The New Math of Retirement

[RonBoyd]

Here is an interesting article

The New Math of Retirement

that points out the big problem with Monte Carlo forecasting.

There's one key fact of life that most retirement planning advice gets wrong: the way people actually live and spend when they retire. Put simply, most retirement calculators and planners aim for decades of level spending, but most people reduce their spending as they move through retirement. That's a disconnect that can significantly skew the results of the typical planning exercise, says a recent study from the Society of Actuaries and the Actuarial Foundation. It could lead workers to take greater investment risks, or be overly frugal during their final years of work or their first active years of retirement.

 

[Leonidas]

Heard Ray Lucia talking with a caller on his show the other day about longevity insurance.

Insurance companies are busy devising new products aimed at the latter years of retirement. Called "longevity insurance," these products really are deferred annuities that don't kick in until the owner turns 80 or so. But they tend to be too expensive for what they deliver, says Lassus. "We aren't big fans.

He felt there were some people that could benefit from the product, but it definitely wasn't an appropriate product for most retirees.

For those that retire extremely early there are so many additional phases that this article doesn't consider. With kids still at home and in school I have bills that the average regular retiree paid off years ago (college costs for example). Like many here, I have the spreadsheet from hell with all my numbers and guesses factored in, but there are plenty of known unknowns and unknown unknowns betwixt here and the end of this roller coaster ride. The key is to be flexible, like Uncle Mick says, "Agile, Mobile and Hostile".

I prefer to think of it as having the spirituality of Gumby.

 

[traineeinvestor]

Interesting but even if true I do not want to plan my retirement on the basis that I will have to cut my expenses significantly after a few years.

Even if I had a pension/SS etc to fall back on (which I do not), I would still take the same approach. The idea of starting with a given lifestyle/spending level ad being forced to cut it - whether I want to "slow down" or not - is unattractive.

 

[Danmar]

Interesting but even if true I do not want to plan my retirement on the basis that I will have to cut my expenses significantly after a few years.

Even if I had a pension/SS etc to fall back on (which I do not), I would still take the same approach. The idea of starting with a given lifestyle/spending level ad being forced to cut it - whether I want to "slow down" or not - is unattractive.

Totally agree. The other fact that is often cited is that you will spend less in retirement than you did before. This can certainly be arranged but isn't always the desire of reirees. We would be examples of spending more in retirement than before (mostly travel related). This may reduce eventually but not because we don't have the means.

 

[growing_older]

I've seen all the studies about level spending and the economist arguments about optimum consumption. I've also seen the studies that "show" spending declines as one ages. I don't believe them. Maybe for the very old spending decreases, but all the examples I personally know of retirees who were NOT constrained by limited means tended to increase spending as they aged, generally by adding services at home and increased amenities while traveling. When I get to the point where I cannot keep up with yardwork, or housecleaning, or even driving, I plan to have the means to buy these services, which means my costs will actually rise as I get older.

 

[kaudrey]

My "spreadsheet from hell", as Leonidas so aptly puts it, allows for multiple scenarios with steady spending (adj. for inflation, of course); increased spending, and decreased spending. I am assuming it will mostly even out. I have a large travel budget for many years (I'm a wanderer at heart), but then eventually I assume that will taper off. However, I fear for the future of health care costs, so that line increases significantly over the age of about 70....I am basically assuming if it is not one thing, it will be another.

I agree with Growing Older too, that as I age, I will pay for more services for things I can't or don't want to do. I'd rather be conservative in my projections, and then have money left over when I leave this earth.

 

[haha]

My "spreadsheet from hell", as Leonidas so aptly puts it, allows for multiple scenarios with steady spending (adj. for inflation, of course); increased spending, and decreased spending. I am assuming it will mostly even out. I have a large travel budget for many years (I'm a wanderer at heart), but then eventually I assume that will taper off. However, I fear for the future of health care costs, so that line increases significantly over the age of about 70....I am basically assuming if it is not one thing, it will be another.

