Many people approach retirement planning as if they’ll spend the same amount every year for the rest of their lives. This assumption simplifies the planning process, but it is not practical. Our spending habits change from time to time, partly due to our circumstances in life. And of course, our desires in life will change because of a number of factors as well.
If you can look back on your own life, it’s not hard to imagine times when you’ve spent more money than normal. Maybe those first few years of having children or when you were buying a home, those years you were likely spending more than you normally do.
Contrast that with times when you were single and had little in terms of obligations, you likely spent less than you did in other years.
Simply accepting that different times of our lives will bring about different spending patterns is helpful in our discussion today about retirement expenses.
There are plenty of rules of thumb about how much you need in retirement, and some of them can be helpful. But today I don’t want to talk about rules of thumb, I want to talk about cold, hard data.
What do retirees actually spend in retirement?
And that’s exactly what David Blanchett researched in an article titled “Exploring the Retirement Consumption Puzzle.” To arrive at these averages, Blanchett tracked inflation-adjusted expenditures for retired families between 2001 and 2009 using real household survey data. So this wasn’t a guess, these are actual numbers of actual retirees he put together.
The main conclusion? In retirement, spending tends to decrease both before and after retirement at a real spending average rate of around 1% per year.
In other words, let’s say that inflation causes the costs of goods and services that we buy to grow 3% a year. So life gets 3% more expensive per year.
Blanchett’s study found that retirees only grow their spending patterns by 2% per year. So while inflation goes up by 3%, retiree spending goes up by 2%, which means that in terms of real spending, they are actually spending 1% less per year.
In addition to this very useful information in terms of household retiree spending, he also discovered a new understanding of retirement spending phases, which can be summarized as the go-go years, slow-go years, and no-go years.
THE THREE-PHASE RETIREMENT CONCEPT: GO-GO YEARS, SLOW-GO YEARS, AND NO-GO YEARS
We are going to cover three phases of retirement, when if you look at it, represents a smile. So keep that in mind as we go into the three stages.
This concept is relatively straightforward.
Early retirement is represented by the “Go-Go” years, which are characterized by an active phase that may contain a continuation of a lifestyle similar to pre-retirement, but with more time for spending time on activities such as travel and hobbies.
People often want to take advantage of the early years of retirement while they are still able to travel, or just make up for lost time on the hobbies that they placed on the back burner while busy with work.
After 5 to 10 to 15 years of this, though, they knock a lot of things off of their bucket list. And at the same time, health (nothing serious) and energy begin to decrease a bit, resulting in some spending reductions as the budget for activities like traveling, hobbies, and eating out declines a bit. This is referred to as the Slow Go years.
Next are the “No-Go” years, which represents the later years retirement, which is when health and energy can really begin to decline and there’s a significant slowdown of activities related to spending, as the consumption comes down to just core expenditures necessary to maintain the household itself.
It should be noted, that while this approach is a reasonable way to characterize a retiree’s discretionary expenses, there is uncertainty about when a retiree will transition from one to another phase, as it can be contingent on rather abrupt health events rather than a slow decline.
Additionally, there is one expense that has the potential to rise dramatically in the later years of retirement, and that is health-care expenses. And this is where the upward trend of the retirement smile comes into play. While most expenses (like eating out, travel, etc) will go down in time, health care expenses are slated to increase over time.
Now if you want to dig deeper and keep track how retiree spending changes per year, I’ve got one more resource for you.
To help factor that in, the Bureau of Labor Statistics, which records consumer spending over time to create the “baskets” used to calculate the Consumer Price Index (CPI), has acknowledged that older spending is “different” than that of the general population.
Thus, for instance, the construction of CPI-E (for the elderly) has a reduced weighting of food and drinks, as well as transportation, and a substantially larger weighting of medical care as compared to the ‘standard’ CPI measure.
If you’d like to track this going forward, here is the BLS website that explains and tracks the CPI-E and you should see the BLS website where you can download a spreadsheet showing those expenses as well as studies on the subject.
Because my aim is to help you have retirement clarity, we need to ask the question, how should you plan for what you’ve learned? How should you plan for this?
Here’s how we should plan to have more control of our spending in retirement than we may think:
- The typical assumption that your expenses will increase every year, adjusted for inflation, has not shown to be the case with retired families. Again, the research has shown that there is an average of 1% decline in inflation adjusted spending. So if you are running projections on your own, or with a financial advisor, your spending may be higher than what it will be in reality. I must admit that it’s impossible to project what your expenses will be. The best we can do is make education assumptions with what we know you’re spending now, anticipate what you’d like to spend in the future, and then adjust as life changes. It’s also okay to be conservative with your assumptions, and not plan for a 1% decline in actual spending.
- There is nothing “fixed” about retirement. People often believe that the last phase of their lives is defined, if not confined, by the limitation of living on a fixed income. The truth is significantly more flexible. There will be years of more and years of less. So again, if you are running projections, you may be assuming a simple 2 or 3% increase in your personal expenses per year, but realize that that likely won’t match up with reality.
- The ebb and flow of your spending, which determines how much distributions you need to make from your retirement accounts, might open up chances for tax planning. For example, in a low-spending year, keeping your adjusted gross income low may allow you to take advantage of certain tax credits, deductions and tax strategies like a Roth conversion (which I’ve discussed in much more depth in my book The Retirement Tax Bomb).
- In years you don’t have much spending, maybe that means you wont need to distribute much from your retirement accounts. Well, if your accounts are subject to RMDs, then you won’t have a choice in the matter. But if you engage in proper tax planning, then you will have more options at your disposal.
- Just because you’re retired doesn’t mean you shouldn’t put money aside for it. Consider using the lower-expense years — those between the ages of 70 and 80 – to start saving for the higher-expense years that will inevitably follow at the end of your retirement because of health care expenses. Especially consider this if you don’t have a long term care insurance policy, and you are thinking about how to pay for it. If you can, put any “leftover” money in a reserve account at the end of the month to cover future medical and personal care bills that aren’t covered by insurance.
- What matters is the real spending ability of an individual. Retirees should concentrate on maintaining the purchasing power of their income sources. This means keeping a healthy allocation to equity investments in one’s portfolio rather than locking everything into a “stable” source of income (like bonds, treasury bills, CDs and annuities).
Okay, we’ve covered a lot for today about the retirement smile, what it means, and how you can use what we’ve learned in your own life.
If you’d like to get started putting all the pieces of your retirement puzzle together, you can book a Start My Retirement consultation with me where we will create a one page retirement plan outlining everything you need to do as you approach retirement.