Could you be overestimating the lump sum you need to maintain a comfortable lifestyle in retirement?
New research, “Estimating the True Cost of Retirement”, suggests that your spending actually decreases gradually year on year. And yes there is an increase in the final phase of our lives with additional health care costs, as you would imagine. Yet, even this is not enough to offset the fall in spending in our last phase of life.
And that’s why the research so beautifully refers to our likely retirement spending as a smile.
Spending trends in retirement
The traditional assumption when it comes to retirement is that our expenditure will look like a straight line. Many of us expect that we will have higher activity expenses in the earlier years, and while these may decline, we are likely to have higher health and medical expenses in the later years.
Yet this new research asks us to think a little more deeply.
Perhaps take a moment to consider individuals and couples you know who are retired – they could be friends, family members, your own parents.
There will no doubt be a group who have recently “hung up their boots” who are very active. I can think of clients who have recently enjoyed 12 months traveling through the US and Europe, another has just returned from an extended sojourn in Spain, one couple has sailed up the east coast of Australia and is now in the process of buying a country property that they plan to renovate. And one inspiring client who on retirement immediately enrolled in art school to complete his Fine Arts degree.
And then, you can probably think of a group of retirees who’ve started to wind back a little from all that activity. They still enjoy golf, theatre, dining out, gardening – just that the level of activity has slowed. One of our clients is currently touring through Canada on what she has described as her last long haul trip. Another just wants to slow down and enjoy time with her children and grandchildren.
Finally, you would no doubt see a group who’ve slowed down significantly. Many of our clients’ parents are in this category. They still enjoy occasional outings, but their health and energy is not what it used to be. As a result, their consumption typically reduces to their day-to-day needs.
With those images in mind, the assumption that we will maintain a consistent level of spending is perhaps not what we experience at all.
So what does the data show?
The data in this recent study show not only a “curve” to retirement spending (rather than just a flat or declining line), but that retirees actually decrease their real retirement spending throughout almost all of their retirement. The rate of decline identified was approximately 1% per year, accelerating to 2% per year through the middle years, and then in the latter years reverting back to 1% per year declines again – with this reversion giving us the uptick of the smile.
What’s important is that spending remains below the starting point throughout the entire retirement period. So even with the anticipated increase in health care in our latter years of retirement, this is not sufficient to offset the decrease in other discretionary spending.
However, a note of caution. The retirement smile only results where retirees match their spending reasonably to their household net worth – either because they are high-spenders with a high net worth, or more conservative spenders with a lower net worth. The results are not contented for those who spend beyond their means. That experience looks more like a jagged cliff.
If you would like to have an improved estimate of the amount of money you need for retirement, we can assist with modeling that reflects the findings in this research. Simply call or email. We would be delighted to help.
Research undertaken by David Blanchett of Morningstar. With thanks to Michael Kitces in Portfolio Construction Forum (26 May 2014) for source information for this piece.