Believe it or not, there is a new concern afoot that retired Americans are not spending enough money!
This runs completely counter to the dominant conversation that Americans are in a retirement crisis and woefully unprepared for life after work. Finance professor Meir Statman writes about the “Consumption Gap”, which he defines as the gap “between people’s actual consumption and their potential consumption made possible by their wealth.” The assumption here seems to be that the purpose of life is to consume, which I believe many of you would challenge. Dr. Statman does include charitable giving in his concept of the consumption gap, but consumption is hardly the right word for philanthropy.
Retirement Crisis or Not?
In his article “Are Your Clients Not Spending Enough in Retirement?” (November 2017 Journal of Financial Planning), Dr. Statman argues that the drumbeat of retirement crisis is much too loud. He asserts that the degree of saving and spending is regulated by the human capacity for self-control and that excessive self-control is as prevalent as insufficient self-control. In a study published by the Vanguard Group based on extensive polling, 55% of American retirees believe there is a national retirement crisis, but only 4% describe their own retirement situation as a crisis. This same study found that 90% of retirees report that they are able to spend freely, and only 10% report that they are on a strict budget.
An important aspect of retirement planning is the variance in spending that occurs between the early years of retirement and the later years. The Howe Institute reports that the average spending by college-educated American couples at age 84, adjusted for inflation, is 23% less than it was at age 62. Social Security tables indicate that only one in ten of today’s 65 year-old men will live to age 95. It is a common reality that we may die sooner than we expect and that our health will restrict what we want to do with our wealth.
In July 2016, Forrest Bell, CFP®, wrote about retiree spending in The Opening Bell with regard to the three periods of retirement, go-go, slow-go, and no-go. The old assumption was that retiree spending keeps rising over time at least at the rate of inflation. New research shows that retirement spending trails the rate of inflation by as much as 20% to 30%. At age 65, if a couple spends $100,000 annually, normal inflation would expand their spending to $158,000 by age 80. But research by Jonathan Guyton, CFP® reveals that on average, spending drops to $146,000. This $12,000 per year decrease has a powerful impact on financial planning results in terms of recommending what retirees can spend in the go-go years.
Ready for Big Medical Expenses?
Of course a long-term care event or other medical expenses can disrupt the scenario above. Financial planning helps determine how prepared people are for such contingencies. Do they have long-term care insurance? How effective is the policy? Do they have enough capital to cover an expensive development?
Another area that influences the level of spending from investments is the amount of guaranteed income retirees receive. -Social Security benefits, pensions, annuities, and disability insurance are some of the categories of guaranteed income. The more income retirees receive from guaranteed sources, the less they need to receive from investments for their core living expenses. Research continues to support the 4% level of annual spending from investment portfolios. This is a good starting point to generate retirement cash flow, and the beauty of an active financial plan is that we continually refresh and test the probability of success for each client based on their spending and investment returns.
In a recent post, Michael Kitces, CFP® reports that bankruptcy rates for retirees over 65 are shockingly low — only 3 per 1000 — and that rate declines as they get older. This is another way of pointing out that the American retirement crisis is overblown. The assumption here is that people in duress are able to make spending adjustments so that they avoid the bankruptcy process. Of course, making radical spending adjustments is not the goal of financial planning, but it can be the reality. Plans distinguish between core living expenses and discretionary spending, and the discretionary part is the first place adjustments are made if necessary.
Prepared to Start Spending and to Stop Saving?
The transition from saving and preparing for retirement to spending and experiencing retirement can be difficult for many people. It is a real sea change, and it often takes time to become oriented to the new rhythms of retirement. The concept of self-induced poverty refers to people who may be afraid to spend when they have spent their whole life saving. We hope that financial planning will help support appropriate and sustainable spending, and will reassure retirees that they can enjoy their life and wealth with confidence as we keep their plan up to date.
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