Bad Retirement Spending Plans

A recent research paper by Chen and Munnell from Boston College asks the important question “Do Retirees Want Constant, Increasing, or Decreasing Consumption?”.  The accepted wisdom until recently was that retirees naturally want to spend less as they age.  This new research challenges this conclusion.

What we all agree on is that the average retiree spends less each year (adjusted for inflation) over the course of retirement.  However, averages can hide a lot of information.  The debate is whether this decreasing spending is voluntary or not.  However, it’s important to recognize that the answer is different for each retiree.  Some don’t spend less over time, some spend less voluntarily, and some are forced to spend less as their savings dwindle.

I’ve been saying for some time that not all spending reductions by retirees are voluntary and that this affects the average spending levels across all retirees.  I’ve discussed this subject with many people, including a good discussion with Benjamin Felix, who was good enough to point me to the new Chen and Munnel research.  (Larry Swedroe also discussed this research.)

Research Findings

“On average, household consumption declines about 0.7-0.8 percent a year over retirement.  However, consumption for wealthy and healthy households is virtually flat, declining only 0.3 percent a year over their retirement.  Thus, at least in part, wealth and health constraints help explain the observed pattern of declining consumption.”

“Retirees likely prefer to enjoy constant consumption in retirement.  The results suggest that a retirement saving shortfall exists since consumption declines are larger for households without assets.”

Resistance

Some commentators want to believe that it is safe to assume declining spending in a retiree’s financial plan.  They dismiss involuntary reductions in observed retirement spending as insignificant.  However, this new research makes it clear that retirees’ preferred spending levels are much flatter than the observed spending data.  (For the record, Ben Felix says he assumes flat inflation-adjusted spending in his clients’ retirement plans.)

The idea that we’ll want to spend less as we age is seductive; it means we don’t have to save as much for retirement, can retire earlier, and can safely overspend in early retirement.  What’s not to like?  The problem is that average retirement spending data shows spending declines right from the first years of retirement.  Does it make sense that people still in their 60s suddenly want to just sit around inside their homes?  It’s plausible that retirees tend to become homebodies deep into their retirements, but not in the early years.

The clever-sounding justification for planning for spending declines is that our retirements consist of “go-go years, slow-go years, and no-go years.”  However, this contradicts the observed early spending declines.  In reality, some unfortunate retirees have not-enough-money-left years.

Other Factors to Consider

Another important consideration is that once retirees do start slowing down deep into their retirements, the possibility of needing expensive care increases.  It’s not clear that we can ever count on wanting to spend less during retirement.

Yet another factor is the tendency for wage inflation to exceed price inflation.  Over time, society becomes slowly wealthier.  If you plan for flat inflation-adjusted spending through retirement, your spending level will slowly fall behind your younger neighbours.  If you plan for declining inflation-adjusted spending, you’ll fall behind faster.

Conclusion

Average retiree spending declines over time in part because some retirees spend too much early on and are forced to cut back.  It doesn’t make sense to me to plan my own retirement using statistics that include data from retirees who have overspent.  The end result for me is that I’ll assume my spending desires will grow with inflation over my retirement.  Anything less is risky.