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How Do Spending Needs Evolve During Retirement?

March 13, 2012

by Wade Pfau

Most people’s spending patterns change over the course of retirement – expenses look very different at 90 than they do at 65. Yet most research on retirement withdrawal rates relies on constant inflation-adjusted withdrawals to develop a client’s forward-looking budget.  Such an unrealistic, one-size-fits-all approach can be disastrous if a client inadvertently retires with insufficient savings. Is there a better way?

It’s critical to understand what the empirical data can – and can’t yet – teach us about how certain expenses change in retirement. One particular method that has recently drawn attention – age banding – employs knowledge about retirement expenses, giving planners a framework to budget for their clients’ retirement in a more realistic manner.

Reality Retirement Planning

In June 2005, Ty Bernicke, a Wisconsin-based financial planner, published Reality Retirement Planning: A New Paradigm for an Old Science in the Journal of Financial Planning. His article challenged the prevailing assumption that investors need constant inflation-adjusted income in retirement, suggesting that existing studies may drastically overestimate retirement needs.

Bernicke used evidence from the Consumer Expenditure Survey (CES) to show that those aged 75+ spend less than those aged 65-74, who spend less than those aged 55-64.  Bernicke described a tug-of-war for retirees: though they do increase their spending over time with inflation, they also voluntarily spend less as they age. Retirees lose their interest or ability to spend as much on vacations or restaurants, for instance.

(A couple of caveats: Because Bernicke’s data are population-wide averages by age group, we don’t know how much variation there is within each age group. Also, as planner Michael Kitces discussed in a recent blog entry, the typical financial planning client probably spends more than these averages imply.)

Figure 1 shows the real spending needs by age, based on the CES and developed for an illustrative example in Bernicke’s article. Spending needs at age 75 are 33% less than at age 65, and 53% less than at age 55. Checking this with the more recent 2010 Consumer Expenditure Survey, I found that those aged 65-74 spend 20% less than those who are 55-64. Those who are 75+ spend 40% less than those who are 55-64 and 26% less than those who are 65-74.

Ty Bernickes Reality Retirement Planning