People often assume that maintaining “financial well-being” in retirement equates to maintaining a constant standard of living, as expressed in terms of after-tax spending.
New research from PGIM’s David Blanchett puts that assumption to the test. Blanchett finds that financial satisfaction increases markedly for older Americans when holding consumption levels constant.
This suggests that retirees do not necessarily need to maintain pre-retirement consumption standards throughout retirement to maintain the same level of financial well-being. As Blanchett explains, the “utility of consumption” changes across the lifecycle, such that people who are late in retirement generally don’t need to spend as much to experience comparable satisfaction.
The finding may sound technical, Blanchett says, but is important for financial planners and their clients in assessing the appropriate level of spending during the retirement journey. A plan that sees spending trend downward to avoid bankruptcy in retirement, it turns out, is not inherently problematic from a well-being perspective.
While only about 45% of respondents spending between $20,000 and $30,000 per year between the ages of 50 and 54 are satisfied with their financial situation, about 84% of those age 80 or older with similar consumption levels are satisfied with their situation. Additionally, financial well-being declines for only about 7% of households moving into retirement, Blanchett notes, despite consumption declining by about 20%, on average.
“This analysis suggests that reductions in spending during retirement are likely to be significantly less cataclysmic than suggested by many existing models,” Blanchett says. “Regardless, we need to approach the implications of these potential spending reductions in later retirement with more nuance to better reflect how people experience retirement and adjust to situations over time.”
Using data from the longitudinal Health and Retirement Study from the University of Michigan, the paper shows that households experience a median consumption decline of about 20% upon entering retirement. However, changes after retirement are relatively constant with the initial retirement spending level and actually trend slightly higher over time.
What Retirement Crisis?
One potential reason for the drop in consumption at retirement, according to Blanchett, is the realization that households simply cannot spend at pre-retirement levels due to a lack of savings.
“This reduction in consumption, as well as the overall lack of retirement savings, has given rise to the notion that we are in, or at least headed towards, a national retirement crisis,” Blanchett says.
He points to a Prudential Financial survey showing that 58% of respondents somewhat or strongly agreed with the statement that “a national retirement crisis exists.”
Workers were much more likely than retirees to agree with this statement. About two-thirds of those age 65 or younger believed that there was a national retirement crisis compared with just 26% of retirees who described their personal situation as a crisis. That drops to 10% for retirees with $50,000 or more in savings.
“There is a clear disconnect between perceptions of a national crisis (what other people are experiencing) and the reported situation of retirees, where retirees are far better off when asked about their situation,” Blanchett writes. “This is consistent with retiree perspectives in the HRS. … Overall, roughly 90% are moderately or very satisfied with retirement.”
These responses, Blanchett argues, suggest that despite perceptions of a retirement crisis, retirees are relatively content. One potential explanation for the disconnect could be that retirees don’t actually need to replace the standard of living in retirement as pre-retirement to be financially content.
Intersection of Age and Well-Being
According to Blanchett, there is “relatively clear evidence” that financial well-being increases with consumption levels. More surprising, he notes, is that there is also notable improvement by age, even when holding consumption constant.
“While it’s possible retirees could be over-reporting financial well-being, there are other potential drivers as well,” Blanchett writes. “For example, retirees are going to have significantly more free time than workers, which may offset lower potential consumption levels.”
Targeting a similar level of consumption throughout retirement seems like a reasonable goal for American workers, Blanchett maintains, but the analysis suggests that those who may not achieve this target are likely to fare far better than commonly assumed in retirement models.
“This means that even retirees who may have to eventually live off less in retirement may actually end up better off from a satisfaction standpoint as compared to how satisfied they were doing while working,” he notes.
Pictured: David Blanchett
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