Defined contribution plan sponsors and financial advisors need to take into account much more than accumulating assets when designing retirement savings plans. They need to construct portfolios that try to match the plan participant or client’s spending budget in retirement, according to Michael Finke, a professor at The American College of Financial Services who specializes in economic security.
Most retirement investment solutions, especially those used by DC plans, use replacement ratios that estimate what percentage of a person’s pre-retirement income will be needed to maintain their lifestyle once they’ve stopped working. The higher their income, the lower the replacement ratio simply due to math, according to a PGIM report, Spending in Retirement: How you just might find what you want and what you need.
Someone earning $140,000 to $150,000 a year, for example, would need to have saved about 48% of their pre-retirement income while someone earning $60,000 to $70,000 should save 68%, according to the University of Michigan Health and Retirement Study.
But those replacement rates don’t take into account expected spending patterns, which can vary depending on income levels, said Finke, who was one of several speakers in a PGIM-sponsored webinar on spending in retirement.
“The average worker will spend more on fixed expenses. The higher income worker will spend more on variable categories,” Finke said.
He and others webinar panelists differentiated between spending needs, like food, housing and health care health care, and wants — clothing, travel and entertainment. Needs spending is more or less fixed; wants spending is flexible. But “needs expenses are greater than wants expenses regardless of income level,” said Finke.