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It's not what you earn, it's what you spend.
You’ve heard the cliché. It’s not what you earn, it’s what you spend. Usually, it’s invoked during discussions of making ends meet on a paycheck. But a new study shows that it’s key to understanding what you’ll need in retirement too.
The research, based on surveys tracking the actual spending of the same 5,000 older households from 2001 through 2007, shows that median household spending declines steadily and dramatically as folks age. Compared to the expenditures of a household headed by a 65-year-old, spending falls off 19% by age 75, 34% by age 85, and 52% by age 98, finds Sudipto Banerjee, a research associate at the Employee Benefit Research Institute. That decline takes place despite the fact that one component of household spending – medical expenses—rises. But increased health costs are more than offset by declines in spending on entertainment and transportation costs, as aging seniors go out less and perhaps give up their cars. “As you age, your health declines and you might not consume what you thought you would. The doctor might say you can’t take that cruise,’’ Banerjee observes.
For retirement wonks, Banerjee presents detailed consumption numbers based on data collected in the long-running Health and Retirement Study, administered by the Institute for Social Research at the University of Michigan. But his work also holds some valuable lessons for middle class and affluent baby boomers planning their own retirements—and for newish retirees.
Don’t worry about replacing 80% of your income.
You’ve no doubt heard the common advice that you should aim to replace 80% of your income in retirement. But that’s a meaningless figure, since what matters is being able to maintain your pre-retirement standard of living. Upper and middle income folks may need less than 80% of their working income to do that, Banerjee notes, because they’ll no longer have large chunks coming out of their pay for superannuation and taxes and won’t have work-related expenses (for example commuting and clothes.) Plus, assuming they did save, they’ll now be drawing down their savings instead of adding to them. By contrast, poor workers who haven’t been able to save and are living close to the bone even before retirement, may need nearer 100% income replacement.
Here’s a telling statistic. In the 50-plus working population in the HRS survey, the median annual income was $53,548 (in 2010 dollars) while median spending was $39,945. Among the retired population, the median income was $30,480 and the median spending, $31,365. Put another way, the median income for retirees was only 57% of the income of working age folks, while the median spending in retirement was 79% of the working median—in other words, close to that much ballyhooed 80%.
Enjoy life (and spend a little) while you can.
Sure, if you’re counting on your investments to help you make it through retirement and the market crashes, maybe you should be ready to postpone the luxury trip to Europe. But don’t wait too long. You won’t need as much income at 85 as you do at 65, and you may not have the same zest for foreign travel. “How well you are determines the quality of your life and the amount you consume. With age, you’re not able to consume as much. If you’re saying you need 80% of (pre-retirement) income at 65, you won’t need 80% as you age,’’ says Banerjee.
Indeed, as much as the retirement gurus like to lecture boomers about being financially unprepared for retirement, a survey last year suggested that baby boomers are more realistic about the money problems they might face in retirement than the coming health challenges.
Long term care insurance could liberate you.
There’s yet another intriguing finding in Banerjee’s work. Retirees who had long term care insurance spent a lot more than those without such insurance. So what? You have to be reasonably well-off to afford the stiff premiums. True enough. But even when Banerjee controlled for wealth and income, he found that those with insurance spent more. That suggests that those who haven’t bought insurance are spending less than they might, because they’re worried about saving for nursing home and other long term care bills. Retired college graduates, for example, had a median income in 2007 of $53,051 and median spending of $45,071. (This group already had median household wealth of $446,073 including home equity, and median wealth of $234,701 not including equity.) Okay, maybe they’re saving more to help their grandkids pay for university. (As a parent of two uni students, I can applaud that.) But just as likely they’re saving to make sure they’re not a burden on their own kids should they need expensive long term care.
Fixed annuities are worth considering.
Long term care insurance isn’t right for everyone, nor is everyone healthy or wealthy enough to buy it. But Banerjee’s findings on long term care insurance suggest that seniors who have some confidence they won’t run through their money might feel freer to spend when they want to. (He didn’t look at ownership of annuities in the spending study.) In an intriguing new column, The Case For Dying Broke, William Baldwin argues that at age 70, you should put a third to half of your money into fixed annuities, using a sliver of that money to buy an annuity that kicks in when you reach 80—as a protection against inflation. It’s worth reading—and considering.