The Retirement Smile

According to a recent article in the Journal of Financial Planning, which looked at spending patterns of retiree households, thee publication found that over a twenty-five year period from ages 60 to 85, the actual annual changes in retirement spending trace a “retirement smile.”  In other words, retirees tend to begin their retirement years spending at a higher-than-average level (one corner of the “smile”) and end their retirement period with another higher expenditure level (the other corner). Between the two is the curve of decreasing, then increasing spending, with the lowest levels coming between the ages of 70 and 75.

What’s the positive message here for retirees? For one, the study shows it’s normal to spend more liberally in early retirement – the time when healthy retirees travel, remain active and enjoy life. For another, the study indicates that the worry about having to spend a lot more – generally on medical expenses and personal care – late in retirement is indeed a reality, but does not result in overall overspending. Those middle years of lower spending actually keep the average going down over the entire retirement span.

Of course, averages are one thing; your individual circumstances are quite another. Does this study of “normal” retirement spending still have any good news applicable to you?

The answer is yes. It demonstrates that each of us has more control over our spending in retirement than we may think. It also reinforces the following empowering principles:

  • There’s nothing “fixed” about retirement. We often think that the last phase of our lives is constrained by having to live on a fixed income. Same for our spending, which is perhaps the source of the popular 80 percent rule as a good estimate of what your expenditures will be relative to your current income. The reality is far more flexible, and more interesting, for retirees. There will be years of more and years of less, years of having fun and years of taking care.
  • While planning for retirement is imperative to ensure you have the resources to support your spending, planning in retirement is critical, too. The ebb and flow of spending, which in turn dictates the amount of taxable income you’ll need from your retirement accounts, creates opportunities for creative tax planning. For example, keeping your adjusted gross income down in a low spending year may qualify you for certain tax credits and deductions.
  • During years of spending more, spend smart. At the beginning of retirement when you’re still healthy, energetic, and have an overflowing bucket list of things to do and places to see, it’s tempting to live large and enjoy life. That’s okay, provided you plan carefully for that largesse and make smart spending choices. Use the free time afforded by your retirement to budget and price compare before you spend. For example, eliminate all those premiums you paid for convenience while working and time was short. Travel during the off seasons; fly through a connecting city, rather than direct; dine out at that new restaurant at lunchtime rather than dinner; get tickets for the matinee film or play.
  • Just because you’re retired, doesn’t mean you should stop saving. During the lower expense years – that period between ages 70 and 75 – prepare for the higher expenses at the end of retirement. If you can, set aside any “leftover” income at the end of the month in a reserve account to hedge against future medical and personal care expenses not covered by insurance.
  • Real spending is what really matters. The study cited above tracked changes in real spending, which means that inflation was factored out of the analysis. If nominal spending rather than real spending had been tracked, the “smile” pattern of retirement would have looked instead like a crooked grin, with spending increasing each year. For many retirees, it’s that rising level of expenditure for the same basket of goods and services that’s most worrisome. If, however, retirees focus instead on maintaining the purchasing power of their sources of income, the rising level of nominal spending can be of less concern. This means keeping a healthy allocation to equity investments, real estate and commodities in the portfolio, rather than locking everything into guaranteed sources of income. Playing it too safe, investment-wise, can mean retiring sorry.