The financial services industry may have underestimated the dramatic fall-off in retiree spending as retirees age, according to our analysis of real-world expenditure data. This is potentially a positive message for retirees and their advisers dealing with the Covid-19 crisis.
How retirement spending falls
The median retired couple’s expenditure falls by more than one-third (36.7%) as they move from their peak spending years in early retirement (65 to 69 years-of-age) and into older age (85 years and beyond). The decline in expenditure for couples is relatively stable in the early years of retirement at about 6% to 8% across each four-year age band, but then rapidly accelerates once retirees pass 80 years-of-age.
Association of Superannuation Funds of Australia (ASFA) has previously estimated a ‘comfortable’ couple aged 85+ years will spend about 8% less than those aged 65-85 years of age. Another industry study by the Australian Institute of Superannuation Trustees (AIST), based on Household, Income and Labour Dynamics in Australia (HILDA) data, has suggested that spending may not decline materially through retirement.
However, the Milliman Retirement Expectations and Spending Profiles (ESP) analysis is the first based on the actual spending of more than 300,000 Australian retirees.
The data shows that retirees’ food expenditure—the largest component of essential spending—declines steeply with age, while health spending increases with age but dips again after age 80. All discretionary expenditure, such as travel and leisure, declines throughout retirement.
The faster-than-expected drop-off in spending casts doubt on some common rules of thumb and suggests that financial plans for retirees that assume a steady or increasing spending over time may be conservative relative to actual behaviour. This is potentially good news for advisers and their clients given recent events.
If we compare a small increase of 3% each year in a $50,000 p.a. retirement spend with an equivalent decrease of 3%, we find that this change has massive implications on retirement account balances (Figure 1). In fact, in the scenario where spending decreases annually, retirees can end up with a higher account balance than when they first retired, due to underlying asset growth outstripping spending.
Even assuming no annual increase in spending results in a drastically different picture that can help to offset the concern of seeing a drop in asset values as a result of market volatility.
Figure 1: How spending rates impact pension balance
