How Expenses Change After Retirement?

February 27, 2014

One of the fundamental aspects of retirement planning is estimating how expenses change after someone retires. Since every individual is unique, and their spending patterns are different from  one another, financial planners have very little consensus regarding spending behaviors of people who are about to retire.

retirement-yachtAccording to some financial advisors, expenses during retirement actually increase because their health care expenses rise due to their age. On the other hand, some financial advisors assume that the expenses during retirement decreases because retired people cut their spending related to lifestyle changes, such as travel and entertainment. However, there is a third group of financial advisors who think that spending during retirement years remain the same and only rise with adjusted inflation levels.

The risk arising from inflation is one of the most long-term fundamental impacts on retirees. However, retirees hardly ever seem to adjust their portfolio withdrawals based on annual inflation. This means that the inflation slowly catches up over years and soon retirees realize their portfolio needs to be replenished. In order to properly understand the impact of inflation, one must compare their spending on a year to year basis.

In 2012, the Director of the Macroeconomic Policy Program at the National Graduate Institute for Policy Studies, in Tokyo, Japan, Mr. Wade Pfau, explored the question, “How do spending needs evolve during retirement?” The article concluded that for most people, their spending patterns changed over the entire course of their retirement. In fact, spending patterns look very different for a person at 90, compared to when they were 65.

Mr. Pfau cited a paper called “Age Banding: A Model for Planning Retirement Needs” by Somnath Basu, a professor from the Californian Lutheran University, that discussed post-retirement spending patterns based on a 30-year retirement divided into three 10-year intervals. Mr. Basu divided retirement spending into four categories; taxes, basic needs, health care, and leisure. Within these categories, he examined the expenditure patterns by age and made allowances for differential inflation rates among these categories. The result came out interesting, as he noted that retirees tend to spend more on their leisure activities, adjusted for  7 percent inflation rate, during the early years of retirement. Here, Health care expenses had an inflation rate of 7 percent, were then adjusted upward by 15 percent at the age 65, 20 percent at  the age of 75, and 25 percent at the age of 85. Taxes and basic living expenses were assigned an inflation rate of 3 percent, and 7 percent for health care and leisure, respectively.

The methodology used by Somnath Basu offers us a useful tool for planning long-term retirement portfolios that will stand the test of time, and inflation. Here, retirement experts emphasis is on tracking expenses during retirement because comparing annual expenses, with past years is the only way to fully grasp the real impact of inflation. It is a statistically proven fact that expenses change during retirement, keeping track of expenses and regularly adjusting withdrawals from a portfolio is the only way to enjoy a sustainable retirement.

Long term retirement planning is comprised of many different components that need to be monitored by a professional. It can be a very overwhelming process, especially since it is so important to make sure you are financially sound through your entire retirement and life. Our financial advisors and professionals are here for you during this confusing process, and will hold your  hand every step of the way during your entire retirement, so you can relax and enjoy this phase of your life. Contact us today and start planning your sustainable retirement portfolio.



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