Where does the money go? Spending is an important component of any sound retirement plan. But individuals and financial advisors often do not know how to estimate spending over the long road of retirement. Older people tend to spend less than younger people, although both groups will face price inflation. Factoring in inflation without taking spending patterns into account may result in overestimation of spending in later years. Not surprisingly, individual experiences will vary along with lifestyles. To create realistic estimates of income needs over the 30-odd years of many American retirements, those differences must be taken into account. Individuals can then build better retirement plans, execute more effective investment strategies and reach more successful retirement outcomes.
In the following article we present an analysis of spending in retirement, drawing on data from 613,000 U.S. households. They are led by men and women age 55 and up, who have debit and credit card relationships with Chase, pay their mortgages through Chase checking and, we believe, use Chase facilities to do a majority of their spending. Although the group represents a national sample, it skews more heavily toward regions in the Chase "footprint."1
Some general patterns in retirement spending can be observed. According to the 2013 Consumer Expenditure Survey of the Bureau of Labor Statistics, average U.S. household spending peaks at age 45. After that age, spending declines in all categories but two—health care and charitable contributions and gifts. Among the categories with the most dramatic reductions in spending: apparel and services (spending in this category declines almost in half by age 80), transportation and mortgage payments (EXHIBIT 1). The trend does not appear to be a generational anomaly. We looked at historical data for the silent generation (Americans born 1925–1945) and the oldest of the baby boomers (the generation covers Americans born 1946–1964), and the decline in spending looks very similar.
The drop in spending at older ages holds across wealth levels. EXHIBIT 2 illustrates the average spending patterns of various age groups for Chase households with $1 million– $2 million in investible assets. We looked at retiree spending at $2 million–$5 million and $5 million-plus wealth levels, and the same patterns can be seen, with only minor variations.
Although the average spending patterns were similar for households of different wealth levels, there is some variation by lifestyle. Examining the data for our 613,000 Chase households age 55-plus, we looked at spending behaviors and observed five different retirement spending profiles. Using statistical analysis that grouped households whose spending was most similar, we identified four profiles—foodie, homebody, globetrotter and health care spender. A fifth profile, snowflake, includes people whose spending did not look very similar to any particular profile. (No two snowflakes are alike.) Of the households in the Chase database, about 75% fit comfortably into one of the four spending profiles, while the remainder, the snowflakes, have distinct spending patterns that are not similar to others. It’s important to note that our data analysis does not reflect the same individuals over time; rather, the profiles are based on a snapshot of spending behavior by age at a particular period of time (September 2012–August 2013).
We determined that 39% of the households could be classified as foodies; 29% were homebodies; 5% were globetrotters; and 4% were health care spenders. Snowflakes, the unclassifiable, accounted for 24% of the total (EXHIBIT 3).
This group, which represents the largest percentage of the population, spends on average 28% of their income at retailers in the food and beverage category. It is important to note that these retailers include big box stores, such as Target, or their online peer, Amazon, so this spending could be on other goods as well. Outside of this shopping behavior, foodies are fairly frugal: of all the groups we examined they had the lowest overall total spending. They tend to have low housing expenses, often because they have paid off their mortgages and do not have significant property tax bills. They also tend to spend less as they get older. Retirement plans for foodies should separately account for health care costs and may use a lower rate of inflation (1% or 2%) for the rest of their expenses.
Housing costs continue to be a major expense in retirement, even for those with no mortgages on their homes: real estate taxes, ongoing maintenance and other miscellaneous expenses often add up to higher-than-expected annual obligations. These expenses tend to increase with inflation, particularly because maintenance costs can increase both as owners age—they need to pay others to do chores they could once handle on their own—and as houses age. Although in the homebody group there is considerable variation in spending on housing, on average households in this category spend 54% of their income on housing expenses, which we define to include utilities, wireless, broadband, cable or satellite television, home maintenance, repairs and furnishings, as well as mortgage payments, taxes and homeowners insurance. Spending such a significant share of total income on housing can be realistic when someone is working, but once earned income slows or stops it can be a significant burden. Homebodies constitute 30% of Chase households age 55 to 64 and 25% of the group age 65 and up.
Financial advisors helping their clients craft retirement plans should ask a range of questions about current housing expenses and plans for the future. This may be a quick way to get a good sense of spending over the retirement years. For example:
Is there a plan to pay off the mortgage, and when?
