Who doesn’t Want to be Rich? Here’s Plan Better for Retirement

How will your retirement expenses evolve over time? Will you spend more, less, or about the same in retirement as you did when working?

It’s a crucial question. Calculating how much you’ll spend in retirement is the first step in retirement planning. And that determines when you’ll retire, how much money you’ll need to retire, when you’ll start collecting Social Security, and so on.

As a fair estimate, you should expect to spend 70% to 80% of your pre-retirement income every year in retirement. It could be a decent start, but most experts consider it to be garbage.

If you want to do it well, you’ll need to estimate how much you’ll spend on what, when, and for how long using a spreadsheet or other tool. You’ll need to account for not only inflation, but also how your spending habits will alter over the course of your retirement — in the good, bad, and ugly years.

Thankfully, data exists to assist you in determining how expenditure changes over time in retirement. And much of the study that has been done on the subject implies that your spending will decrease as you become older.

When he was with Morningstar, (MORN) – Get Morningstar, Inc., retirement expert David Blanchett published Estimating the True Cost of Retirement, a study that found real retiree spending declines slowly in the early years, more rapidly in the middle years, and then less slowly in the final years, in a path that looks less like a slow and steady decline and more like a “retirement spending smile.” Read The Retirement Spending Smile And Estimating Changes In Retirement Expenditures.

Do Retirees Want Constant, Increasing, or Decreasing Consumption?, a research released by Boston College’s Center for Retirement Research, reveals that spending does fall in retirement, but that restrictions – such as assets and health – rather than real preferences matter. For example, the study discovered the following:

1. Over the course of retirement, household consumption falls by 1.5 percent to 1.6 percent per two years (or around 0.7 percent to 0.8 percent every year).
2. The consumption of wealthy and healthy households, on the other hand, remains basically unchanged, decreasing barely 0.3 percent each year throughout retirement.
3. Thus, wealth and health limits assist to explain the observed pattern of diminishing consumption, at least in part.

According to the researchers, the following policy implications exist:

1. In retirement, retirees are prone to seek steady consumption.
2. Because consumption losses are worse for households without assets, the findings reveal a retirement savings shortage.
3. Social Security is a vital source of income for them to maintain their preferred lifestyle.

Many questions remain, according to the researchers. Do top quintile or decile household spending continue to flatten; do survival expectations matter; and do other factors such as risk aversion or bequest incentives impact consumption paths?

So, what are the opinions of other experts on the Center for Retirement Research report?

Sharon Carson, executive director of J.P. Morgan Asset Management’s retirement strategist team, agrees that a lack of savings is an issue for many people and can lead to unintended spending cuts. (According to Carson, the study’s median wealth level was $271,248.)

Carson, on the other hand, does not feel that all households, particularly those with greater affluence, want consistent spending. She pointed out, for example, that the authors of the Center for Retirement Research report’s top third of participants may not be indicative of people with considerable assets. Given this, she agreed that more research into various wealth levels would be beneficial.

How does Carson’s study compare to that of the Center for Retirement Research at Boston College, especially at greater wealth levels?

Get JPMorgan Chase & Co. using anonymous and de-identified JPMorgan Chase Bank (JPM) data. Carson’s team sees evidence of higher expenditure peaking around midlife for Chase households in report data at a point in time.

“When we look at households with at least some retirement income – including households with a mix of work and retirement income – the peak expenditure around midlife is not as spectacular as it is for the overall population, including those with income from work,” she added. “This is true for households with non-housing wealth estimated to be between $250,000 and $750,000.”

According to J.P. Morgan Asset Management Research, average household spending for people with a bachelor’s degree or more starts at $88,890 for those 45-54, drops to $81,010 for those 55-64, $69,990 for those 65-74, and finally $55,970 for those 75 and up.

Carson also pointed out that JPMorgan is in a unique position: it possesses a big database of households, many of which have estimated non-housing wealth of over $1 million. “Those households with $1 million or more in non-housing wealth had a bigger peak in spending around middle age than those households with less than $1 million in non-housing wealth,” they say.

So, what’s the bottom line if you’re attempting to figure out how much money you’ll need in retirement?

Well, if you’ve saved enough for retirement, your expenditure will most certainly fall modestly – by choice — over time. However, if you haven’t set aside enough money and/or are in bad health, your expenditure will fall more slowly. If you want to avoid this, now is a good time to increase your savings and possibly postpone retirement.

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