I agree with Growing Older too, that as I age, I will pay for more services for things I can't or don't want to do. I'd rather be conservative in my projections, and then have money left over when I leave this earth.

I don't even like the concept behind most life-cycle financial planning. Supporting a life with a gradual (or sometimes abrupt) liquidation of assets of unknown path and volatility strikes me as a recipe for disaster, or at least a recipe for a lot of nervousness.

Although the governments around the world (barring Japan) seem to be quite able to stop deflation threats in their tracks, I do not believe that it will come without large costs to the citizens in the form or increased taxation and higher, maybe much higher, inflation.

Many have interpreted the 07-09 break and recovery as a stress test successfuly weathered. IMO it is no such thing. It so happened that anyone with 18-24 months of ready cash felt nothing except anxiety. Nerves messed with, but no real damage. This didn't have to be. The mean-reverting property of stocks does not mean that they have to bounce around above the median longterm valuation. Always in the past there has been undershoot as well as overshoot of median values.

Of course eventually if this situation continues we will have a new higher median, and commensurate with this a new lower mean expectation of future total returns.

Ha

 

[LARS]

I've also seen the studies that "show" spending declines as one ages. I don't believe them. Maybe for the very old spending decreases, but all the examples I personally know of retirees who were NOT constrained by limited means tended to increase spending as they aged, generally by adding services at home and increased amenities while traveling. When I get to the point where I cannot keep up with yardwork, or housecleaning, or even driving, I plan to have the means to buy these services, which means my costs will actually rise as I get older.

I think it really depends on each situation. I would have to say that our spending has decreased overtime. The patterns have changed since retiring at 38 and now in early fifties. We no longer buy as many "things" such as art, or jewelry, or furniture, or oriental carpets, etc. Those "things" were expensive.

The decrease in expenditures is not a function of $ constraints, but "how many more watches do I need"... Clearly travel has offset some of that spending, but it is still a net positive in our case.

 

[jIMOh]

My take on expenses is that there is a fixed portion- like housing, utilities, car maintainance, clothing... which goes down over time. Some items (like utilities) will be high when babies are in house, when kids are home in summer then drop as kids move out, house is downsized and similar.

There is a second portion of expenses which shift. Sometimes they shift to lower costs, sometimes they shift to higher costs, sometimes they shift and stay close to the same. Whether w*rking or retired, I believe this is true. (I am still w*rking, so what do I know?)

Examples of shifting costs in my household:
Twin 2 yo boys right now... when they were born, we spent about $400/mo on diapers and formula, no daycare as I switched to second shift to watch them in mornings.

once they were off formula that cost shifted to gerber baby food
once off the gerber food, that expense just went to a higher grocery budget.

Other examples-
we have a mortgage payment now... if that is paid off before retirement, I can see the vacation budget getting much larger. Maybe cost will go down, but some of the mortgage cost is spent (it will not all be saved).

We have insurance payments now (term policies) and I would assume when the need for the insurance went away, that cost would shift... to golf club dues, hobbies, or something else.

How much things shift is unique to the person/family. Some shifts you have control of (like paying off mortgage or insurance not being needed) and some shifts control you (like the expenses associated with kids).

 

[kumquat]

Isn't this a new incarnation of an old study?

I think FireCalc can use Bernicke's Reality Retirement Plan, in the 'Spending Models' page.

 

[Katsmeow]

Interesting but even if true I do not want to plan my retirement on the basis that I will have to cut my expenses significantly after a few years.

Even if I had a pension/SS etc to fall back on (which I do not), I would still take the same approach. The idea of starting with a given lifestyle/spending level ad being forced to cut it - whether I want to "slow down" or not - is unattractive.

You seem to be saying that it is unattractive to ever be planning to spend less than you are spending on the first day you retire because if you did that they you be forced to cut expenses.

But, I think this is all in how you look at it. I just semi-retired (working 1 day a week). DH will retire in the summer. If we felt we had to have a retirement nest egg that would sustain for 35 years our projected spending for the next 4 years ...we wouldn't be retiring.