Is there a vacation home or a desire to buy one? A plan to sell a second home?
Do property taxes and utility bills represent a substantial share of household spending? If so, overall spending may track close to overall inflation.
Are there plans for downsizing, renovating or generating rental income?
Gathering this information is important: including any major changes in planned spending is a necessary component of any sound retirement plan.
Our inveterate travelers, the globetrotters, represent about 7% to 8% of all households age 65 and up, devoting on average 25% of their income to travel. (Of the 55–64 age group, 3% are globetrotters.) Of all our household types, globetrotters have the highest overall spending. Among households with investible assets of $1 million-plus, 11% to 13% are globetrotters. This suggests that more households might fall into this profile category if they felt they could afford to travel more. Travel in retirement may reflect good savings behavior at younger ages—a good reason for some younger clients to boost savings.
Surprisingly, perhaps, there are just as many globetrotters over age 75 as there are in younger age groups. Spending on travel was also the highest for those age 75+ who fit this profile. We would assume that these are individuals who have traveled throughout their lives, like to travel and hope to keep going. Given how important travel is for these individuals, their financial plans should account for these ongoing expenses as a specific spending item. Although there is no inflation rate we can identify for travel expenses, it is important to tailor the spending assumption to the type and frequency of travel each individual prefers or has chosen in the past. For this group, it is probably best to assume their spending will keep going up with inflation. Unsurprisingly, globetrotters are thought to be a relatively happy group, illustrating a key finding of happiness research: experiences often deliver more lasting contentment than material things.2
Health care spender
For some retirees (2% of households age 55-64 and about 6% of households age 65+), health care expenses absorb a significant share of disposable income. On average, this group spends 28% of their income on health care; interestingly, about the same percentage of households are health care spenders across all household asset levels.
Medicare-related expenses were the main component of this spending. Given the historically high rate of health care spending growth and the considerable fluctuation in the inflation rate of health care costs, we believe it is prudent to assume that a 65-year-old with median prescription drug expenses will spend $4,400 a year on health care expenses, with those costs rising 7% a year. For those with very high prescription expenses, plans may include a cost of $6,900 at age 65, with a 5.4% inflation rate. In terms of the prospects for long-term care, higher net worth individuals may be especially concerned about spending down assets to pay for these expenses. These costs may be estimated and included in a financial plan at older ages as a stress test or an insurance solution may be considered.
USING SPENDING PROFILES IN A FINANCIAL PLAN
As part of the planning process, financial advisors should focus their clients' attention on current spending patterns and future goals. In EXHIBIT 4 we present a roster of important questions that should be considered in creating a financial plan for retirement. Included in our advice to financial advisors:
Plan for health care costs as a separate expense.
Ask about housing costs and include significant changes: it is especially important to get housing expenses right, whether or not a retiree falls in the homebody category. Even when a mortgage is paid off, ongoing maintenance costs can be higher than expected.
Inflation may be a particular concern for globetrotters and those with high non-mortgage-related housing expenses. This group may want to use a standard inflation rate for projected expenses in retirement.
Inflation may be a less pressing concern for foodies as they may not increase spending in line with inflation each year. Their financial plans may sensibly use a relatively low rate of inflation (1% to 2%) for expenses other than health care.
When assumptions are personalized for particular spending types, financial plans can be more targeted and effective. After a financial advisor has identified a client's spending profile, the advisor should have detailed discussions of where income has been—and will be—spent. The assumptions of the financial plan can then be tailored to fit the client’s particular experience. Health care costs should always be carved out as a separate item in a plan. All other expenses should be carefully projected to most closely match a client's profile. In this way, spending assumptions will be more accurate and clients will have greater peace of mind based on what is important to them.
If inflation is a concern, as it is particularly for health care spenders, globetrotters and some homebodies, then there is a basic need for growth in the portfolio, even if income is important as well. If a retiree is likely to decrease spending over time, as foodies tend to do, income generation may be the chief concern. (Still, foodies shouldn’t dismiss inflation concerns completely given that health care expenses tend to increase as we age.)
Across all profiles, realistic, personalized projections about spending and inflation will inform the most useful retirement plans and lead to the most successful outcomes.