By Allyn Hughes, CFP®, ChFC®, CLU®, CAP®
A couple of financial planning myths have been around for a long time.
- Myth #1: annual spending throughout retirement should grow at about the rate of inflation.
- Myth #2: financial planners should use a different spending pattern for the financial plans of their clients. Instead of planning for increased expenditures throughout retirement, they use a modified spending pattern which reflects decreasing annual spending during the “go-go years” the “slow-go years” and the “no-go years” of retirees.
Researchers have been studying both of these ideas and an article “Exploring the Retirement Consumption Puzzle” in the May, 2014 Journal of Financial Planning by David Blanchett of Morningstar suggests that these two myths are both wrong.
Blanchett studied a variety of papers on the subject by other analysts as well as government data on consumption by age to try to better determine spending levels throughout retirement.
Instead of retiree’s spending increasing each year as they age, or decreasing over time, the research suggest that spending in retirement is more is more “U” (or smile) shaped for most Americans.
In the early years of retirement spending is relatively high as more is spent on travel and family. Spending tends to be lower than before retirement on such items as apparel, education, food and transportation. Costs for housing and especially medical care are higher. Medical care expenses are approximately 10% of household spending for the average 65-year-old household. Medical care also has a higher inflation rate than other expenditure groups in retirement.
In the middle years of retirement spending continues to grow, but at a rate lower than inflation for most retirees. So real spending declines. This suggests that retirees are trying to budget for a retirement period with an unknown length.
Finally, in the last few years of retirement there is much higher use of nursing homes and/or home health care, and medical and care costs grow quickly. Spending on medical care—which increases to 20% of household spending for an 85-year-old household—and housing become the largest expenditures for most retirees.
We use financial planning software to model ongoing retirement income needs as well as one-time or semi-regular goals that cause expenses to rise temporarily. We incorporate these assumptions when evaluating the probability of being able to fund adequate income even if life expectancy is long. New and better information is always useful in our analysis and recommendations although the research doesn’t accurately reflect how any individual or couple will live their lives. That’s why a personal financial plan is so important.
~ Brooks, Hughes & Jones Wealth Advisors – Tacoma, WA