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Another look at retirement math
Old 07-25-2010, 11:03 AM   #1
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Another look at retirement math

I think retirement analysis is finally starting to catch up to the reality of variable withdrawal rates.

Every financial adviser has "always" known that retirees don't spend as much near the end of retirement as they do at the beginning, but the knowledge has never really been used for much more than a margin of safety. Bengen and the Trinity study were among the first to give retirees an idea of how much of their principal they could consume during retirement, but it was still an assumption of fixed spending. Monte Carlo analysis has been an improvement over "running out" of historical data used in FIRECalc and other calculators, but neither has been able to accurately predict when retirees would (or should) start slamming shut their wallets. Some have used two budgets-- "bare bones" and "life is good", but it's proven difficult to program that concept into a mainstream retirement calculator. ORP has addressed this "consumption smoothing", as has Bill Sharpe's later article on efficient consumption, but the first is too expensive hasn't gained broad acceptance and the second is still somewhat controversial without an actual analysis product. I think Bob Clyatt's 95% rule is the first really practical tool for cutting back ER spending.

But now the retirement media's understanding of variable withdrawals seems to be evolving from "advanced" to "mainstream". For those who do their own projections, Linda Stern's column has some interesting data:
Quote:
But, in general, it isn't the methodology of these studies that is troubling, but the ideas behind them. They assume, for example, that people will blithely spend their nest eggs at a fixed rate until the day they wake up at 87 or 92 with no money left. And they suggest that retirement is an all-or-nothing proposition: You either can afford to bring your lifestyle into retirement, or you can't. They don't focus -- or often, even acknowledge -- that retirement is a series of budgetary trade-offs, just like the first 2/3 or 3/4 of life.
...
Quote:
Here are some mitigating points.
-- You'll spend more than you think for a while, but not forever. ... By the time a person passes 75 years of age, his spending is almost half of what it was for the years between 55 and 64, according to figures from the Bureau of Labor Statistics. Older retirees spend about 76 percent of what people between 65 and 74 spend. So you can aim to take more out in earlier years and take less out in later years.
-- You won't want to stay in your house forever. You may, but not many people do. So at some point in mid or late retirement, you can sell your home, downsize, and add your accumulated equity to the pot of money you have to spend (lowering your expenses along the way.) Even if you do want to stay in your home forever, new and improved reverse mortgage products will allow you to tap that equity at some point along the road.
I've always been skeptical that retirees will have the personal discipline to reduce their spending later in ER. But the fact that there's broad-based statistical evidence of the occurrence of reduced spending leads me to believe that discipline isn't necessary. In fact, the lack of overall discipline may be leading to that reduced spending. Maybe the reduction in spending really is imposed by the inevitable consequences of undisciplined living-- the external forces of reduced mobility, declining health, and senility. Or maybe the excessive spenders were all victims of "survivor bias" and are now being supported by their offspring.

Either way there's more data than there used to be. It's not just anecdotal info being swapped at CFP conferences and surveyed in obscure research journals.

Note that none of the above really address the issues of long-term care and end-of-life medical spending. However Stern also points out the useful application of SPIAs and the utility of the hypothetical "solid LTC insurance policy".

But it's nice to see some numbers in popular media that can be plugged into a spreadsheet and used for practical discussions. "Well, honey, if you think you'll be happy to reduce our spending by at least 25% starting at age 75, then we can ER tomorrow. If you don't think that's likely then you should consider working for another five years."

It'd also be nice to see FIRECalc options for "reduced spending after age 65". Andy, perhaps you need to devote more effort to FIRECalc or find someone who has the programming skills to do so. Its relevance is at stake.

Personally I don't see spouse and me ramping up today's spending. Heck, for one reason or another our spending has already been dropping ever since we ER'd. However this later-in-life spending data can support a useful discussion of whether we still care to continue hedging longevity risk with equity risk. I've been trying to work up a post on that topic but it has a long way to go.
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Old 07-25-2010, 11:56 AM   #2
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Valid points, however I think many of us (well, me) are just afraid to assume we are going to fit the averages. Maybe those other needs will increase and we will have constant or increased spending. I just don't want to bank on the reduction.

