Does spending go up or down over the course of the retirement years, or does it remain the same? This question is obviously of critical importance for retirement planning, yet the standard answers may not be accurate.
Traditionally, financial planners have assumed that during retirement, income needs remain constant but that due to inflation, expenditures rise every year. However, hard data on consumer spending demonstrates otherwise.
Financial planner Ty Bernicke has shown that as retirees age, they actually lower their expenditures enough to more than offset the effects of inflation.
Examining data from the U.S. Department of Labor’s annual Consumer Expenditure Survey, Bernicke noticed that retirees spent significantly less than people who were still working, and that older retirees spent less than younger retirees. The drop in retiree spending was present in all basic categories — food, shelter, clothing, transportation and entertainment — except healthcare, which was somewhat higher for older retirees.
The reduction in spending does not seem to be the result of historical circumstances, such as having lived through the Great Depression, since it is evident across generations. As seen in the chart above, people aged 55 to 64 (born between 1932 and 1941) spent a little more than $55,000 per year in 1996. Twenty years later, they were spending $38,691.
Now, consider a younger generation. In 1996, those aged 45 to 54 (born between 1942 and 1951) spent an average of $65,111 per year. By the time they had retired in 2016, they were spending just $50,873, suggesting that regardless of the generation, personal expenditures decline in retirement.
It is well documented that retirees’ assets often grow during retirement, so decisions to cut back are not due to a lack of financial resources. If outlays actually decrease during retirement and net worth grows, why do we see consistent cuts?
The answer may be found in the stages of aging that many of us witness in our family and friends. In early retirement, people often spend on long-postponed experiences, from cross-country trips to visit the grandkids to far-flung adventure vacations. Some have dubbed these the “Go-Go” years.
Next come the “Slow-Go” years, characterized by less ambitious, more local experiences that are often lower in cost. Later still are the “No-Go” years, when activity tapers off further. Nikes that once served for climbing up and down Machu Picchu may now be needed only for weekly exercise classes.
Conventional wisdom about saving for retirement seems to implicitly recognize some version of this trend up until retirement.
For example, target date funds are more aggressive or conservative depending on their time horizon, and younger savers are generally assumed to have a higher tolerance for risk because they have more time to recover from market downturns. It makes sense for retirement strategies to recognize that not all retirees are the same, either, and that not all years of retirement should be treated equally.
Some providers of retirement solutions have taken note of retiree spending patterns and have designed products to fit them. Among the most effective of these are annuities that offer riders providing accelerated income — higher initial payouts in the first several years and then lower, or reduced, payments in subsequent years.
This payout structure may help clients who need greater income to fund their activities in the Go-Go stage. In addition, an accelerated income rider will provide retirees with a guaranteed stream of income for the rest of their lives, even after the annual income amount is reduced beyond the first 10 years.
Regardless of what products financial advisors deem appropriate for clients, they should re-examine their assumptions about retiree spending. Taking into account actual behavior patterns may help them to construct retirement savings portfolios that better anticipate the real needs of their clients.
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