Any retirement income strategy has to be based on expectations about retirement spending.

As people approach retirement, they must grapple with a number of complex questions about expenses: How much will my health care and prescription drugs cost? Will I spend less on clothing and transportation than before retirement? Can I afford to travel? Could any of my relatives need financial support? What impact could inflation have on my living expenses?

Resolving these questions is a critical first step in the retirement planning process. It establishes the framework for retirement income decisions and guidance.

For example, if lifetime retirement expenses are anticipated to be greater than income from guaranteed lifetime sources (e.g., Social Security and defined benefit pension plans), then retirees and their professional advisors must determine how best to fill this gap by generating income from savings. Furthermore, if total expenses are predicted to rise throughout retirement, it would be necessary to model income as increasing also.

Most planners assume that expenses in retirement will increase over time. With a few exceptions, the prices of most goods and services that retirees consume have risen with overall inflation (health care costs have increased even faster), so it would be irresponsible to base retirement planning strategies on inflation-free costs.

However, even if prices increase over time, it could be that retirees will have lower expenses over time. By gradually cutting down on the number or frequency of purchases, a retiree potentially could offset inflation and thereby reduce the need for an increasing retirement income level.

Several experts say spending levels tend to decrease, not increase, throughout retirement, thus requiring planning approaches that anticipate such declines. Should professional advisors adopt this theory when implementing retirement income strategies? No, that would be a disservice to their clients. Here’s why:

Generational differences. Professional advisors should not assume that tomorrow’s retirees will act just like today’s in terms of spending habits. Today’s retirees are more frugal, have less debt and spend less on themselves than baby boomers will when they reach retirement. The boomers will live longer and be more active in the earlier retirement years, leading to more spending and higher income to meet these needs. Boomers have refashioned each life stage, and retirement is likely to be no different.

Voluntary or involuntary? It is difficult to determine conclusively that actual retirement spending needs decrease voluntarily. It could also be rational for many retirees to spend less as they age in order to conserve remaining assets over an unknown time frame. This self-imposed belt-tightening could be avoided via an income plan that creates lifetime income sources from savings.

Long term care expenses. Data on consumer spending is derived from national surveys of non-institutionalized individuals. Therefore, LTC costs and related expenses are underrepresented. Along with out-of-pocket health care costs, these expenses can be substantial, increase rapidly and ultimately derail a retirement income strategy that fails to take them into account.

LIMRA’s own research findings repeatedly have shown these costs to be the top concerns for pre-retirees who are asked to consider what risks could impact their standard of living in retirement. For example, a 2005 survey among non-retired individuals aged 55-59 and having at least $50,000 in household financial assets found that over half considered LTC costs to be a “major concern,” and 60% considered health care and prescription drug costs to be a “major concern.” Advisors should acknowledge these concerns and craft income strategies to manage the risks–perhaps through LTC insurance.

Inflation. Despite rising medical costs and recent consternation about fuel prices, serious inflation has been absent from the U.S. economy for over 2 decades. Future retirees may not be so lucky. Even if spending needs decrease during retirement, prices could easily increase enough to counteract such reductions.

Savings. Do any of today’s retirees ever claim that they “saved too much”? LIMRA research indicates that most retirees have similar expense levels in retirement as before retirement; among those admitting they could have benefited from additional retirement planning, many wish they had saved more, not less, and had saved sooner.

The bottom line: Baby boomers are not likely to run the risk of “oversaving” (and “underconsuming”). In fact, the opposite is far more likely to occur. Therefore, tomorrow’s retirees need the opposite message from financial professionals–to save as much as possible, cut down debt and prepare for retirements that will likely be longer, more active and more expensive than in their parents’ golden years.

Matthew Drinkwater, FLMI, PCS, is an associate scientist at LIMRA International, Windsor, Conn., specializing in retirement research. His e-mail address is mdrinkwater@limra.com.

Do any of today’s retirees ever claim that they ‘saved too much’?

Consider These

The Retirement Cost Factors

?Generational differences

?Voluntary or involuntary spending

?Long term care expenses

?Inflation

?Spending

Source: Matthew Drinkwater, LIMRA International, Windsor, Conn.