I guess it is a glass half full or glass half empty kind of thing. You could argue that since we can't sustain that spending for 35 years that we are being "forced" to cut back in future.

I see it more as a glass half full. I have expenses now that I know I won't have later particularly as they relate to the fact that we have 3 adolescent children. Our spending over the next 4 years projects to be much higher than it will be when we truly have an empty nest.

So, yes, I projected fire calc based upon varying levels of spending that do in fact reduce. To me, this is just sensible. Why should I be forced to assume that I will spend the same when it is just DH and as I as I am spending with 3 kids? It is much more realistic to assume our expenses will go down. I don't want to feel forced to keep working just so I can spend 20 years from now what I am spending now.

 

[Katsmeow]

. I've also seen the studies that "show" spending declines as one ages. I don't believe them. Maybe for the very old spending decreases, but all the examples I personally know of retirees who were NOT constrained by limited means tended to increase spending as they aged,

And my experience with my family and DH's family is just the opposite of yours. My mother is now 86. She was always frugal but even so spends less now. She is not as active. She doesn't want to go as many places. She tires more easily. She still lives on her own, drives, etc. but just doesn't like as active a life. She doesn't want to buy new things that much and so on.

I saw the same thing in other family members. I'm not sure I saw much of a difference in activity between, say, 65 and 75 but there is a big difference between 65 and 85.

 

[donheff]

And my experience with my family and DH's family is just the opposite of yours. My mother is now 86. She was always frugal but even so spends less now. She is not as active. She doesn't want to go as many places. She tires more easily. She still lives on her own, drives, etc. but just doesn't like as active a life. She doesn't want to buy new things that much and so on.

I saw the same thing in other family members. I'm not sure I saw much of a difference in activity between, say, 65 and 75 but there is a big difference between 65 and 85.

+1 Definitely saw that with my parents and even see it to a lesser degree in my 15-18 year older siblings. My sisters (78 and 80) just don't do as much as they used to (and they used to do a lot). I suspect that DW and I will follow a similar trajectory. We don't budget witgh a plan to reducve spending, but I see that as a safety net if the finances don't hold up.

 

[Danmar]

This thread got me thinking about spending levels. So I went back and looked at the last 10 years of spending. Excluding real estate purchases and alimony lump sum settlements (by their nature non recurring)Our average spend in 2006-2009 doubled from the average of 2000-2005. Retired in 2006. Mostly travel, auto, maintenance on new place, clubs, clothing, entertainment. 2009 saw some retrenchment but still much higher than pre retirement. Obviously, if you retire with dependent children it makes sense to factor some reductions in at some point. I guess my point is ( perhaps a recurring theme for me) the retirement I want is expensive and I like it that way. Obviously this attitude would not suit everyone and I certainly don't want to offend anyone.

 

[MasterBlaster]

For your info... here is a related article on spending in retirement.

Retirement spending proves to be hard part - latimes.com

Financial planner Ty Bernicke in Eau Claire, Wis., generally sticks to the 4 percent withdrawal rule, but builds in flexibility in other ways.

Although he may suggest that initial withdrawal rate, for example, he is less strict about adhering to a constant inflation rate.

"I've never had a client call and tell me to bump up their income by inflation," he said. "There may be periodic adjustments, but not every year." Retirees generally spend less in retirement, his own research shows.

here's another article...

http://www.retirementwatch.com/CashSample4.cfm

Spending varies by age.
Even after retirement there are several cycles. For most people, annual spending peaks around age 50 and then steadily declines, according to the Department of Labor's Consumer Expenditures in 2003.
There are additional fluctuations after 50. For many people, there is a bump in spending immediately after retirement. There is a burst of spending on pent-up demands such as travel and recreation. After age 75, spending declines somewhat rapidly.

