This post is a follow-up to our post of March 19, 2021, “What is Your Plan for Future Spending in Retirement?” Impetus for this post was the recent release of a retirement spending pattern research paper by Anqi Chen and Alicia Munnell from the Center for Retirement Research at Boston College entitled, “Do Retirees Want Constant, Increasing or Decreasing Consumption?”
We briefly discuss the results of Mses. Chen and Munnell’s research and possible implications for your financial planning in or near retirement.
Research Conclusions
Mses. Chen and Munnell summarize their research results as follows:
“The results show that when households have assets and their health, they keep real consumption [spending] relatively flat over their retirement. This pattern is evident when comparing wealthy and healthy households separately and when the top tercile is ranked by health status. For those with less wealth or with health issues, consumption declines more over time. As a result, looking at all types of households together produces a clear pattern of declining consumption, as reported in other studies. But the results suggest that the decline most likely reflects wealth and health constraints as opposed to true preferences.”
Their interesting research appears to support the conclusion that retirees generally prefer relatively constant real dollar spending in retirement as opposed to preferring decreasing real dollar spending, as one might infer from results of some earlier spending pattern research. We note that their research appears to be more focused on government policy implications than personal financial planning implications.
Our Thoughts on Spending Pattern Research and Implications for Personal Financial Planning
Since data generally used in retirement spending pattern research doesn’t distinguish between non-recurring and recurring spending or between essential and discretionary spending, we are uneasy applying general spending pattern observations of researchers (based in large part on averages) to personal financial planning situations for individual retired households. Is it safe or prudent to assume for planning purposes that all future expenses will decrease over time in real dollars? Our intuition tells us that most retirees would be more comfortable implementing a financial plan that anticipates constant (or increasing) real dollar spending, at least with respect to their essential recurring expenses.
Our Actuarial Financial Planner (AFP) allows you to input different rates of future increases for up to three types of essential recurring expenses and up to two types of discretionary recurring expenses, in addition to separately accounting for various types of non-recurring expenses. So, if you believe that your future recurring medical expenses or your future taxes will increase at a faster rate than general assumed inflation, you can separately determine the actuarial reserve for those items utilizing higher annual future increase assumptions. And, if you believe that some or all of your future recurring discretionary expenses will not increase, or even decrease in retirement, you can model the financial impact of that assumed future. Finally, the AFP will automatically model spending non-recurring expenses over the relevant assumed payment period (and not your entire period of retirement).
As developed in the AFP, your total annual spending budget is the sum of your
- total recurring essential spending,
- total recurring discretionary spending, and
- total non-recurring spending.
Depending on many factors, including household spending goals, actual experience, emergency needs, etc., total household spending from can vary considerably from year to year. It is not unusual, for example, for retiree household spending goals to include front-loading of spending on travel, hobbies, pre-Medicare healthcare insurance, home renovations, paying off mortgages, etc. Therefore, it is only natural for households to experience some decrease in total spending after incurring these up-front non-recurring expenses. Because of this front-loading, we don’t believe that research that observes some decline in average total household spending should necessarily be used to justify a planning assumption that all spending will decrease throughout retirement. Further, our conclusion actually appears to be fairly consistent with the recent research of Mses. Chen and Munnell.
Summary
As we have said many times in our blog, you can either spend your assets now or you (and your heirs) can spend your assets later. All things being equal, the more you spend in the near future, the less will be available to spend in the far future. With respect to essential recurring expenses, we prefer to assume these expenses will remain approximately constant (or will increase) in real dollars in the future. We are much less concerned about the anticipated future pattern of discretionary expense spending, and, for planning purposes, don’t necessarily have a problem with assuming that those expenses may be less in the future than they are today. Finally, we believe that if you are using a planning model that assumes future non-recurring expenses will remain constant throughout your entire retirement (by lumping these expenses in with your recurring expenses), you are probably over-funding those expenses.
Financial planning for your retirement involves setting spending goals, making reasonable assumptions about the future and adjusting those goals and assumptions as actual experience emerges. Ultimately, it is up to you to decide how to balance your current spending vs. your future spending. We provide tools and recommended processes in our website to help you do this.
Be sure to check out our latest essay, A New Approach to Building a Sustainable Retirement Plan Using Proven Actuarial Principles published by the Retirement Income Institute/Alliance for Lifetime Income.
