"How does spending change during retirement?"

[Nords]

Wade Pfau keeps churning out the hits.

This week he put out a column in "Advisor Perspectives" on spending changes during retirement.
http://advisorperspectives.com/newsletters12/pdfs/How_Do_Spending_Needs_Evolve_During_Retirement.pdf

You may recall that a few years back Ty Bernicke publicly proclaimed what advisors had been sharing anecdotally among themselves for years: retirees spend less money as they get older. Although everyone could accept that retirees spent less on fantasy vacations and expensive restaurants, there was some question over (1) whether the survey data was applicable to all aging retirees and (2) how it accounted for medical expenses.

But Pfau took the original data and went back to Bengen's original SWR study data to conclude that:

Over time, Bernicke’s lower spending needs result in sustainable withdrawal rates that are between 1.3% and 2.4% higher than those required to maintain constant inflation-adjusted spending. For both spending assumptions, the worst-case scenario happened in 1966. Bernicke’s spending assumptions would have supported an initial withdrawal rate of 5.55%, compared to 4.15% with constant spending. For someone using Bengen’s historical worst-case maximum sustainable withdrawal rate as a spending guide, that implies retirement could have begun with 25% less wealth. This is not a trivial matter!

Unfortunately Pfau goes on to determine that this indeed is too good to be true, and that medical expenses are a critical factor after all.

By capturing both the differential inflation rates and the changing dynamics by age, age banding provides a useful tool for planning long-term client budgets. With this approach, however, it is not obvious that retirement spending will decline with age. It may, and the data suggest that spending does decline, but rapid growth in health care expenses could potentially lead to an overall increase in spending needs at the highest ages.

Spending may decline and I would not fault anyone for using assumptions of gradual real spending declines along of the lines of 10% or even 20% over the retirement period. But pending further research developments, I would avoid moving too far in the reduced spending direction as a baseline assumption. Though the standard assumption of constant inflation-adjusted withdrawals could be improved, it builds in reasonable conservatism and may not be too far off as a baseline

Those quotes were from Pfau's article in the publication. However he also included a "director's cut" version in his blog discussing some of Bengen's own research on age-related spending changes:
Pensions, Retirement Planning, and Economics Blog: How Do Spending Needs Evolve During Retirement?

By spending less later in retirement, retirees should be expect to spend more early on, and William Bengen shows that with these spending reduction assumptions, the initial SAFEMAX (lowest sustainable withdrawal rate in history) withdrawal rate increased from 4.15% to 4.59%. For a retiree planning to use the appropriate SAFEMAX, this implies a 9.6% reduction in the required retirement date nest-egg to fund retirement expenses.

Again, these conclusions should be approached with caution-- especially if you're self-insuring for long-term care or under treatment for chronic diseases or doomed by family genetics. But I really enjoy watching Pfau taking the research that we've been discussing for a few years, digging deeper into it, and improving the quality of the discussion. Unlike other bloggers (who don't necessarily crunch a lot of data for their posts) or the big-name writers (who put out 1-2 articles a year and a book every few years) Wade seems to be pumping out regular doses of data analysis on all the topics we've been picking apart. I feel like we're watching what a young Bernstein would have been doing 15 years ago with a Blogspot account.

I think I'm posting about two-thirds of his content here. If you're a blog reader then I strongly recommend subscribing to his blog. Sign up for e-mail or the RSS feed at the top of his blog just below the header graphic.
Pensions, Retirement Planning, and Economics Blog

 

[MichaelB]

Thanks for the update and summary, Nords.

 

[Ed_The_Gypsy]

Unfortunately Pfau goes on to determine that this indeed is too good to be true, and that medical expenses are a critical factor after all.

So, we are back to between 3% and 4% again.

Bernicke’s spending assumptions would have supported an initial withdrawal rate of 5.55%, compared to 4.15% with constant spending.

Three significant figures! For projecting portfolio survivability into an unknown future! I know, it is just numbers based on historical data and fixed assumptions. You see the results and set your sails and take what comes.

Remember: Man plans; God laughs.