Retirees can plan for a three-stage spending cycle.
The first cycle can be referred to as the honeymoon period of the first few years. This is when the retiree has pent-up demands and also is relatively young and healthy. After that period, the lifestyle becomes more normal and regular. Spending settles at a level that is lower than during the initial years of retirement.
Sometime after age 75, spending is likely to downshift again. The Department of Labor study indicates that spending by those over age 75 is 25% or more below that of younger retirees. People simply become less active at some point, even when they are healthy.
There might be a fourth spending stage in which major medical expenses or long-term care expenses are incurred. Often when this occurs other living expenses decline. The total expenses incurred by the retiree during that period depend on the extent of insurance coverage.
Under this model, a retiree plans to spend more in the first years of retirement. Perhaps spending could rise to as much as the 8% of the portfolio that many pre-retirees say they are planning. After a few years, the plan has a spending decline, following by another decline in later years.

Personally I really like the following suggestion in the article.
the article suggests you take 15% of the retirement portfolio and invest it to cover longevity risk. The other 85 % of the portfolio gets spent down to zero by age 85. this type model for retirement spending will probably result in greater cashflow while you are alive and lessen the risk of leaving behind a large unspent stash for the heirs.

 

[Katsmeow]

Our average spend in 2006-2009 doubled from the average of 2000-2005. Retired in 2006. Mostly travel, auto, maintenance on new place, clubs, clothing, entertainment. 2009 saw some retrenchment but still much higher than pre retirement. Obviously, if you retire with dependent children it makes sense to factor some reductions in at some point. I guess my point is ( perhaps a recurring theme for me) the retirement I want is expensive and I like it that way. Obviously this attitude would not suit everyone and I certainly don't want to offend anyone.

I do think it depends on the individual. I can see that even leaving aside children I could spend more on certain hobbies in the immediate future since I have more time for them.

I do agree with the article posted about some pent up demand spending.

Once it gets beyond that you get into personal preference. For example, I've realized that I really don't enjoy traveling all that much. I do like some of it but I don't anticipate huge travel costs.

I can see I will have some immediate clothing costs. Currently my wardrobe falls largely into two categories: nice clothes for the office and jeans/T-shirts. I wear the latter the vast majority of the time out of the office. If I go out to dinner on a week night I wear office clothes. I don't have a lifestyle to need/want fancy evening clothes. I can see that I will want to buy some clothes that are nicer than jeans/T-shirt but don't have that office feel to them as well. Over the years there have been a lot of casual, but nice, clothes that I've wanted but weren't office appropriate. I'm sure I'll buy some of those now. Still once that immediate demand is met I don't see me spending much on clothes.

My entertainment needs are mostly inexpensive. My main hobbies are reading, surfing the internet (including coming places like this) and playing World of Warcraft. The only one of those costs that goes up with retirement is reading and I do think that the book budget will increase.

 

[Danmar]

Agree it depends on individual. That's why the "rules of thumb" are best used only as starting point.

 

[kevink]

This is something that the always-worth-reading Scott Burns and his writing partner Laurence Kotlikoff wrote about in "Spend 'Til the End." There's also software that I have not checked out to help with smoothing consumption:

ESPlanner Inc. | Economics' Approach to Financial Planning

Obviously individual wants will vary greatly, but I think it's great that there are a few voices out there letting those who want to retire know that there are alternatives to working themselves to the bone (or into an early grave) trying to amass impossible sums in order to provide for 70-90% of their pre-retirement income.

For many, many people having a paid-for roof over their heads even if that roof is a small apartment or mobile home and social security to cover three-quarters or more of their living expenses is retirement reality - and they do just fine. A huge step up from that are folks like the Kaderlis, traveling the world on less than 30K a year with a park model manufactured home as home base, choosing life experience over owning and managing "stuff," while livign very well indeed for decades on an annual draw that many on this board (and many more financial planners) would consider to be bare-bones or worse.

 

[haha]

This thread got me thinking about spending levels. So I went back and looked at the last 10 years of spending. Excluding real estate purchases and alimony lump sum settlements (by their nature non recurring)

Or so the Germans would have us believe...

