The Smart Take:
In the last episode, Kevin answered a listener question on inflation. He explained why retiree spending patterns in part combat inflationary risk retirees face.
Now hear Kevin delve deeper into retiree spending patterns. If you don’t want to work longer than you have to or want to spend more in retirement, this is an episode you’ll want to listen to.
Traditional retirement advice of having a steadily increasing income for life is wrong for most. Rather, spending tends to decline with age at a real rate of 1% yearly although increasing healthcare costs at the end of life are common.
Carefully modeling these age-related changes and monitoring your plan over time will help you Retire Smarter.
Need help making sure your investments and retirement plan are on track? Click to schedule a free 15-minute call with one of True Wealth’s CFP® Professionals.
2:14 – Different Stages Of Spending In Retirement
8:42 – Chase Bank’s Retirement Spending Data
14:02 – David Blanchett’s Health & Retirement Study
17:06 – Getting Accurate Spending Data Into Your Plan
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Intro: Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to retire smarter.
Walter Storholt: It’s time for another Retire Smarter podcast. Walter Storholt alongside Kevin Kroskey, president and wealth advisor at True Wealth Design. You can find us online at truewealthdesign.com. Kevin, great to be with you for another episode. How are you?
Kevin Kroskey: Walter, I’m good. I am looking forward to talking about some retiree spending today, and how it changes, and some misconceptions that are out there. And importantly, in true Retire Smarter fashion, talk about some data that support what we are going to be discussing.
Walter Storholt: Nice. Love it. Bring the data on. And also, isn’t it more fun to talk about spending versus saving? I mean, we all like to spend money, so this sounds right up everybody’s alley.
Kevin Kroskey: Well, the other thing, too, budget is like a four-letter word, even though it’s more than four. But most of our clients don’t have a budget. You think about maybe early in your life you did, or early in your professional career, but then as you’re climbing the ladder and things are getting better financially, and you don’t have to worry about money as much. Then you retire, and you go into this, “Well, I mean, I’ve earned all the money that I’m going to earn from work. What I got is what I got, and it’s got to last.” And now a lot of people think that they need a budget. We’ve renamed that, called it a spending plan. It sounds better.
Walter Storholt: You slapped a different label on it, and it’s a whole new thing.
Kevin Kroskey: Yes. There you go. It’s not a junk bond, Walter. It’s a high yield bond.
Walter Storholt: There you go. There you go. You just make it feel a little bit different.
Kevin Kroskey: Yeah. In the last couple of episodes, we talked about some of the stimulus money that’s going out there and all the spending, and then we had a great listener question in a prior episode about, hey, do we need to be concerned about the spending, and what can we expect for inflation? What do we need to do differently? And one of the things that I mentioned in that last podcast about inflation was the way that retirees spend. There’s a natural decline in their spending. And because of that, it tends to have a natural combat, if you will, to just any inflation increases that they do experience. So if we think about the 4% rule that most people have heard about, we talked about it early on in the podcast history a couple of years ago, but I walked through it in detail, if you want to go back and listen to it.
But in short, the 4% role is just some seminal work about how much you can spend from a portfolio. And the way that the researcher Bill Bengen looked at it was, how much can I pull out, and the worst-case situation through historical returns over a 30 year period, have my money last? And so, a simple example was, let’s say if I retired in 1950, I needed my money to last 30 years. So how much can I pull out starting in 1950 and then increase by inflation each year for that 30-year period? And he just repeated that over, really, since the 1920s, when we have good data for the US. And in some of those 30-year periods, you could spend maybe eight or 10% because the returns were so good and they were so good at the early part of a 30-year period, which is important, and had that wind at your back early on.
And then in other periods, it was not that much, and the historical worst case was a little bit more than 4%. And it was just rounded down and called the 4% rule. And that worst 30-year period was started in 1966 and went for the 30 years after that. And through the late ’60s and through the ’70s and into the early ’80s, you had this increasing inflation, and returns on stocks and bonds weren’t all that good. You had stagflation in the ’70s, and that’s when that 4% was reached. So you still could pull out 4%. If you use round numbers, a million bucks, 4% of that is 40,000 per year. And then again, each year. So now, in year two, you’re pulling out $40,000 plus an inflation adjustment. So if the inflation adjustment, say inflation is 3%, 3% times 40,000 is $1,200. Now you’re pulling out $41,200 in year two, and you keep repeating that process for all 30 years.
