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Why Retirees Are Spending More Than They Used To

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From 2016 to 2019, retirement income-replacement needs rose to 92% from 80% for folks who were earning $70,000 a year pre-retirement, according to J.P. Morgan Asset Management research.

That number “has been creeping up steadily for [about a decade],” Katherine Roy, managing director and chief retirement strategist at J.P. Morgan Asset Management, tells ThinkAdvisor in an interview. “There’s not as large a drop-off [as there used to be] between pre-retirement spending and comparable lifestyle post-retirement. 

“It’s time to take a fresh look at actual spending behavior to understand that rise.” 

Though 2020 was an anomaly because of the coronavirus pandemic, Roy cites savings behavior last year as “proof” that households “can spend less on certain things.”

“It was a record savings year nationally” for both workers and retirees, she notes.

That savings could hypothetically be “redirected” toward saving for retirement, she argues.

At the other end of the spectrum, Roy serves up a suggestion for how “good savers/bad spenders” can be encouraged to spend more in retirement by opening a separate account that would “recreate their paycheck.” 

“The second account would act as their spending account,” she says. “Their investment income, RMDs, etc. would be periodically transferred to the spending account to ‘recreate’ a paycheck-like experience.  Another option is to take a fresh look at annuities for the pure benefit of the payment mechanism.

“Annuities have different flavors and fees, and all that has to be understood by the client.”

Roy, who started out at Merrill Lynch, has specialized in the retirement space for more than 20 years.

Citing other J.P. Morgan research from 2019, she notes that 42% of 401(k) plan participants still keep assets in their plan three years after they retire. 

Plan sponsors are at work on low-cost solutions, particularly annuities, to invest some of that money, she says.

Part of the interview focused on President Joe Biden’s tax plan. For example, Roy discussed potential tax consequences, depending on the proposal as passed and perhaps future changes to the tax code, of having a heavy concentration of tax-deferred assets in retirement.

ThinkAdvisor recently interviewed Roy, who was speaking from New York City, where she’s based. She talked about the importance of de-risking ahead of retirement but stressed that there’s an inadvisable time to do that.

Here are highlights of our conversation:

THINKADVISOR: What level of income replacement needs do retirees have in actuality? 

KATHERINE ROY: In 2019, we did a study of typical participants, making about $70,000 before they retire. It showed that their income replacement needs — to support their current lifestyle in retirement — had gone up by 12% since 2016, from 80% to 92%. It’s been creeping up steadily for [about a decade]. 

The number one question: Is inflation driving that? No. It’s all inflation-adjusted. And up till now we’ve had [relatively low] inflation.

So individuals aren’t spending significantly less after they retire?

It used to be that people would spend less in retirement because they’d paid off their mortgages, say, or their transportation costs had gone down.

But that trend, as we’re seeing in our research, has narrowed. There’s not as large a drop-off between that pre-retiree who’s making $70,000 and their comparable lifestyle post-retirement, which is part of what’s driving that 92%.

So it’s time to take a fresh look at people’s actual spending behaviors to understand that rise in spending. It’s [partly] inflation, but it’s also the choices that households seem to be making and have been making for the last decade or so.

How different was 2020 with regard to spending behavior?

Last year gave us a glimmer of hope, albeit in very challenging circumstances — an anomalous year due to COVID and market volatility in March.

We saw earners and retirees spending meaningfully less in 2020. It was a record savings year nationally. We saw steady earners spend between 2% and 5% less and retirees 5% to almost 9% less as households.

That presents some proof that there can be less spending by most households on certain things that, maybe, they didn’t miss that we could redirect toward savings in pre-retirement.

One of the most powerful levers that a retiree has is to spend less or to adapt their spending so that they’re not drawing on a portfolio that could be struggling, depending on what’s happening in the market.

Some retirees are just the opposite: They don’t spend much in retirement because they fear they’ll run out of money, correct? 

Yes. A good saver often has a very difficult time shifting to being a spender.

So I believe that for certain clients — those good savers/bad spenders — who are really nervous about spending their principal, recreate their paycheck by putting money into a separate account. That could result in their having greater confidence to spend down the money.

This is [better than frequently] checking their account balances. Retirees looking at their account balances can inhibit their spending even if they’ve been told through their planning and by their advisor that they have more than enough money. 

Your research found that folks still have assets in a 401(k) plans three years after retirement. What are the implications?

