Forecasting Retirement Spending Updated

A researcher at Morningstar recently received an award for an article that appears to be consistent with what I’ve been writing for years. Most retirement plans forecast spending incorrectly. They take a starting spending level that usually is an arbitrary percentage of pre-retirement income. Then they assume the spending increases each year at the same rate as the Consumer Price Index. But studies done regularly by the Department of Labor clearly show that retired Americans don’t spend that way. They spend at a steady rate for the first years of retirement, then spending declines. In the later years of retirement, spending might decline further, or it might rise sharply as higher medical expenses and personal care are incurred. You can read the full article at the link.

Executive Summary

• Empirical research on retiree spending has noted a “retirement consumption puzzle,” where retiree expenditures tend to decrease both upon and during retirement. This decrease in spending is inconsistent with general economic theories on consumption, which suggest individuals seek to maintain constant consumption over their lifetimes.
• Government data on consumption was analyzed in this study to understand how retiree consumption actually changes over time.
• The results of the analysis suggest that although the retiree consumption basket is likely to increase at a rate that is faster than general inflation, actual retiree spending tends to decline in retirement in real terms. This decrease in real consumption averages approximately 1 percent per year during retirement.
• A “retirement spending smile” effect is noted. This finding has important implications when estimating retirement withdrawal rates and determining optimal spending strategies.