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Running out of money in retirement. It’s a nightmare scenario, the reason for all of the hard work you put into your retirement planning: calculating, saving, investing, recalculating — and likely a bit of stressing out.
If you’re already retired, perhaps the idea keeps you up at night — and maybe it stops you from spending your money as freely as you’d like. Perhaps you’re putting off that bucket-list trip in the fear that you haven’t gotten the numbers just right.
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For those retirees who have savings, there’s some new research that could help put your mind at ease.
What is the retirement ‘smirk’?
David Blanchett, head of retirement research at Prudential Financial, introduced the concept of the “retirement spending smile” in 2014 (1). That research noted that retirement planning and research generally assumes that spending in retirement increases annually, in line with inflation.
Blanchett proposed that a growing body of research showed that retirement spending actually decreases, “both upon, and during, retirement.”
He also found that spending in retirement tended “to be greater in both early and late retirement,” attributing this higher spending for both younger and older retirees to “the fact younger retirees are better able to travel and enjoy retirement, while older retirees incur higher relative medical expenses.”
In his new research, Blanchett says that spending for many retirees actually goes down over time.
“[I]nflation-adjusted (real) retiree spending tends to decrease over time, challenging the common assumption that expenses rise in line with inflation throughout retirement,” Blanchett writes in “How Spending Evolves in Retirement: A Smile, a Smirk, or Something Else?” (2) his new paper.
The paper notes that while for some, spending follows his U-shaped “smile” trajectory, other researchers have found that spending actually continues to decrease over time, “suggesting changes in spending resemble more of a ‘smirk,’ without the upward curl.”
Blanchett writes that both of these theories are supported by the data analyzed, because when research considers the “average” retiree, meaning the median person, the “smirk” pattern of decreasing spending over time emerges. But when “changes are averaged across all retirees,” Blanchett writes, the smile pattern is shown, likely because healthcare spending shocks may not affect the median retiree, but “would affect the average change in spending across all retirees.”
So, what does all this research mean for retirees and those nearing retirement? It means that the spending calculations in your retirement income projection could be reconsidered.
That is, you might be able to take that trip you’ve been putting off.
Blanchett says that using a spending model that incorporates reduced spending into income forecasts “can result in initial spending rates that are approximately 20% higher,” compared to models that assume the traditional, inflation-adjusted upward trajectory.
However, there is a caveat.
The healthcare wildcard
In the new study, Blanchett notes that there is one outlier: healthcare costs.
“[H]ealth care risks are a clear wildcard when it comes to planning for retirement given the significant amount of idiosyncratic risk present, at least in the United States,” Blanchett writes.
While “transferring this risk” to insurance would make sense, Blanchett says, many Americans can’t qualify for long-term care insurance, and those that do have experienced “significant premium increases over time.”
Consider speaking to a financial advisor if you’re not sure whether the possibility of needing long-term care — which isn’t covered by Medicare (with Medicaid covering only qualified individuals) — is something your retirement portfolio could tolerate. An advisor can create a plan that takes into account multiple scenarios, including a high-cost health event.
Other considerations
Blanchett also advocates for lessening the focus on “a perfect hedge” when it comes to inflation and building portfolios. While portfolios should still be “inflation-aware,” Blanchett’s analysis shows that retiree spending doesn’t “[increase] lockstep with inflation.”
Since public pension benefits such as Social Security are indexed to inflation, Blanchett argues that a retiree’s portfolio can be “more focused on nominal spending.”
It’s important to note that specific circumstances will always differ for every retirement plan. Blanchett notes that the study’s findings would exclude “individuals with very low or very high spending changes, unstable marital status, or missing wealth information.”
“Retirement is incredibly complex and incredibly personal,” Blanchett concludes.
The retirement plan that will work best for you is one that’s tailored to your personal life circumstances.
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Article Sources
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Financial Planning Association (1); Wiley Online Library (2)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