That has been pretty much a steady trend that we’ve seen over the last 10 years with people that have higher balances, and it’s picked up. We looked at participants in 401(k) plans and found that 42% have assets in the plan after three years. 

It used to be that about 20% had some sort of balance in their 401(k) plans after three years.

What could an incentive be to stay in the plan?

Plan sponsors are working through which retirement income solutions they plan to or will offer to participants who stay. The sponsors usually have lower-cost types of solutions, particularly in the annuity space.

More on this topic

How much demand do you think there would be?

Our research shows that about 85% of participants would be interested in retirement income solutions.

It could be a solution that delivers income, such as annuities — many fit in that retirement income tier. There’s a lot of innovation to solve participants’ needs happening in that space.

It’s important for advisors to be aware that, increasingly, those types of solutions will be available to clients that fit within a longer-term strategy.

What are your thoughts about expected higher taxes for the wealthy in President Biden’s tax plan? 

I absolutely think this is something advisors should be talking about with clients in coordination with their tax advisor, such as a CPA.

It’s really important to reinforce with clients that what might be proposed or what might pass is out of their control and to also think about taxes as what we call “the price of admission for investing.”

If you’re paying taxes, that means you’ve made money, which is preferable to, let’s say, sitting in cash, where you’re earning nothing and therefore paying no tax.

So advisors need to reinforce with investors that paying tax can be a byproduct of a good investment position.

What else do they need to bear in mind?

It’s really important that they’re well-diversified [in various retirement accounts].

I’m primarily concerned with the millions of households that have successfully used their 401(k) and have really grown their IRA wealth: They may be on a trajectory to be heavily concentrated in tax-deferred assets in retirement and at greater risk for paying more taxes.

They’ll be pulling out money from their tax-deferred accounts to pay them. As a result, it’s more likely that their Social Security benefits will be subject to taxes and also, longer term, increasingly likely that they’ll trigger Medicare surcharges.

What might an FA recommend?

If you’re seeing that tax-deferred-concentrated client, help them diversify or suggest to diversify their first Roth IRA if they’re below that income limit, or a Roth 401(k) if they have access to that through their employers. 

Also, people working for companies with more than 500 employees have a Roth 401(k) option without income limits.

What else can advisors do to help?

They can recommend building up taxable assets: locating long-term equities in those accounts so clients can benefit from capital gains treatment.

These are ways that investors should think about diversifying from here on out so they have greater control and flexibility and are less concentrated should a particular part of the tax code change and impact them significantly.

What could the impact be to retirees of today’s rising inflation?

Hopefully, it’s somewhat of a wake-up call. It’s really important to get our arms around how much we spend [retired or still working] — we’ve seen that trending up regardless of inflation.   

We saw in our research that if we have an influx of new income — more money in our checking accounts, like a tax refund or fiscal stimulus payments — we tend to spend it fairly quickly versus save it, which has implications, obviously, for accumulating wealth.

So it’s really important that, whether you’re saving for retirement or spending in retirement, to [understand and watch] that spending.

What investment strategy would be good for retirees or pre-retirees at this time of rising inflation?

We always take the long-term view. We’ve been talking for years about how important it is for clients to maintain some growth exposure to get to retirement but also growth post-retirement.

We see a lot of clients wanting to de-risk pretty significantly — a lot of equity being taken off the table as people roll out from their 401(k) into an IRA.

But they need to have some level of growth [investing] because in retirement, you’re buying more health care, and health care is the fastest inflating category in the basket of goods that individuals buy. 

We have a 6% growth rate on our health care expenses, which, to keep pace, really necessitates equities as a component of that long-term investment strategy. 

Should investors be ever-vigilant in protecting their assets against recession or a market crash?

The awareness of your risk tolerance and risk capacity needs to be well thought through and understood. What our research shows is that when [investors’] capital is the greatest — that’s when they’re at greatest risk — is when they need to be well diversified and de-risk in advance of retirement.

It’s very important for investors to de-risk to an appropriate allocation in advance of retirement so they’re well positioned should they experience market volatility.

Pre-retirees should think of retirement as a long-term position and not a short-term investing opportunity.

They need to de-risk [ahead] of retirement but continue to have a long-term investment objective.  

Could there be a bad time to de-risk?

Our research shows that people tend to de-risk when they roll over into an IRA. But that [can be done] at the wrong time, [such as] when markets are turbulent. 

De-risking in challenging markets has [negative] long-term implications.