A report published in the Journal of Financial Planning earlier this year argues that most retirees spend significantly less money during their retirement years than their advisors realize.

Given this decline in consumer spending among retired individuals, suggests Ty Bernicke, the report’s author and a financial planner in Eau Claire, Wis., investors need not save nearly as much as previously thought.

Bernicke’s arguments fly in the face of conventional wisdom, however, and are winning him his share of critics. Conventional wisdom in retirement planning is that retirees will need to replace roughly 60%-70% of their earned income at retirement. In addition, inflation will cause their income needs to grow each year until they die. (See story on page B3.)

That rule of thumb has proved convenient. It is easy to target as well as to program into
online retirement calculators. Nonetheless, it may actually overestimate how much North Americans need to save, Bernicke suggests, thus adding unnecessary stress to their lives.

His conclusions, which relied on data from the U.S. Bureau of Labor’s 2002 consumer expenditure survey, suggest that spending in almost every category — from housing to clothing to entertainment — actually declines with age. The only category in which spending rises with age is health care, he notes.

People in their mid-70s spent 26% less, on average, than those between the ages of 65 and 74. The greater the age difference, the greater the difference in spending, he discovered. Those over 75 spent 46% less than those aged 55 to 64, and 51% less than those aged 45 to 54.

In dollar terms, Bernicke found that average annual spending per household fell 27% to
US$32,243 for the 65- to 74-year-old age group and from US$44,330 for people aged 55 to 64. Spending fell even more, to US$23,759, for those aged 75-plus.

In the report, entitled Reality Retirement Planning: A new paradigm for an old science, Bernicke illustrates how traditional calculation methods can distort what people think they need to save for retirement.

Under a traditional planning method, a married couple who retires at 55 years of age and spends roughly US$60,000 a year would see spending needs rise to US$145,635 a year by the time they reach age 85. (The reason for the rise is an annual inflation rate assumption of 3% tacked on to the original expenditures.)

If this couple’s nest egg was, say, US$800,000 — plus government pension benefits of US$12,000 a year — most projections would see them run out of money as early as age 81. As a result, many advisors would probably suggest that they work a few more years to boost their savings or temper their potential expenses in retirement.

However, that US$800,000 nest egg goes a lot further when Bernicke’s assumption that spending drops with age is used. Under his model, the same couple would spend noticeably less, even with inflation. The US$800,000 nest egg would, therefore, not only last past age 81, it would probably grow —allowing the couple to live out the rest of their lives without the fear of running out of money.

And what about those long-term medical costs? While probably of even greater impact in the U.S., there is considerable data to suggest that health-care costs can certainly increase with age. But in his analysis, Bernicke argues that even those expenses typically won’t eliminate all of the financial benefits from spending less on other things such as food, clothing and transportation.

Despite this — and to hedge any potential risk — Bernicke recommends people still consider buying long-term health-care insurance to protect against depleting their savings because of a need for prolonged medical care.

But Bernicke has his share of critics. They say he fails to consider adequately the impact of overall health maintenance and that he underestimates the impact of these long-term health-care premiums for future generations of retirees.

While employer-paid health insurance during retirement is increasingly a thing of the past, the data sets on which Bernicke bases his conclusions reflect the spending patterns of retirees who have enjoyed health insurance in retirement covered by their former employers. This underestimates future retirement needs, critics maintain.

Others think the data are simply skewed. In many cases, older investors simply started off spending less years ago, maintaining that pattern through retirement. Another explanation is that people often retire as a result of unanticipated negative events such as a job loss or illness, changing “normal” spending patterns.

@page_break@For instance, among men who retired voluntarily, spending didn’t change. But it fell by 9% among men who had to retire early because of sickness or redundancy, according to Sarah Smith, an economist at the Institute for Fiscal Studies in London.

The debate continues. IE