So that’s the 4% rule. And, and that’s how a lot of people thought about retiree spending. And then, really, over the last, I would say, decade, a lot of this research was coming out, 2013, 2014, that we’ll touch on today. It was just showing that that’s not really how retirees spend. It’s not like you start with pulling out $40,000 per year and increase it by about 3% each and every year for those 30 years. Rather, they found like, hey, I mean, you just were spending less as you got older. It makes sense.
Walter, you may have heard of three broad stages, like the go-go years of retirement; the early, active, you’re healthy, you got all this pent-up demand for travel. You’re going to do some golf. You’re going to go see some shows, all that stuff. You’re going to do that in the go-go years. And then you start slowing down, maybe somewhere around your mid-70s or so. Different ages for different people, but you’re just scaling back on your activities. You’ve checked off a lot of those bucket list items. Your body’s got some more health issues that you’re probably dealing with. Maybe you’re are not as capable of handling vigorous activity. But hey, your mind still needs to be stimulated. And so now you’re not going, and you don’t have as much activity type spending, but maybe you’re focusing on family and charity and the needs that you have for yourself.
And then as you get further on down the line, and now you go from go-go, slow-go, now you’re a no-go. And as you might suspect, this is really where you’re consuming a lot more health care and dealing with maybe some end-of-life issues, your kids trying to take away your driver’s license and all that fun stuff. Walter, I’m sure you’ve heard these stages before. Am I right?
Walter Storholt: Yeah. The go-go, slow-go, and no-go years.
Kevin Kroskey: Yeah, you got it. So I think that’s an easy way to think about it. And if you think about your parents, it probably makes sense to a large degree. But the thing that I would caution you on is just always when you look at your parents; you’re looking the wrong way. I always jokingly say, it’s like you’re driving using the rearview mirror. Life expectancy, coronavirus excluded, is generally increasing. And we continue to have different biotech innovations, healthcare, and so we tend to live longer than the prior generation. So those go-go slow-go no-go years keep getting pushed out.
And our health tends to; it’s not necessarily like a slow decline over those years. Studies that I’ve seen anyway, they call it rounding the curve. So rather than starting very good and then looking like you’re going downhill, sloping downhill straight, it’s like you’re still up on a plateau. Maybe the plateau is getting a little bit shorter, a little bit less amplitude. And then you fall off the cliff, if you will, back in the no-go years. This seems to be how things are changing. And all of that has implications on how our activity levels are and our spending and what have you.
So some of the data that I’m going to reference here is based on the past, but I think it’s important to mention that as we continue to age and as we continue to get biological healthcare improvements and things like that, some of the old spending data may need to be updated. And we may find that current spending data for retirees is a little bit different. So just keep that in mind as we go through this. Planning is a process. It’s not a one-time thing. But some of the different data sources I’ll mention. Everybody’s familiar with Chase Bank. It’s one of the largest banks that’s out there. A lot of people have Chase credit cards and bank accounts, and Chase analyzes that spending data.
And so, some of the things that Chase finds in doing so is that household spending tends to peak around the age of 45. I will be that ripe old age here later in 2021. So maybe this is something I have to look forward to, and we’ll be able to start saving more after this year when I turn 46 if the average is true for me. But spending tends to decline in categories over that time period reaching a peak at age 45 and then declining in aggregate. Think about it. You’ve got kids; we have kids. Kids are expensive. Maybe you’re paying off the mortgage. And so that’s going to go away at some point, assuming you reach that goal. But basically, this is what Chase is finding with their actual spending data from their credit cards and from their bank accounts.
And if you take a look further, and maybe just look at some categories for not just 45-year-olds, but now we’ll just look at two age groups, 55 to 64. So I would say you’re still working or maybe an early retiree, and then 75-plus. And so that’s how they grouped their data if you will. And just in terms of how they’re communicating it, some of the things that you would think will go up, again, healthcare you see going up. It’s 9% of your spend if you’re 55 to 64, according to Chase. It’s 14% of your total spend when you’re 75-plus. Your housing, excluding your mortgage, goes up as you age. It could be getting into a continuing care retirement community, assisted living, things along those lines. Food and beverage tend to stay pretty much similar. They’re both at 13%, at least as Chase has defined it. See education coming down. You see some other things coming down, like transportation coming down quite a bit, entertainment coming down. Apparel, you’re not buying clothes, all that stuff, but just becoming more sedentary and getting more towards the slow-go and no-go years.