Same reason I don't use the 'average' life expectancy for me and DW. I look at Vanguard's calculator and take that out to the 95% level (somewhere around 95YO for us).
Quote:

So at some point in mid or late retirement, you can sell your home, downsize, and add your accumulated equity to the pot of money you have to spend (lowering your expenses along the way.)
I can also see this playing out as: Sell your home, buy one for as much or more than you get for your old place and with all maintenance included and other fees results in a higher monthly bill...

Who knows? There are so many variables, that I choose not to count on reduced spending as part of the plan. If it happens, I'll either find goodies to spend it on, fund grandkids college, or charity or what-not.

I guess I'm saying, if your portfolio/SWR is marginal enough that it has to count on reduced spending to work, you are on shaky ground. If it works, great. If it doesn't, it's too late to go back to work, or you go into forced reductions in spending. To each their own, not my cup of tea.

edit/add: You could coarsely simulate this in FIRECALC either with spending options (limited number of entries though), and/or lump sum portfolio changes at 75, 80, 85 or something.

further edit/add (bold mine):

Quote:
Andy, perhaps you need to devote more effort to FIRECalc or find someone who has the programming skills to do so. Its relevance is at stake
.

Rather over-dramatic, isn't it? It might be a useful option for those interested in investigating this line of reasoning, but it hardly moves it any closer to irrelevancy. It is one of the most relevant calculators I've seen, relative to its ease-of-use (which means people will actually use it).

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Old 07-25-2010, 12:03 PM   #3
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Originally Posted by Nords
I've always been skeptical that retirees will have the personal discipline to reduce their spending later in ER. But the fact that there's broad-based statistical evidence of the occurrence of reduced spending leads me to believe that discipline isn't necessary. In fact, the lack of overall discipline may be leading to that reduced spending. Maybe the reduction in spending really is imposed by the inevitable consequences of undisciplined living-- the external forces of reduced mobility, declining health, and senility. Or maybe the excessive spenders were all victims of "survivor bias" and are now being supported by their offspring.
People ages 75+ are usually starting to slow down due to age. I am already planning to stop driving completely at around that age, and I doubt I'll be doing as much shopping at bricks and mortar stores. I think that is true for a lot who are 75+, due to arthritis and other conditions that make shopping trips difficult.

However, I don't think that the reduced mobility, declining health, and senility that you (very correctly) mention will continue to cause a decline in discretional spending as baby boomers move into advanced age. I wonder if the statistics used in this study might have been gathered in the era before the average 75+ senior became accustomed to doing much online shopping. By age 75+ most people have everything they need for day to day living, but do they have everything they want? That seems less likely. I could see seniors over age 75 doing a lot more shopping at e-bay, Amazon, and other shopping websites than is presently done by those presently in that age category, due to generational differences in computer usage.

Visualizing myself at that age, I think the "clunk" of a UPS package being deposited at my front door would be just as fun and exciting at age 80 as it is at age 62. I certainly do not plan to abandon my computer and have someone drag me to the mall every time I need something when I pass age 75.

A different aspect of variable spending would be what we witnessed on this board in 2008-2009. Many retiree members cut way back on their spending due to the economic situation, because they/we didn't want to spend as much when the economy was tanking. This, too, is reality.
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Old 07-25-2010, 12:12 PM   #4
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Nords raises a valid point about discretionary spending - most older people probably don't drive as much, buy new duds, etc. There's a reason why advertisers value customers under age 55 far more than those over 55. Indeed, although only one of us is over 55, our discretionary spending dropped off years ago.

It's the forced spending that keeps going up with no end in sight:
Repairs
Replacements
Improvements
Services

The suggested solution seems always to be "move to flyover country, where people charge less to do stuff," but what if you don't know a soul in flyover country, and suspect you, as a free-spirited Northeasterner, would be seen as an outsider there for the rest of your life? The remaining option is to acknowledge that the cost of having other people do stuff for you will continue to rise. I prefer, therefore, to base my figgerin's on the assumption that our expenses will, at best, not go down, and may go up.

(I'd love to hear that any of my above assumptions could be wrong, and if so, why).

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Old 07-25-2010, 12:43 PM   #5
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Good read, good post. Guess it's a good thing we already live in flyover country (it's really not so bad), and probably always will. We visit the trendy places from time to bad, wonderful places to visit, but I wouldn't want to spend live there. And their costly appeal lessens with each passing year (been there, done that?)...
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Old 07-25-2010, 12:55 PM   #6
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Originally Posted by Nords View Post
I think retirement analysis is finally starting to catch up to the reality of variable withdrawal rates.

