A more recent contribution to the retirement spending debate is David Blanchett’s May 2014 article from the Journal of Financial Planning, “Exploring the Retirement Consumption Puzzle.” Blanchett’s “puzzle” concerns how spending tends to decrease both at and then during retirement at a real spending averages rate of about 1% per year.
While this again reflects the average outcome, Blanchett’s dataset provides some ability to follow the same households over time throughout retirement. He uses real household survey data from the to track the inflation-adjusted spending for retired households between 2001 and 2009. This helps correct for problems present when focusing on the spending of different age groups at the same point in time.
Blanchett observes a “retirement spending smile” that varies slightly for retirees with different household spending levels. The following exhibit provides Blanchett’s spending smile for a retiree that begins retirement with expenditures of $100,000.
On average, this household can expect to experience declining real expenditures through age eighty-four, when real spending reaches a trough of $74,146. This reflects a nearly 26% drop in real expenditures.
After this point, average real expenditures increase, though they do not necessarily exceed their initial retirement levels until retirees reach their mid-nineties. I produced these calculations using Blanchett’s own equation, which relates changes in annual retirement spending to age and the expenditure target at the start of retirement.
Blanchett observes that the spending smile reflects the same types of outcomes we have described thus far. At the start of retirement, retirees spend more as they enjoy traveling, eating out, and other types of discretionary expenses. As they continue to age, retirees tend to slow down and spend less.
However, while discretionary expenses are declining, health costs tend to rise, and at some point later in retirement, these rising health costs offset reductions in other spending categories. Exhibit 2 provides a further illustration of this process.
The assumption of constant inflation-adjusted spending, according to Blanchett’s article, will lead individuals to over-save for retirement. The easiest way to understand this is to simply explore historical sustainable spending rates for different retirement spending patterns.
In Exhibit 3, I provide the time path of historical sustainable spending rates for both constant inflation-adjusted spending and the retirement spending smile I showed in Exhibit 1. As seen earlier, for a thirty year retirement and 50/50 portfolio, 4.03% represents the historical worst-case sustainable spending rate using Bengen’s preferred dataset.
With the spending smile, the initial spending rate can increase to account for subsequent spending declines. In this case, the worst-case initial spending rate rose to 4.73%. For a retiree basing their spending on these historical worst-case numbers, the retirement smile pattern would allow retirement to begin with almost 15% less accumulated wealth than otherwise.
This makes clear that retirement spending patterns are an important component of deciding on a sustainable spending rate. Constant inflation-adjusted spending is a simplifying and conservative assumption.
Wade Pfau is a Professor of Retirement Income at The American College in Bryn Mawr, PA. He also serves as a Principal and Director for McLean Asset Management, helping to build retirement income solutions for clients.
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