 

[donheff]

I agree Pfau's blog is worth following. My takeaway on that post was that DW and I can probably expect to spend less in our late 70s or early 80s as we cut back on travel. Health care should probably not eat up the difference since we have good insurance and LTC. Just a little extra wiggle room in case the economy stays as sluggish as everyone is predicting.

 

[Midpack]

Good article thanks. I was already following his blog, thanks to you. I liked this discussion too...

Table 1 - An Age Banding Illustration

	Inflation Rate	Lifestyle Adjustment Factor at Age 65	Lifestyle Adjustment Factor at Age 75	Lifestyle Adjustment Factor at Age 85
Taxes	3%	0.5	1	1
Basic Living	3%	0.7	0.8	0.9
Health Care	7%	1.15	1.2	1.25
Leisure	7%	1.5	0.5	0.25

Source: Adapted from the stylized example in Somnath Basu's "Age Banding: A Model for Planning Retirement Needs"

Table 1 details how the approach works with these four spending categories and three time segments (65-74, 75-84, 85-94). These numbers are not calibrated closely to data; they are meant to be illustrative for a typical client. The inflation rate for taxes is 3%. At age 65, the lifestyle adjustment factor for taxes is an assumed drop to 50% of their pre- retirement level, as payroll taxes are no longer paid. Those lifestyle adjustment factors are progressive; a value of 1 at age 75 means that tax amounts will not change relative to their real values at age 65, they may only grow with inflation. The same is the case for taxes at 85. Overall, taxes drop by 50% at retirement but then stay at this same inflation-adjusted level.

Next, though always adjusted for 3% annual inflation, basic living expenses are assumed to fall by 30% at retirement, and then by another 20% at age 75, and then by another 10% at age 85. Thus, by age 85, real spending on basic expenses has fallen to about 50.4% of its pre-retirement level. (0.7 x 0.8 x 0.9 = 0.504.)

As for health care and leisure, both have an inflation rate of 7% instead of 3%. And health care expenses also increase with age, adjusting upward by 15% at 65, by 20% at 75, and by another 25% at 85. By 85, real health expenses are assumed to be 3.7 times larger than their pre-retirement value, assuming a somewhat simplified overall inflation rate of 3%. Leisure increases by 50% at retirement as clients set out to enjoy life, then drops by 50% at 75 and another 75% at age 85. By 85, even with the higher inflation rate, leisure spending is only 40% of its pre-retirement level in terms of the overall price index.

 

[Finance Dave]

Good article thanks. I was already following his blog, thanks to you. I liked this discussion too...

Table 1 - An Age Banding Illustration

	Inflation Rate	Lifestyle Adjustment Factor at Age 65	Lifestyle Adjustment Factor at Age 75	Lifestyle Adjustment Factor at Age 85
Taxes	3%	0.5	1	1
Basic Living	3%	0.7	0.8	0.9
Health Care	7%	1.15	1.2	1.25
Leisure	7%	1.5	0.5	0.25

Source: Adapted from the stylized example in Somnath Basu's "Age Banding: A Model for Planning Retirement Needs"

Nords thanks for the summary!

Midpack, that's how we do our planning..categories that will see different inflation rates and growth/shrinkage through the years.

 

[arebelspy]

Always nice to see real data instead of anecdotal evidence.

Thanks for posting Nords.

 

[audreyh1]

Yep - really great blog. I have been perusing it since Midpack posted a link to the SAFEMAX article with it's awesome graphs.

Audrey

 

[MasterBlaster]

Like the article says, you'll probably spend less as you age and probably need a smaller nestegg than all the calculators suggest. Caveots for medical, and economic collapse/stagnation.

Nonetheless I personally, and I suspect few others on this forum, are willing to spend more in retirement or save less before retirement based on an age-based declining spending model.

It just doesn't sit well with me. I would never choose such a model.

 

[martyp]

I like this model. I can pretty much see how it works by observing my parents and in-laws right now. They are in their 80's and their lives and spending have pretty much shrunk. They go to the Dr. more often and have more serious procedures but so far most everything is covered by some kind of insurance. It's the health expenditures that are the big unknown. That's what you need to plan for (within reason).

 

[bld999]

From Nords' post #1:

"....especially if you're self-insuring for long-term care or under treatment for chronic diseases or doomed by family genetics."

