Spending, on average, generally decreases in retirement. But that doesn’t mean your spending will decline each year.
Rather, spending will likely fluctuate greatly in retirement, according to recent research written by Sudipto Banerjee, a vice president with T. Rowe Price.
In fact, about one in four retirees experienced at least a 17% to 20% increase in annual spending over a two-year period, while another one in four experienced at least a 20% or 21% decrease in annual spending over a similar period, according to Banerjee’s research.
Financial planners are noticing this volatility. “I’ve come across this a lot with my clients,” said Nicholas Bunio, a certified financial planner with Brookstone Wealth Advisors in Downingtown, Pa.
Bunio and his colleagues have observed a notable uptick in expenditures on major home improvements such as new roofing and bathroom renovations, alongside significant investments in new heating and air conditioning systems, vehicle purchases, and indulging in once-in-a-lifetime dream vacations.
“Oftentimes people underestimate what they are going to need to maintain and upkeep their homes,” said Monica Dwyer, a certified financial planner with Harvest Advisors in West Chester, Ohio. “They absorb those costs with ease when they are working and fail to factor them into the retirement plan.”
Another often overlooked expense is cars, she said. “Some people think that the cars will last longer in retirement, or they estimate that they will not be driving as long as they do,” said Dwyere. “I encourage clients to plan to have at least one car their entire lives, even if they think they won’t be driving into their 80s.”
“‘If it’s a priority for you, you should plan for it. Don’t just wait for the portfolio to have a good year.’”
Banerjee’s research also found that retirees face a considerable risk of experiencing large increases in spending at some point in retirement. Notably, one in two retirees (50.1%) experienced a spending increase of 0%–25% between ages 65 and 90. More than one in four (28%) households experienced a 25% to 50% spending increase, and over one in five (21.5%) households experienced spending increases between 50% and 100% during retirement.
“I have clients who have spent more than $25,000 on plumbing in the last two years,” said Chris Cybulski, a certified financial planner with Chisholm Trail Financial Group based in Austin. “They replaced galvanized pipes under their house twice and a water heater.”
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Cybulski noted that his client’s annual budget is about $100,000 per year, but just those expenses raised costs by 25%. “Fortunately, they had cash reserves to cover the cost, but they had to dip into their accounts while the market was down,” he said.
What’s more, Cybulski tells the story of a major hailstorm rolling through his area in Texas not long ago. “A number of retired clients had to get new roofs, fix car windows, and hire workers to clean up debris,” he said. “Insurance covered most of it; however, clients had to pay out of pocket to get the work started. You can’t drive with a busted-out windshield or live in a leaky house.”
“So, it’s significant,” Banerjee said in an interview. “And no matter how wealthy you are, you have almost the same odds of experiencing spending fluctuations.”
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Translation: For retirees with household income of, say, $50,000 those spending increases could hit $50,000; for retirees with household income of $100,000 those spending increases could hit $100,000, and for retirees with household income of $150,000 those spending increases could hit, in the extreme, $150,000.
“‘What hurts is when people just start spending on an expensive HVAC, car, etc., and then next year a trip to Greece, then the following year an expensive country club membership, then after a trip to France…now spending is out of control.’”
Causes of spending volatility
So, what’s causing all this spending volatility? Changes in nondiscretionary or essential spending accounted for much of the variation in total spending for retirees, Banerjee said. And overall, home and home‑related expenses accounted for the largest share of the variation, distantly followed by health‑related expenses and transportation.
Spending fluctuations vary across different income groups, Banerjee said. For instance, for retirees with annual incomes of less than $150,000, volatility was largely due to changes in nondiscretionary spending, while for those with incomes above $150,000, it was primarily due to changes in discretionary spending.
And that seems to be the case for clients of David Shotwell, a certified financial planner with Shotwell Rutter Baer in Lansing, Mich. “Travel seems to be the biggest discretionary expense with a lot of variability,” he said.