...
I have seen some studies about retirement published by the government that show spending by age. Those data show reductions.

One (somewhat skeptical) question I have had about it: Is the reduction an effect of aging (a result of aging) or was it caused by something else. For example, Perhaps the reduction in spending is because they are running lower on money at an older age. To understand this better, more data would be needed (than I have seen).


However, I have seen anecdotal evidence of this phenomenon in parents and other elderly family members... each of which had excess money and left sizable estates.

I think there could be many reason for the reduction and the reasons probably vary from person to person.

A few things I have noticed that seem to coincide with aging and reduced spending... (my conclusions):

  1. The people were somewhat conservative to begin with and get more conservative as they age (perhaps because they become more fearful or careful).
  2. Their spending seemed to reduce as they slowed down (i.e., less discretionary/entertainment/travel spending). Some of it may have to do with having less energy.
  3. At that age most major non-discretionary expenditures are paid for and not repurchased unless absolutely necessary (own the home, fewer new cars, less redecorating, etc).
  4. How many people in their late 70's or 80's spend a lot of money on new clothes?
Of course, if one has a long-term health problem they will probably spend more.


When it comes to planning. We did not set our FIRE goal based on some arbitrary spending reduction (or based on some survey data). I do not have enough confidence to make specific plans around it.

Where this phenomenon does help is with having less fear of experiencing lifestyle reductions forced because of having less money rather than it being a factor of the aging process (IOW - we make fewer purchases because we already own our stuff and we do less because of slowing down as we age).

When I FIRE next year... I am very confident about our planned spending pattern and the ability to support it. I will be less concerned about doing some splurging in our late 50's (within reason of course)... because I think it is likely we will reduce spending if we live to be fairly old.
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Old 07-25-2010, 12:55 PM   #7
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The remaining option is to acknowledge that the cost of having other people do stuff for you will continue to rise. I prefer, therefore, to base my figgerin's on the assumption that our expenses will, at best, not go down, and may go up.
I am absolutely convinced of this.

Of the personal examples that I am close enough to know the people and the finances involved, every one of them experienced gradually rising expenses as they aged through their 70's and 80's as they hired out more and more services that they used to do themselves. The only two exceptions to this were people who did not have the option to increase expenses (they were both forced to reduce expenses as they aged not by choice but because of lack of funds). Both of these "lower expenses" as they age ended up living with younger family members, who effectively performed the services for free.

I did see lower expenses in my family among people who could afford to spend more as they became very old (late 80's to 90's.) in their last decade or so of life. But until they became very old, this was not true. And I guess it also reminds me that I need to plan for longevity. There is some in my family.

I am skeptical of statistical measures of lowering expenditures as people age because some of these factors will be difficult to control for, and I see no evidence that the studies even attempt to control for them.

Now, I know my "evidence" is only a limited set of personal experiences. Feel free to make whatever personal decisions you want based on your assumptions. My assumption is going to be that my expenses will rise as I age, not fall. If I am wrong, I could have retired a few years early. Oops. If I am right, I will enjoy a nice retirement and not have my desired lifestyle curtailed by lack of funds when I am too old to do much about it. I'm making my choice. If I made a mistake, I will have money left over. Or maybe I'll do something I'm not planning on to splurge and use some of the extra for a deluxe experience I wouldn't otherwise plan on. Perhaps my heirs will get a windfall. None of these sound like terrible outcomes. If I am right, I will enjoy my retirement and avoid the real terrible outcome of slowly running out of money and needing to shrink my lifestyle involuntarily when I am too old to work.
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Old 07-25-2010, 01:02 PM   #8
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While the question of whether or not any individual will spend less after 75 yo or so is interesting, it's somewhat meaningless unless there are consequences today. I encourage posters to think of the question in terms of whether you would be willing to work longer in order to fund the assumption that your spending will be constant vs retiring sooner and assuming your spending will reduce after 75 (or some age).

When I made the decision 4+ yrs ago, I assumed constant spending.
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Old 07-25-2010, 01:14 PM   #9
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I am skeptical of statistical measures of lowering expenditures as people age because some of these factors will be difficult to control for, and I see no evidence that the studies even attempt to control for them.