Anyone know what percentage of retirees fall into these categories?

 

[martyp]

From Nords' post #1:

"....especially if you're self-insuring for long-term care or under treatment for chronic diseases or doomed by family genetics."

Anyone know what percentage of retirees fall into these categories?

My wife and I both bought Long Term care insurance starting about 10 yrs ago. Our parents don't have it. My guess is that few people do have it.

 

[Nords]

From Nords' post #1:
"....especially if you're self-insuring for long-term care or under treatment for chronic diseases or doomed by family genetics."
Anyone know what percentage of retirees fall into these categories?

Well, my phrasing was intended to cover 100% of the demographic.

My point is that it's really really tough to predict whether you're going to have chronic health problems and high geriatric medical expenses. It's probably so tough as to be impossible. I've made it through all the scary medical situations that we read about in our 20s-40s, only to discover that there's even scarier stuff awaiting us in our 80s & 90s.

It's pretty straightforward to decide to stay lean, to exercise frequently, and to stop smoking/drinking/sex/drugs/rock&roll. But under those circumstances, who wants to live into their 80s/90s?

Wade Pfau is doing great work, and he's on to something here, but it may take another decade (and a lot of health insurance reform) to nail it down.

 

[Finance Dave]

It's pretty straightforward to decide to stay lean, to exercise frequently, and to stop smoking/drinking/sex/drugs/rock&roll. But under those circumstances, who wants to live into their 80s/90s?

Agree. It's a balance. I skip the smoking and drugs, but enjoy the other three.

 

[bld999]

Well, my phrasing was intended to cover 100% of the demographic.

My point is that it's really really tough to predict whether you're going to have chronic health problems and high geriatric medical expenses. It's probably so tough as to be impossible. I've made it through all the scary medical situations that we read about in our 20s-40s, only to discover that there's even scarier stuff awaiting us in our 80s & 90s.

It's pretty straightforward to decide to stay lean, to exercise frequently, and to stop smoking/drinking/sex/drugs/rock&roll. But under those circumstances, who wants to live into their 80s/90s?

Wade Pfau is doing great work, and he's on to something here, but it may take another decade (and a lot of health insurance reform) to nail it down.

I take your point there, 100%
My question was intended to express something like: How many people enter retirement with serious chronic conditions, or an awareness of poor family survivability [genes]. Is it 30%?, 50%? I don't know, but these issues make the planning problem much more complex.

 

[Khan]

Well, my phrasing was intended to cover 100% of the demographic.

My point is that it's really really tough to predict whether you're going to have chronic health problems and high geriatric medical expenses. It's probably so tough as to be impossible. I've made it through all the scary medical situations that we read about in our 20s-40s, only to discover that there's even scarier stuff awaiting us in our 80s & 90s.

It's pretty straightforward to decide to stay lean, to exercise frequently, and to stop smoking/drinking/sex/drugs/rock&roll. But under those circumstances, who wants to live into their 80s/90s?

Wade Pfau is doing great work, and he's on to something here, but it may take another decade (and a lot of health insurance reform) to nail it down.

But what if the DNA is stacked against you?

 

[ejman]

But what if the DNA is stacked against you?

I've read a number of times that DNA is responsible for about 30% of longevity and what we do the balance. I've no idea how to translate this bit of common knowledge into something usable. I mean if one's unlucky stars place one in the 30 % side, it doesn't matter what you do and there is so much conflicting advice on the 70% side ( drink coffeee - don't dink coffee; drink wine don't drink wine; take aspirin don't take aspirin and so on and on) It's all a crap shoot anyway might as well have fun while you can SS at 62!

 

[misty57]

I can definitely see how spending is reduced as long as the retiree(s) stay relatively healthy. In the early years of retirement, my folks were traveling the world. My dad has since passed on and my mom has no desire to travel these days, even with a traveling companion.

She is healthy for her age (86) and what she does need is paid for by Medicare, the balance being picked up by TriCare.

Now she has a boatload of pension money rolling in, but spends her days gardening and participating in various retirement clubs, etc. The mortgage has been paid off for almost 20 years. Her biggest expense is income taxes.