first must remember not all conservatives have high income, many are real poor. How a retired can survive with less of 10.000$ per years? I am a deep very deep conservatives, white Latino, I was work all my life and never ask nothing to a GOV, now old and disable when real I need a help is give me a few cent for survive. Why politician don’t thing a portion of retired living real poor and under 10.000$ per years? why not give more rise to that group?. Now a day when GOP understand… Read more »

Gloria Maturi
7 years ago

I agree 100% with Gene. My income was no where near his but because I retired DEBT-FREE, PLANNED on my future needs, and also had INVESTED in blue chip dividend stocks, I now live comfortably in a townhouse community which is suited for my living style.

I also have long term care insurance in the effect I might need nursing care. Early PLANNING is essential to have a comfortable retirement.

Sue F
7 years ago

Why don’t you write your book (get someone to help you write it)? I would read it, and I’m sure it would be welcomed by many who never made near the kind of income you had. Hopefully, the rules you used would still apply more than those published by most financial advisors today.

Gene Mathis
7 years ago

I am 71 years of age, and have read many articles that supposedly “advise” those approaching retirement, or already retired, how much a person will need in their retirement years. 99% of them are full of bull &%^*. In the 10 year period before I retired, my income as a general manager of a HR company averaged over $175,000 per year. Based on articles I read, I would have needed well over $1 million in retirement capitol to comfortably retire. What none of the so-called experts seemed to understand was the fact that 80% of Americans just will never have… Read more »

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