So again, this is actual spending data that I just referenced, 2017 to 2019, in terms of those categories. But again, I would just push you to think about just your parents. Like my grandfather on my dad’s side of the family, he worked for American Bridge Company for I’m not exactly sure how long, but I know he retired around age 60, might have even been like his late 50s. He bought the RV, was traveling around everywhere with Grandma, with his wife. And they would just show up at our house sometimes and say, “Hey, we’re here. We’re retired. We can do whatever.”
And then they went out to California, and they ended up getting a little place in California. And then, as things went on, if you want to see Grandma and Grandpa, eventually, you are going over their house. They weren’t coming over to our place anymore. And we were helping out more around their house and things like that. And my grandfather just had a great sense of humor. He built his house. It’s that generation; he’s very handy. So he built the house that they raised their family in. And he had a leak in his roof. And so at the ripe young age of, I don’t know, 94, 95, he’s up on a ladder fixing a leak in his roof.
Walter Storholt: Wow.
Kevin Kroskey: I’m like, “Grandpa, come on. Don’t do that. Don’t get up on the ladder.” And then I came back out to his house, not too long thereafter, and he still had the leak in this roof. I’m like, “Grandpa. You still got the leak in the roof.” He’s like, “Well, you told me not to get up on the damn ladder.” So I’m like, “Yeah, but you have money. Call somebody to get the roof fixed, Grandpa.” So he was pretty funny about that. But he passed away at age 99. I have his driver’s license, which was good through the age of 102, according to the state of Pennsylvania. And I remember when he got it, he showed it to me. He’s like, “You believe these idiots? They’re not making me come back till I’m 102.” But anyway, he’s been gone for a while, but he passed away just a little bit before, a few months before he was going to turn 100.
And so he was getting his pension for about 40 years or maybe a little bit more than that. But I saw it with him. They were active; they were doing a lot. And then, after a while, they were just really maybe going to the grocery store once a week and going to church, and they weren’t doing anything else. So that’s a personal example for me. I’m sure everybody can visualize somebody that’s in their life that they went through that. But you can see how it happened. My grandparents didn’t update their house. They still had the same old carpeting that they had since the 1970s. And so they weren’t spending the money there. They weren’t buying clothes. They weren’t going out and traveling anymore, all those sorts of things.
But that’s how people tend to behave. That’s what we see in the Chase data. Some other data came out in 2013 by a guy by the name of David Blanchett. He is the head of retirement research at Morningstar, which most people are probably familiar with. You think of the mutual fund’s star ratings are probably what they’re best known for. But he wrote a paper in 2013 based on a different data source, something called the Health and Retirement Study. Basically, this was household survey data that followed these people and continues to follow these people over a number of years and just analyzes them. So it’s been an ongoing study over time. But the paper was entitled Estimating the True Cost of Retirement.
And in short, what he found was that retirees need about 20% less in savings than the traditional planning rules. So the traditional planning rules, things like, hey, you need to replace 80% of your pre-retirement income. Hey, you need to use that safe withdrawal rule and take out that $40,000, that 4% of your million in year one, and increase it by 3% per year. And what he’s saying is you actually need about 20% less accumulated in your savings and investment accounts than if you just use those traditional rules of thumb. And then, one year later, he came out with a paper in 2014 and looked more at the spending changes a little bit more detail. And what he found was there was a smile pattern that existed. So say if you retire at age 60, you’re spending at age 60 is going to be probably pretty similar to what you spend at age 59.
But then, as you go through the go-go, as you go through the slow-go, and as you get into the no-go years, you’re going to see this decline. So that’s part of the smile, but then it comes back up at the tail end of life with additional healthcare costs. And so that’s the other side of the smile if you will. But basically, he found that it was about a 1% decrease per year in real consumption. So that’s important to know. The things I mentioned about using this data in terms of how we’re modeling spending goals are important. Some caveats, these are averages. These are large data samples. Whether you have, I don’t know how many millions of people Chase is looking at to come up with these patterns or what was in the Health and Retirement Study. There are a lot of people.
So he had this law of large number effect. And for you or for your household, you have a sample size of one. If you go into any specific household, you may see wide variation, and you may not see that decline over time. You may not see the go-go, slow-go, no-go. You may see a lot more spending on healthcare or other spending that makes that pattern not apply. So we definitely want to use this information, but we want to use it responsibly in our modeling and make sure that we’re doing this on an ongoing basis to keep ourselves on track and not just go off with some runaway spending. I think that is incredibly important to remember.