Now, I know my "evidence" is only a limited set of personal experiences. Feel free to make whatever personal decisions you want based on your assumptions. My assumption is going to be that my expenses will rise as I age, not fall. If I am wrong, I could have retired a few years early. Oops. If I am right, I will enjoy a nice retirement and not have my desired lifestyle curtailed by lack of funds when I am too old to do much about it. I'm making my choice. If I made a mistake, I will have money left over. Or maybe I'll do something I'm not planning on to splurge and use some of the extra for a deluxe experience I wouldn't otherwise plan on. Perhaps my heirs will get a windfall. None of these sound like terrible outcomes. If I am right, I will enjoy my retirement and avoid the real terrible outcome of slowly running out of money and needing to shrink my lifestyle involuntarily when I am too old to work.
I have this same attitude and experience. People reduce expenses for the most part because they have to or fear that they have to. Rarely will they say that hardship or fear is a reason, any more than posters on this board will say that they forgoe pleasures to live on tight budgets. Americans put a bright face on necessity.

Read the what did you do today section of this board. Many people spend a lot of time doing house and lawn maintenance, and even housekeeping that may become increasingly difficult, or actually dangerous with advancing age. Ask any triage nurse in an ER how many old guys she sees with broken backs or limbs from falling off ladders cleaning cutters or trimming shrubbery or whatever. How about cutting wood with a chainsaw or splitting with an axe? If that is your heat source, you are going to be buying it, or switching to a fossil source, or taking possibly very grave risks.


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Old 07-25-2010, 01:16 PM   #10
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Personally, I assume constant total spending throughout retirement. But I suspect that the makeup of that spending will change overtime. In the early years, discretionary spending will represent close to 40% of total spending. As years pass, the share of total spending devoted to discretionary spending will probably shrink while the share of total spending devoted to health care costs and convenience costs in particular will increase. When my grand-parents were in their 70's and 80's, they spent very little on discretionary items. Buying a fresh croissant from the bakery was all it took for them to feel as happy as I feel when I buy an iPhone.

Note: I just traded in my iPhone 3G for an iPhone 4 and while I was waiting for my new iPhone to be setup, I couldn't believe the number of 70-80 year old people buying iPhones too! I talked to a 74 year old guy who was as excited as I was to get his third iPhone! So perhaps, older people nowadays still want to enjoy the latest gadgets...
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Old 07-25-2010, 01:16 PM   #11
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Possibly mortgages are running out by age 75. I've been planning on carrying our mortgage well into retirement. But that's already accounted for in my calculations.

Looking at my explicit budget, I don't see a whole lot of other expenses that I expect will go down. I've always expected medical expenses to go up. Plus I would think where possible, many people would have to start paying for house cleaning and yard maintenance as that becomes more difficult for them to do themselves. My 80 YO mom is finally going to pay someone to paint her house instead of doing it herself.

I've been assuming an inflation adjusted flat spending level for projections. If spending goes down, that's a nice margin of safety, but not something I'd be willing to count on.
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Old 07-25-2010, 01:22 PM   #12
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Possibly mortgages are running out by age 75.
That may well bet true, provided people have stayed away from the re-finance window. However, in times of relatively rapid inflation, taxes, insurance, utilities and upkeep can advance rapidly enough that overall housing expenses may drop little or none from say 5 or 10 years earlier, though they will almost certainly go down year over year.

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Old 07-25-2010, 01:26 PM   #13
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When I made the decision 4+ yrs ago, I assumed constant spending.
I did too.

Now if we're fortunate enough to live to be 75, I'm sure we won't have two cars and a motorcycle. We'll probably only have one car. We won't have the expense of animals and more than likely will not have our parents and the money associated to them as gifts. Travel will be very limited. Additionally if only one of us remains, expenses should go down even more.

However, the wild card for my way of thinking is health care and the services we may need. If we are able to live in the house we have now, we will have expenses due to maintenance that we will be unable to do ourselves.

That being said, this article does give me a bit of hope for the 'now'. I have a budget that enables us to live fairly well. However, I do have an additional $10k set aside each year for the "oh crap" and "c'mon, we've just got to do it!" Maybe I won't feel as much guilt if I really 'just gotta do it'.
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Old 07-25-2010, 01:51 PM   #14
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While it may be true that retirees spend less as they get older, I think incorportating this into the ER plan calculations may be just fooling people into thinking the plan is more accurate than it is (and give people more confidence than is warranted). Increasing the precision of one component doesn't necessary improve the accuracy of the overall forecast when you have other numbers with massive uncertainty.

