Preparing Your Savings for the Stages of Retirement

November 18, 2016
SHIRLEY MUELLER, MD

There is a recent evidence that spending in retirement is not consistent year-to-year. The general line of thinking goes in three stages – are you ready for them?

If spending tapers in retirement, do people need to save as much?

There is a recent evidence that spending in retirement is not consistent year-to-year. The general line of thinking goes something like this. In early retirement (stage 1), more is spent than later. It is then that health is generally better and allows for more activity which requires a monetary outlay. In middle retirement (stage 2), less is expended than early on, but more than at the end. This is true, at least partly, because health can be waning. And, finally in the closing years (stage 3), the least money of any stage is needed as activity ceases.

This line of thinking suggests that retirees in general don’t need to save as much for their golden years as previously thought. The fallacy, of course, is that though this may be true for a collective of retirees, it may not apply to any one retiree. For example, someone who maintains better health than average and thereby is spending at level one or two until death, unlike those in her or his age-matched group.

Where’s the Support on this Concept?

There are several studies on this subject, each gleaning somewhat different results, though all show a decrease in expenditures with age among the general population. The Center for Retirement Research found that spending drops about 1% per year with aging, even when controlling for other factors. Ty Bernicke reported in the Journal of Financial Planning that retiree spending decreased about 15% per year for every year of retirement. This means that retirees in their 80s had an outlay of about half of that in their 60s.

J.P. Morgan Chase took a different approach in their study. They examined a wealthy subsection of the population, those with between one and two million investable assets. In their study, though spending did diminish during the early retirement years, it tended to level off rather than continuing to drop. Even so, there was a decrease of about 1% per year for the first 20 years of retirement.

Health and Retirement Spending

When incorporated into financial planning for retirees, these data have some important implications. One is that health is an important factor that contributes to spending during retirement. Thereby, considering a family history could be helpful in predicting the likelihood of sustained health and the age of final demise of a client who is a retiree or near retiree. For example, if both parents died of disease such as stroke or cancer before 65 years of age and this was consistent with the rest of the family history, then an earlier rather than a later death could be anticipated. A retirement plan consistent with this scenario could be constructed, albeit with a fallback position in case the client lived longer. One such plan could be a Roth IRA that grandchildren would receive if the client did not need the monies.

On the other hand, if both parents lived past 90 and this too is consistent with the rest of the family history, then a later demise could be anticipated and plans would have to made accordingly for a stretched-out retirement. More money would be needed in the nest egg.

Categorizing Needs May Help

Additionally, when planning for retirement, older citizens can use categories for their money expectations that might be of help in anticipating what expenses increase or decrease. One such plan is based on Somnath Basu’s approach published in the Association for Financial Counseling and Planning Education. His categories include:

  • Basic living essentials
  • Leisure
  • Health Care
  • Taxes

Though essentials might fall only a little as retirement progresses, leisure costs could drop precipitously if health becomes fragile. At the same time, healthcare expenses might increase. Taxes would be anyone’s guess, but likely fall as income needed for living expenses decreases. Whether all will balance out will depend on the fluid percentage of available monies anticipated to be spent in each category.

The Bad News; Then, the Good News

We live in a country where one-third of households 55 or older do not have any retirement savings beyond social security. Some don’t even have that. This is sobering.

For the remainder, however, there may be hope when this new paradigm of thinking is incorporated into retirement planning. Saving with the thought of living to the average age of death and level spending throughout retirement may not be the optimal approach. Rather, considering the probable age of death of the person in question, and that her/his spending will likely taper during retirement is a better solution.