Walter Storholt: I’m watching my own grandparents starting to go through these transitions, really from the slow-go to the no-go, in different ways over the last couple of years. And it’s one thing to watch it emotionally, and then two, financially, to see the impact. First, it went from international travel getting cut to then domestic travel starting to even get cut back, and then various health issues starting to pop up, just as you outlined for your grandfather. It’s been interesting to watch that transition and to try to define different ways to interact. And we’ve crossed that same threshold where now you got to go see them in order to visit and be together. It’s probably not going to go the other now. You’ve caused me to look back and think about that transition, talking about this.
And then it also seems to me like based on their experiences that although they’re spending less as they get older, the things that they do have to spend money on come in bigger pops. Bigger spends all of a sudden start popping up. Obviously, a lot of them due to healthcare. But with my grandmother, because of an incident, she now needed to have a chairlift installed. So boom, really big expense to have. They live in a third-story condo, to now have to have three stories worth of this chairlift put in so that she can still have some independence and get out of the house for doctor’s appointments and things like that. So they’re just little things that maybe you don’t think about planning for that start to pop up as you get a little bit older as well.
Kevin Kroskey: Yeah, healthcare is so specific to each person, and obviously, it’s largely unpredictable. There are certain things that we can control about our health, but we can’t. And, I won’t say the counterintuitive thing, but even if we’re very healthy and we live to be quite elderly, well, dementia starts setting in at a much, much higher rate the older that you are. So you could have a very healthy body, but your mind could not be keeping up with it and integrating. Those are some of the cases where you could be in a long-term care memory care unit for quite a period of time because the body’s healthy, but the mind isn’t. So you don’t know. But your spending, even though healthcare does increase at the end of the life. And for some, it’s going to increase a lot, but for most, it’s probably a little bit more. I would say it’s more of a fear than a major risk for many, once you actually understand the data and the actual risk that’s involved, and maybe some ways that you can combat the risk.
Early on, we did a series called Retirement Rules Gone Awry, and I talked about this in more detail. It’s probably back in the first ten episodes. But you can listen to it if you want. I go into the long-term care need and some of the stats behind it. It’s good to know this. If you factor in these age-related spending changes, on average, rather than just assuming you’re spending the same amount each year and increase it with inflation, on average, you’re going to find that you probably retire about three years sooner.
That’s great. Or at least you’re financially independent. You can retire if you want to, or keep working if you want to. That’s up to you. But it is just an average. And so everybody’s going to be different. So it’s really important to use those spending changes, but you still have to keep your eye on the ball. And I haven’t even mentioned it, but the most important thing is whatever you’re putting in for your spending has to be accurate. We haven’t talked about this. I can do a whole episode on it, but because a lot of people don’t have a budget and they haven’t had to worry about money, a lot of our clients don’t know what they’re spending when they start working with us. And maybe they have some income that’s lumpy or expenses that are lumpy, meaning that, hey, maybe it’s a one-time thing, like the chairlift example that you just mentioned for grandma, but they’re not going to continue year in, year out through retirement.
So it’s really important and somewhat challenging to get good spending data into the plan. Certainly, clients may come up with spreadsheets, but I can give you many examples. I mean, heck, I had one client who was a CFO for about a hundred million dollar company. I went through his budget, and I reconciled his tax return, and I’m like, “Hey, we’re missing about $10,000 here.” And then it didn’t really take that well, but we worked through it. And if you’re spending a $10,000 difference per year, if you think about it, it could be a couple hundred thousand dollars that you need to have saved up to go ahead and meet that $10,000 per year additional lifestyle expense. So we’re not talking about small dollars for most people. But it’s really important. Again, I’ll make a mental note, and maybe we’ll come back to this about getting good spending down in there, but it’s tough.
People hadn’t had to worry about money, and maybe they don’t know how things are going to change in retirement. Maybe they’re helping out their kids now, but that’s maybe not going to be there forever. So you really have to get data, but then you have to massage it and make sure that you have really good inputs to the plan. And candidly, one of the best ways to do this is to do it over a period of a couple of years, meaning that, hey, we start with some good assumptions.
Say we’re starting working with a new client this year. You know, “Hey, what spending data do you have? There are some different things that we can do to triangulate that and reconcile it. But then, when we’re updating things next year. Now that we’re measuring let’s keep an eye on this. Let’s make those adjustments and make sure that the inputs that we have into the plan for spending are accurate. And if they’re not, let’s make sure that we adjust them to reflect your lifestyle currently, and then we can make those age-related spending adjustments that are important to get a more representative plan, not just today of your lifestyle, but how it’s likely to change over time.”
