Surprise! The Greatest Retirement Spending Changes Come from What Now?

And other key insights from a new T. Rowe Price study, including what makes retirees most content living in retirement.

In just a few years, I expect to reach work-optional status.

It’s been a long, hard slog, financially speaking, and things can certainly still go wrong.

That’s why I keep reading and writing about “retirement planning” (though, as I’ve written before, I hate that word – “retirement”). 

Each time I read another study report, I gain new insight.

The most recent is a T. Rowe Price report titled “What Aspects are Important When Planning for Retirement Spending Fluctuations?”. 

The report is based on a pair of biennial studies conducted by the University of Michigan, following a group of over 1300 retiree households aged 65-90 for several years.

Spending in Retirement Fluctuates a Lot and the Increases Aren’t Always Temporary

It shouldn’t shock you that spending doesn’t magically stabilize and become constant, month in and month out, as soon as you call it a career.

Retirement researchers find that, on average, retirees spend about 10 percent less each decade - calling these the “go-go decade” (age 65 to 75), “slow-go decade” (75 to 85), and “no-go decade” (85 and on). 

However, this spending decline isn’t universal and is not a simple, slow downward glide.

Personally, over the last decade (while working full-time-plus), our spending fluctuated by up to 60 percent (year-over-year). When projecting forward (for years when I expect to work half-time or less), I foresee year-to-year fluctuations as large as 25 percent some years.

That’s why I find this new report so fascinating – it looks at retirement spending in far more detail.

The first interesting, if not shocking, result was that nearly 3 in 10 households reported spending increases between 25 and 50 percent in a two-year period, with another 2 in 10 reporting spending increases of 50 to 100 percent!

Overall, half of households experienced an annual spending increase of at least 25 percent!

Worse yet, 15 percent of those who experienced such large increases saw their spending remain high for 4 or more years.

Further, they found that spending variability (i.e., the fractional increase in spending) doesn’t depend on your portfolio size or your baseline annual spending, so don’t think you’re safe just because you have a multi-million-dollar nest egg!

With such large changes, we should all consider carefully how much of our retirement funds need to be kept easily accessible (liquid). T. Rowe Price recommends keeping one to two years’ worth of expenses in liquid assets (such as short-term bonds, money-market funds, certificates of deposit, high-interest checking and savings accounts, etc.).

Personally, I plan to keep 3 or 4 years’ worth of expenses liquid (a) because we can and (b) because market downturns often last longer than 1-2 years.

When I asked financial advisors to share their clients’ experience, Chris Shoup, CFP®, Founder & Financial Planner, Southshore Financial Planning said, “My clients’ child moved back in with them due to a health-related issue. The uncertainty of health outcomes and related expenses created an extremely stressful situation. To help, we modeled different scenarios with changes to expenses, investment returns, and inflation. After this exercise, we adjusted their portfolio for greater flexibility in case they needed larger withdrawals. This helped reduce their financial stress since it gave them confidence that their retirement would stay on track.”

Where Do These Large Spending Increases Come From?

The report divided spending in two different ways. 

First, by how much control retirees have over the decision to spend:

• Discretionary (these could be, e.g., travel, donations, gifts, entertainment, hobbies, dining, remodeling, etc.).
• Non-discretionary or essential (these could be, e.g., mortgage or rent, home maintenance and repairs, utilities, homeowner or renter insurance, property taxes, health insurance, deductibles, copays, prescriptions, over-the-counter medications, medical supplies, auto payments, auto insurance, auto maintenance and repairs, gas, groceries, home supplies, apparel, etc.). 

The second, separate way they classified spending was by major categories:

• Home (e.g., mortgage or rent, home maintenance and repairs, utilities, homeowner or renter insurance, property taxes, etc.).
• Health (e.g., health insurance, deductibles, copays, prescriptions, over-the-counter medications, medical supplies, etc.).
• Transportation (e.g., auto payments, auto insurance, auto maintenance and repairs, gas, etc.).

Using these two classifications, they found that, on average, the largest source of spending increases came from non-discretionary spending (over 30 percent!).

Increases caused by discretionary expenses were, on average, less than half as large.

Looking at spending categories, transportation, and health each led to 3 to 5 percent spending increases. The average increase caused by housing, however, was a shocking 25 percent!

How Much Do Discretionary vs. Essential Spending Account for Increases for Different Incomes?

The report breaks down the expense increases between discretionary and essential causes by income.

• Under $50k: 41 percent essential vs. 14 percent discretionary.
• $50k to $99k: 34 percent essential vs. 17 percent discretionary.
• $100k to $149k: 47 percent essential vs. 30 percent discretionary.
• $150k and up: 5 percent essential vs. 40 percent discretionary.

This shows that up to $150k a year income, essential expenses are responsible for increases that appear to stay in the range of 34 to 47 percent. For those making over $150k a year, however, that drops significantly to a mere 5 percent of annual spending increases.

Spending increases due to discretionary spending, on the other hand, show a gradual increase across the four income groups, from 14 percent to 17, to 30, to 40. This is easily understandable – having a higher income in retirement allows people to go on expensive trips; give large gifts to children, grandchildren, and charities; etc. without fear of running out of money later.

Does Change in Essential and/or Discretionary Spending Affect Financial Satisfaction?

The report finds that changes in how much retirees spend on essential costs didn’t show a high correlation with people’s financial satisfaction.

On the other hand, changes in discretionary spending were highly correlated with the level of financial satisfaction.

• Those who reported they were much more satisfied than they had been six years earlier had an average increase of more than 7 percent in discretionary spending.
• Those who said they were somewhat more satisfied kept their discretionary spending about the same.
• Those who didn’t feel much change in satisfaction had about a 10 percent drop in discretionary spending.
• Those who were somewhat less satisfied had a 22 percent decrease in discretionary spending.
• Those who were much less satisfied experienced a 32 percent cut in discretionary spending.

These results imply that being able to maintain or (especially) increase spending on things they wanted but didn’t need led to increased satisfaction.

Minor cuts in such spending seem to have been taken in stride, without reducing satisfaction.

However, cuts of more than 20 percent in discretionary spending led to people feeling less satisfied.

The Bottom Line – Lessons We Can Learn from the Report

Although a catastrophic illness can and does throw retirees’ finances off the figurative rails, such cases are outliers. On average, housing expenses are far higher and lead to five-fold greater spending increases than health.

This being the case, we should try and enter retirement after doing everything possible to avoid major housing expense increases. 

For example:

• Consider downsizing before retirement.
• Complete anticipated major repairs (e.g., roof replacement, repair or replacement of heating and cooling systems, replacement of large appliances).
• Carry out age-related modifications (e.g., remodeling bathrooms to ensure your safety as you grow older and less steady).

Next, make sure you keep a large liquid financial reserve, so you’re not forced to sell investments when the market is down. You’ll need to assess how many years’ worth of expenses this should be. When you make this decision, consider that bear markets can last 3 to 5 years, and that from one year to the next, you may find your expenses increasing by 25, 50, or even 100 percent.

Finally, since financial satisfaction appears to be driven by maintaining or increasing discretionary spending, try to minimize the fraction of your retirement budget covering essential items, and maintain a large enough liquid reserve so unexpected housing expenses don’t force you to cut your discretionary spending permanently.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

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Disclaimer: This article is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.