There is no way we can tell you with certainty whether you will need to generate more lifetime income in retirement than you think because we simply don’t know how much you think you are going to be spending in retirement. The authors encourage individuals to give some thought to their expected spending in retirement, which is undoubtedly a good thing to do when planning for retirement. Having said that, we believe accumulating sufficient assets during your working years to support annual retirement income that is 130% or more of your pay just prior to retirement is likely to be excessive, and it is also likely to be a prohibitively expensive task for most people.
Since tax expenses and work-related expenses generally decrease upon retirement and individuals save at different rates, we recommend targeting income replacement in retirement at about the same level as pre-retirement spending adjusted for the decrease in tax expenses and work-related expenses expected upon retirement. We believe that replacement of this adjusted level of spending is more theoretically defensible than some replacement percentage of one’s final pay.
For most individuals, the total spending replacement percentage (total post-retirement spending, including taxes, divided by total pre-retirement spending, including taxes and work-related expenses) will vary from individual to individual depending on individual circumstances and the actual reduction in taxes and work-related expenses experienced upon retirement. For calculation simplicity, we have recommended a target spending replacement percentage of about 85% in our ABC workbooks for Actuarial Budget Benchmark calculations.
The following tables illustrate how one can calculate a target spending replacement rate for two individuals with different savings rates. Person 1 and Person 2 have the same $100,000 gross pay in the year before retirement and they pay the same taxes and have the same work-related expenses. They expect their taxes and work-related expenses to be decreased by the same amounts when they retire. Person 1 has been saving 20% (spending 80%) of his gross pay each year for the years leading up to his retirement, while Person 2 has been saving 30% (spending 70%) of her pay each year.
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While we are not particularly enamored with the 70% to 80% of final pay target, we are certainly much less excited about the authors’ suggested 130% of final pay target for the following reasons:
- The authors’ 130% target is inconsistent with recent research regarding actual spending in retirement
- It is not a particularly easy task to save enough to replace one’s spending (adjusted for lower taxes and work-related expenses) when retiring, let alone a spending target that is substantially higher like the authors’ 130% target
- It would be almost impossible for most individuals to achieve a reasonable balance between their pre-retirement and post-retirement spending if they adopted the authors’ 130% target, and
- The authors overstate the level of savings required to hit their 130% target, as It is unnecessary to accumulate as much assets to provide for non-recurring (or temporary) expenses in retirement as it is for recurring expenses.
Recent Research
As discussed in our January 14, 2018 post, research from several sources shows that retirees tend, on average, to spend just about their income each year, where income is defined as income streams from sources such as Social Security and employer provided pensions plus interest, dividends and capital appreciation on their investment portfolios. According to the research, “The vast majority haven't been spending their retirement savings—leaving nest eggs mostly untouched and living on ready sources of income instead.” The research also shows that spending tends to decrease in real dollar terms as retirees age, confirming the “Go-go, slow-go, no-go” patterns of spending in retirement noted by researchers. So, while some retirees may have desires to spend significantly higher amounts, they tend to control their desires and many get the urge out of their systems after just a few years in retirement.
As they say in Maine, “you can’t get there from here”
We took a look at how much our Actuarial Budget Calculator (ABC) for single pre-retirees workbook indicated a 45-year-old female making $100,000 a year with $100,000 of accumulated savings would have to save each year to accumulate sufficient assets at her assumed retirement age of 66 to provide her with lifetime retirement income of 130% of her expected final years’ pay. Except as noted below, we used the program’s default assumptions and assumed her pay increased by 3% per year (1% per year higher than assumed inflation). We also maximized the amount of her calculated recurring spending budget at retirement by assuming no long-term cost, no unexpected expense cost, no desired amounts left to heirs, and we assumed zero desired increases in her spending budget after retirement (i.e., spending decreases in real dollar terms after retirement).
Using the Social Security Quick Calculator (and adjusting future pays to be consistent with 3% per annum pay increases), we developed an estimated annual Social Security benefit of $60,888, or about 34% of her projected final years’ pay of $180,611. The calculator indicated that if she saved 50% of her pay each year and wasn’t eligible for matching contributions from her employer, her first year of retirement spending budget in nominal dollars would be $208,152, or about 115% of her projected final pay. So, even if we assumed a 50% savings rate for this individual, we couldn’t get her to the 130% of final pay target.
And would you really want to?
Let’s fast forward our example to her retirement at age 66, 21 years from now, and assume that she actually saved 50% of her pay each year and all the assumptions she made above were realized. She is now looking at total spending in her first year of retirement of $208,152, or about 115% of her final year pay. Let’s also assume her taxes and work-related expenses increased with inflation each year from the amounts used in the tables above. Her pre- and post- retirement spending table would look something like this:
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We understand that there will be some individuals who want (or need) to temporarily or permanently spend more after retirement than they spent before retirement. We also understand that there are also non-recurring expenses in retirement that need to be advance-funded. In order to accomplish higher levels of spending in retirement, however, individuals (or couples) are either going to need to inherit a lot of money or they are going to have to increase their savings during their working years. By asking people to significantly increase their savings while working so that they can spend relatively more in retirement, you are asking them to significantly decrease their pre-retirement standard of living to significantly increase their post-retirement standard of living (to enjoy much higher levels of spending after retirement than before). Most individuals are likely to balk at this proposition and are going to want to find a more reasonable balance than found by our hypothetical female.
Higher spending after retirement is generally a temporary phenomenon
The key concept that the authors (and many retirement researchers) ignore in these instances is that expenses in retirement can either be recurring or non-recurring. While we may need to have sufficient assets to cover expected recurring expenses over our expected lifetime planning period, the same is generally not true for non-recurring expenses. Assets accumulated prior to retirement for non-recurring expenses (such as increased travel expenses for the first 5 years of retirement, for example) need to be sufficient to cover 5 years of such expenses and do not need to be sufficient to cover 30 + years of such expenses. Therefore, while it is important to anticipate expenses that may be incurred after retirement that were not incurred before retirement (such as increased medical costs prior to Medicare or travel expenses), it is also important to estimate how long these extra expenses will be incurred when establishing a reasonable spending budget.
Retirees who believe that they will experience the classic “go-go, slow-go and no-go” periods will be wise to budget accordingly rather than develop a spending budget that anticipates one continuous “go-go” period that is expected to last for the rest of their lives.
Conclusion
We agree with the authors that it makes good sense to think about spending in retirement when planning for retirement. There is no perfect rule of thumb or retirement calculator, however, that can tell you how much you will actually spend in retirement and therefore, how much you need to save to fund your expected spending. You need to make reasonable assumptions about the future and make sure you adjust your plan over time when your assumptions prove to be inaccurate. You also need to find the right balance between spending today and spending tomorrow. We suggest you start with our ABC calculators and re-visit them at least once a year. We encourage you to consider all the assets that may be available to you and all your potential spending liabilities, including non-recurring expenses such as, education costs, home mortgage costs, long-term care costs, “unexpected” expenses and bequest motives. We also encourage you to consider the potential impact on future spending of future price increases (inflation), spousal deaths (for couples), and aging into “slower-go” years.
