There’s a decent amount of research out there that suggests retirees underspend, an effect that’s been dubbed the “retirement consumption gap.”
The idea that retiree households under-consume has important policy implications, as well as for retirement savings in general: Why save all that money for retirement if you’re not going to spend it?
Most research exploring retirement spending has focused primarily on retirement asset levels (i.e., whether assets are being depleted and the extent the depletion would be considered optimal) or used surveys of retiree households, but has not also considered pre-retirement spending (i.e., the retirement liability) when noting the effect.
To better understand retiree spending, I recently teamed up with Warren Cormier, who heads up the Retirement Research Center at the Defined Contribution Institutional Investment Association, on some research that was just released.
In our research we not only focus on retiree spending, but we also consider pre-retirement spending along with assets available to fund retirement, such as savings and pensions, using data from the Health and Retirement Study. Considering assets, along with pre-retirement spending, should provide a richer context for the understanding of spending than a review of retiree spending alone.
We found a few interesting things in our analysis.
First, most households are not on track to replace pre-retirement income. We estimate only 18% of retirees have enough retirement wealth to maintain pre-retirement spending levels using a relatively conservative replacement metric.
This finding is not that surprising given media coverage of retirement readiness (retirement crisis!); however, it’s important context when understanding the spending choices of retirees.
Second, most retirees deplete financial assets, but at different rates. Median real financial assets were 35% lower 10 years following retirement and 65% of households had fewer assets 10 years after retiring, in today’s dollars.
Households with the lowest initial funded ratios tended to spend down financial assets the most, relatively speaking, and had the fewest assets initially (in absolute terms). While retirees might not like spending down their savings, they definitely appear to be doing so.
Third, spending declined in real terms over the first 10 years of retirement for 75% of households, with a median total reduction of 23% (i.e., approximately 2% per year). This has important implications when forecasting retirement spending in a financial plan.