Estimating expenses over the duration of one's retirement is a fundamental part of retirement planning. Yet, there's surprisingly little agreement among financial planners about spending behaviors. Some suggest that retirement spending rises as clients age, due to accumulating health care expenses. Others suggest that expenditures decrease as retirees reduce their spending in areas such as travel and entertainment. Still, others suggest that retirement spending stays relatively level and simply keeps pace with inflation.
The long-term impact of inflation is a fundamental risk for retirees. Yet most individuals never adjust their portfolio withdrawals each year for inflation. Instead, the checking account bears the brunt of inflation which means funds need to be replenished. To determine how much inflation you are experiencing, you must look at changes in the checking/savings account balances over time, preferably over one year.
A recent article by Wade Pfau, Director of the Macroeconomic Policy Program at the National Graduate Institute for Policy Studies, Tokyo, Japan, examined the question of, "How do spending needs evolve during retirement?" It concludes that most people's spending patterns change over the course of retirement. Expenses look very different at age 90 than at age 65.
He cites a paper by Californian Lutheran University professor Somnath Basu, "Age Banding: A Model for Planning Retirement Needs," which discussed post-retirement spending patterns. Basu considered a 30-year retirement divided into three 10-year intervals. Rather than assuming a constant rate of inflation for expenses in retirement, he divides spending into four general categories: taxes, basic needs, health care and leisure. Within these categories, he investigated the spending patterns by age and made allowances for differential inflation rates among these categories.
For example, he noted that retirees spend more on leisure (7 percent inflation rate) in the early part of retirement and more on health care later. Health care expenses, which had an inflation rate of 7 percent, were adjusted upward by 15 percent at age 65, 20 percent at 75, and 25 percent at 85. Taxes and basic living expenses were assigned an inflation rate of 3 percent, and 7 percent for health care and leisure.
This methodology provides a useful tool for planning long-term retirement budgets. Having a system to track your expenses is a must. Make it a habit each year to review where your money is going and what increased and decreased.
Your expenses will change during retirement.
The above material was prepared by Peak Advisor Alliance. Securities and advisory services offered through LPL Financial, a registered investment adviser, member FINRA/SIPC. LouAnn Schulfer is an LPL investment adviser representative and the co-owner of Schulfer & Associates LLC Financial Professionals, 1417 Main St., Stevens Point. She can be called at 715-343-9600 or emailed at LSchulfer@LPL.com.