Forget The Myths About Retirement Spending
Years ago, I took issue with the widespread belief that people could assume they would spend less in retirement than during their working years.
Research continues to support my view. The foundation of retirement planning was that once retired, a person would spend 80% or less of pre-retirement income because certain expenditures would be eliminated, including payroll taxes, 401(k) contributions, commuting, clothes for work and more.
A problem with that theory was that retired people have to fill the time they used to spend working. Also, many people enter retirement with a list of planned activities and experiences.
Often, these things cost money. Traditional retirement advice seemed to assume people would spend retirement primarily in no-cost activities such as watching television and would eat all their meals at home. The latest research from J.P. Morgan Asset Management found that even if the traditional retirement spending assumption once was true, it no longer is.
The firm studied actual behavior over about a decade of retirees who made about $70,000 before retirement. It found the 80% assumption was largely accurate for this group some time ago, but retiree spending steadily increased. In 2019, the retirees were spending about 92% of their pre-retirement income.
Other research over the years showed that the level of spending by retirees varies with the level of pre-retirement income. The higher pre-retirement income was, the higher the spending in retirement will be. Those making $100,000 or more before retirement were likely to spend the same amount or more in retirement as before.
Another oversight in traditional retirement advice is that spending isn’t steady in retirement. The U.S. Department of Labor regularly studies spending by different age groups. Those studies consistently show spending doesn’t decline much in the early years of retirement, when retirees are younger, healthier, and have lists of planned activities and experiences. The data also show that as people age, spending declines, even after adjusting for inflation.
The composition of retirement spending also changes. As time passes, retirees on average spend more on medical expenses and less on travel, entertainment and some other leisure activities. All this research leads to several conclusions for retirees and pre-retirees. General rules about retirement spending shouldn’t be used. While research can develop averages and medians for spending, everyone who makes up the averages and medians is spending differently.
Instead of using general guidelines, think about the lifestyle you want in the coming years. Develop a spending estimate for that lifestyle. To make that process easier, use the Retirement Spending Model spreadsheet that’s available free to all subscribers under the “Member Extras” tab on the members’ section of the website.
Don’t assume retirement spending will be constant. Most plans assume a retiree will spend the same amount increased by inflation each year. Almost no one spends that way in retirement. Planning that way will cause you to spend less in the early years of retirement, when you’re younger and healthier, than you could. A better approach, with which the Retirement Spending Model spread- sheet can help, is to assume spending will change over time. Some of the basics, such as utilities, will be about the same but increased for inflation from year to year.
Other spending will change over time. You might travel more in the early years of retirement and less as you age. Your out-of-pocket medical spending will increase as premiums for Medicare and other insurance increase, but good selection of your Medicare coverage should avoid large, uninsured out-of-pocket payments. Another lesson is to try to recreate having a paycheck. Retirees tend to be more confident and satisfied when they have a system that simulates a regular paycheck. They’re more anxious and less satisfied when the see only an investment portfolio that rises and falls with the stock indexes. Other research shows that people spend substantially more in retirement, without running out of money, when they have sources of guaranteed lifetime income.
I covered this research and what it means for your retirement planning in detail in the November 2021 episode of the Retirement Watch Spotlight Series. One way to recreate a paycheck is to put a portion of your nest egg in immediate annuities and deferred income annuities (longevity annuities). You’ll receive steady income that, coupled with Social Security, ensures your basic living expenses are paid regardless of what’s happening in the markets and no matter how long you live. Another option is to put a portion of your nest egg into a spending fund every year or so.
This fund is the source for paying expenses during the year. You worry less about what’s happening in the markets, because the money to pay for your spending already is set aside. Some advisors recommend keeping two to five years’ worth of spending in the fund to maximize the safety and security.
The paycheck re-creation strategies are especially helpful for people who were good at saving during their working years but have difficulty spending from their nest eggs during retirement. They’re more likely to spend from a paycheck than to tap investment portfolios. Above all, a spending plan should be flexible. Most retirees have a lot of spending they can adjust by defer- ring some activities or doing less of them this year.
We saw that in 2020 when the COVID-19 pandemic eliminated a lot of activities. Savings soared during the year, and people found they could adjust their spending and lifestyles. I hope such severe adjustments won’t be necessary in the future. But the experience showed many people that they can make adjustments, if needed, to keep their retirement plans on track.