If the average ER person retires at 50, the slowdown by 75 is 25 years away. Any increased accuracy in spending requirements towards the end of the period is going to be dwarfed by the variability caused by the return sequence at the beginning of ER. Furthermore, we know that there are things like PPACA coming (new healthcare legislation) that could radically change ER costs that I suspect will have a much bigger impact than reduced spending in later years.
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Old 07-25-2010, 01:54 PM   #15
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My 80-year-old mom has put herself on a the waiting list for a very nice assisted living community. While she is still in her house now, I imagine that her expenses will go up when she moves and they will not get cheaper in the assisted living facility as time goes on. It's a nice option to have rather than cutting back expenses from age 85 to death because you didn't plan ahead.
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Old 07-25-2010, 01:57 PM   #16
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I have this same attitude and experience. People reduce expenses for the most part because they have to or fear that they have to.
Not according to Bernicke, and he has statistics and science-y stuff to back it up.

Personally, I can see us doing a lot less travelling (our main expense even today) after 70. What I don't know is how much more we will spend on "getting people to do stuff". And if I were American, "getting people to do stuff" would also have to include medical care ($$$$). So I'm not planning my spending strictly along Bernicke's lines, but I've scaled back the degree to which I'm planning for spending to match inflation.
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Old 07-25-2010, 04:05 PM   #17
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I am absolutely convinced of this.

Of the personal examples that I am close enough to know the people and the finances involved, every one of them experienced gradually rising expenses as they aged through their 70's and 80's as they hired out more and more services that they used to do themselves. The only two exceptions to this were people who did not have the option to increase expenses (they were both forced to reduce expenses as they aged not by choice but because of lack of funds). Both of these "lower expenses" as they age ended up living with younger family members, who effectively performed the services for free.

.

My Mom who is 94 had a gradual drop of expenses . She used to love to travel but after 90 it became pretty difficult . She also sold her car so that expense went away . At 92 she moved in with my sister and spends time between her house and mine . She does pay my Sister rent but all her other household expenses are gone . She does shop online mostly QVC and Lands End . She still enjoys dressing nice and the weekly hairdresser .Now if she would have to enter an assisted living or a nursing home her cost of living would be crazy .So I guess it all depends on your health and how much help is available for free .
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Old 07-25-2010, 04:09 PM   #18
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Not according to Bernicke, and he has statistics and science-y stuff to back it up.
That's all well and good, and I like stats and data as much (more than?) the next guy, but I just don't feel comfortable with averages for something like this (applied to an individual).

The FIRECALC 4% SWR isn't based on averages - it tells you what the worst periods would have done to you. While we can't predict the worst that will happen to us spending-wise, I just can't feel comfortable planning on a reduction in spending, even if that is the norm.

There are so many unknowns ahead of us, if this just turns out to be a cushion, so be it. But that cushion might help me cover some other unknown, unknowable event down the line. Even if it works out for 86% (or whatever) of the people, I don't want to end up being in the other 14%. We also have a lot of threads going on about expecting the future to be worse than the past - just seems dangerous to try to cut this any closer.

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Old 07-25-2010, 04:25 PM   #19
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I think that a lot depends on health. My observation from seeing my elderly relatives is that poor health is very expensive---not just medical care but the need to hire assistance with daily living. With good health, I could see a gradual drop off in expenses.
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Old 07-25-2010, 04:28 PM   #20
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I assume that I will probably spend more as I age. This is due to higher health care costs and the fact that standard of living goes up over time. Bernstein and others have written about this.

It also may depend on your lifestyle. For a single, frugal guy, you are likely to spend relatively more in the future compared to a couple who has not yet downsized. My life is already arranged in a very efficient manner, I have no house to downsize, no boat to sell, no car expenses, no garage to empty out, no ongoing family expenses, etc.

Thankfully, longevity insurance is really, really aided by Social Security. Except in the case that my health were to fail, I plan to wait until age 70 to collect mine.

On variable withdrawals, I am a strong believer and practice what I preach. You have to pay attention to long term market conditions and not just blindly take large sums indefinitely because X years ago you had a certain amount. This also means that failure happens more often. For the guy that retired at 45 with a million and no pension, if his bankroll is $400K at age 51, he has effectively failed and may need to get back in the workforce. Even if there is a fair chance his portfolio will recover.
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