 

[chinaco]

using large numbers of a population, people do reduce spending. There are a number of studies that show it. Of course for an individual.... YMMV.


I have read the studies and made anecdotal observations of relatives.... it does occur.

For planning purposes, I am using 4%. But if the need arises... I know we can spend more. It helps to understand what generally happens if situations occur that requires one to deviate from the plan.

Whether it is 75, 85 or 95... eventually one slows down. In the late years, health costs can increase expenses. But which would you choose; spend the money on a grand tour of Europe at 60 or nursing home at 90?

 

[chinaco]

Has anyone seen any studies on the 6% rule that was listed in this article?

Retirement: The New Math of Personal Finance - Newsweek.com

 

[traineeinvestor]

You seem to be saying that it is unattractive to ever be planning to spend less than you are spending on the first day you retire because if you did that they you be forced to cut expenses.

Not quite. I see an important difference between planning to cut expenses and being forced to. When I retire I will still have two young children in school. I plan for my expenses to drop once they are through school and (hopefully) university. What I don't want to happen is to spend so much money in the early years of retirement that I am forced to reduce my planned spending later on. As an expample, I intend to do a lot more travelling when I retire but, if I follow the article's approach and plan for my travelling to cut back at a given age, I do not want to get to that age, decide that I want to keep travelling but am forced to cut back.

 

[teejayevans]

Has anyone seen any studies on the 6% rule that was listed in this article?

Retirement: The New Math of Personal Finance - Newsweek.com

That may work if you retire at 65 or have health insurance from megacorp or
govt. But if you health insurance is going up at 20%/year or better as is common
now, might want to leave some wiggle room.
TJ

 

[Masquernom]

This is a subject I've given a great deal of thought to, as I plan to retire at the end of 2011. I read Ty's original paper and some other books on retirement planning. In Ty's original paper, he proposed a model that shows spending reducing in old age. That phenomenom occurs mostly because his rate of spending reduction was a little higher then the rate of inflation in his model. A few points the other way with both, and you get a slow rise in spending.

On the other hand, I struggle with the traditional planning for 3% or 4% inflation added to retirement age spending for the next 35 straight years. Ty does a good job of pointing out the cost in time or money it takes to prepare for that huge spending stream.

For myself, I'm trying to shoot for something in the middle. Beginning in retirement at age 54, I'll inflate my spending by 3.5% a year until I'm 60. Then inflate 3% till 65, 2.5% till 70. 2% until 75, 1.5% until 80, and 1% a year thereafter assuming I'm still around that long.

I won't go into my full financial situation, this is just my spending inflation plan during retirement. As with all things in life YMMV....

 

[smjsl]

I do think it depends on the individual. I can see that even leaving aside children I could spend more on certain hobbies in the immediate future since I have more time for them.

I do agree with the article posted about some pent up demand spending.

Once it gets beyond that you get into personal preference. For example, I've realized that I really don't enjoy traveling all that much. I do like some of it but I don't anticipate huge travel costs.

I can see I will have some immediate clothing costs. Currently my wardrobe falls largely into two categories: nice clothes for the office and jeans/T-shirts. I wear the latter the vast majority of the time out of the office. If I go out to dinner on a week night I wear office clothes. I don't have a lifestyle to need/want fancy evening clothes. I can see that I will want to buy some clothes that are nicer than jeans/T-shirt but don't have that office feel to them as well. Over the years there have been a lot of casual, but nice, clothes that I've wanted but weren't office appropriate. I'm sure I'll buy some of those now. Still once that immediate demand is met I don't see me spending much on clothes.

My entertainment needs are mostly inexpensive. My main hobbies are reading, surfing the internet (including coming places like this) and playing World of Warcraft. The only one of those costs that goes up with retirement is reading and I do think that the book budget will increase.

Katsmeow, you just described the perfect retirement that I am shooting for. I wish there were more women like you... Otherwise, so far it looks like I'll have to do it on my own