Walter Storholt: So we’re not going to put together a budget for folks. It’s the spending plan. That’s the fresh twist on things, right, Kevin?
Kevin Kroskey: Yeah. You got it. I mean, it’s a spending plan. We need to have good data. So the good thing is we can do that heavy lifting. Most people don’t want to go through their bank statements and do all that. I mean, there are different ways that we can do that. We’ve been able to figure out where we can get good data to start. And then, with each successive year, we can measure it going forward, and we true it up. So it’s really important. If you have a plan that looks great on paper, but it’s not reflective of your lifestyle, and you’re actually spending a lot more, that is not a good plan, and it’s going to run into ruin without some major changes. So yes, yes, there’s retiree spending, but even more important than estimating how things are going to change over time, you really need to have a good measurement of what your current lifestyle is to begin with.
Walter Storholt: Having these conversations should actually be easier, though, than the traditional everyday budget that nobody really likes. Because that’s every day, that’s something that’s got to be in the back of your mind every day if you’re sticking to the budget and doing those kinds of things. This is more infrequent, at least in terms of having to pull everything together, talk about it, analyze it. But for all intents and purposes, it doesn’t affect your day-to-day life of that flow. So to me, it feels like it should be less intimidating for folks to have to walk down that path, and if anything, it should be empowering to get your plan in line with what’s actually happening in reality. And that’s where you step in.
Kevin Kroskey: Well, empowering, yeah. You get a lot more clarity. And we didn’t touch on this, but you think about things that are needs to you, things that are more discretionary or wants, and things that are maybe most discretionary; we call them wishes or aspirational. But when you go through the retirement planning process, and you stress test the plan, if your needs are met to a high degree, regardless of the economics scenario or going through some bad investment markets, and you’re fine with your needs, to me, and I would say to our clients in working with them over the years, that’s very reassuring. We’ve talked about this in different regards, but if the worst case is you have to sell the second home maybe a few years sooner than what you would really like and anticipate doing, but everything else is intact, well, maybe enjoy the second home for ten years, not 20 years. But hey, maybe that’s a decent trade-off.
Those sorts of things, that where are you cutting from if you really have to cut, just helps people get clarity on how their money is connected to their lifestyle. And it helps them become much more prudent going through tough times as we did a year ago when the market sold off by a third, going through the onset of the coronavirus pandemic and then coming out the other side of it. So there was a lot of that going back to, hey, the market just sold off by a third. Here’s where your planning results are now. You’re still fine. In fact, hey, you’re so fine that we can actually be opportunistic and maybe consider a risk increase here because the market just sold off a lot. So that’s really important.
I know we’re talking about retiree spending and inflation, but obviously, you push over one domino in a lot of this, and ten others fall over. A lot of them are interrelated. But hopefully, this brought some more clarity to the comment that I made in the last episode about why inflation is maybe not as big of a risk as it appears for retirees because their spending does decline on average over time. If you’re doing a good job measuring and reflecting your spending changes versus doing it the old traditional way where you’re just having one spending goal and increasing by inflation per year, on average, Blanchett for Morningstar found that you’re probably going to be able to retire about three-year sooner. We’ve been able to see similar results in just our common practice in serving clients. And if you can reach financial independence sooner, and then you have more clarity around what your needs, your wants, and wishes are, and where you would have to cut back if things went awry for any reason, to me, that’s good financial planning.
Walter Storholt: It’s nice to have some natural balancing that happens in the financial realm and some good examples of that on today’s podcast, for sure. If you have any questions about what Kevin has talked about today or you haven’t put together a spending plan or not quite sure if what you’re spending matches up with reality, and you need to go through a little bit more in-depth analysis, it’s always very easy to set up a time to chat and meet with the True Wealth Design team. You can do that by going to truewealthdesign.com and clicking on the are we right for you button to schedule a 15-minute call with the team. And you can also call 855-TWD-PLAN if you prefer that way. 855-TWD-PLAN is the phone number. Or again, truewealthdesign.com. Kevin, another episode in the books. Thanks for the guidance, my friend, and we’ll look forward to chatting again soon.
Kevin Kroskey: Thank you, Walter.
Walter Storholt: All right. Take care. That’s Kevin Kroskey. I’m Walter Storholt, and we’ll talk to you next time on Retire Smarter.
Disclaimer: Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.