What does all this research mean for those saving or living in retirement?
Aim to replace 70-80% of preretirement spending
Those saving for retirement should plan on replacing 70% to 80% of their preretirement spending. “I think 70% to 80% is a decent rule of thumb for the transition into retirement, but not throughout retirement,” he said. “But even during the initial years of retirement, the data shows a lot of variation in spending. A lot of people spend more than the suggested amount in the early retirement years.”
It could be, he noted, celebratory spending such as traveling or other fun things. “But it could also be the case that people don’t know what level of spending is sustainable,” said Banerjee. “Usually within a few years of retirement they reach an ‘equilibrium’ or sustainable level of spending and they certainly don’t need to replace 70% to 80% of preretirement spending throughout retirement.”
Have a plan for income generation and spending risk mitigation
Retirees and would-be retirees should plan for spending volatility and have strategies for both income generation and spending risk mitigation.
“If clients have specific dream vacations we try to come up with a budget and a goal,” said Shotwell. “If not, we try to create an average goal, recognizing that it will most likely be bigger in some years and smaller in others. Flexibility in planning is key for both the fun stuff like vacations, and not fun — new roofs.”
Create a budget
A budget is also critical. “While I think it’s normal, of course having a budget is key,” Bunio said. “Withdrawing 10% might even be needed in one year, as long as these are one off expenses and we know spending declines back down to a healthy level. Also, as time goes on, in your 80s and 90s, some spending does increase due to health issues. But other spending does decline, like vacation, golf, cars, etc. This is why factoring these expenses in your plan is key, to make sure you can afford the car, HVAC, new roof.
What hurts is when people just start spending on an expensive HVAC, car, etc. and then next year a trip to Greece, then the following year an expensive country club membership, then after a trip to France. now spending is out of control.”
The need for liquidity
Banerjee’s research also highlights the importance of liquidity: the need to have funds available not just for daily living expenses (one to two years of cash on hand to manage and mitigate the risk of market declines) but also for funds available to spend on essentials.
“We always recommend setting aside a reserve and we try to factor any known expenses — such as a new roof in a certain time frame — into goals and an average expense for the unexpected stuff,” said Shotwell.
Average spending on an inflation-adjusted basis steadily declines with age, Banerjee said, somewhere around 2% or 3% every year.
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“But as our new research shows, there is a lot of variation around that average,” Banerjee said. “That’s why a realistic plan would be to plan for higher spending in the initial years, and maintain liquid funds for sudden increases. In general, I think people, particularly retirees, adapt well to whatever their income is. At the end of the day, spending is very personal, particularly at older ages. So, I think it’s best just to run your own numbers, anticipate what might change, and plan how to support it.”
Manage and mitigate spending volatility risk
Would-be retirees ought to investigate strategies that minimize unexpected home expenses in retirement, including completing extensive repairs before retirement or right‑sizing to a newer home.
For those with household incomes above $150,000, it’s important to have money set aside for discretionary expenses such as traveling, charitable and political contributions, and cash or gifts.
“By planning for and being prepared to adjust to such volatility in spending, retirees can increase their odds of success in retirement,” Banerjee wrote in his report.
Avoid liquidating your portfolio and don’t over-annuitize
The amount of liquid assets retirees should hold in their portfolios to address any potential shortfall will vary, Banerjee noted in his report. That amount will depend on personal factors such as income, expected expenses, health status, family situation and risk preference.
But at a minimum, retirees should avoid liquidating their portfolios to pay for increases in either discretionary and/or nondiscretionary spending. If you experience a situation where you need to withdraw funds from your investments, it’s not the ideal scenario, said Banerjee.
In fact, making “untimely withdrawals” can lead to several potential negative consequences. You might face an increased tax bill due to additional ordinary income or capital gains. Furthermore, if you are enrolled in Medicare, a higher income could result in being subject to an income-related monthly adjustment amount on your Part B, Part C and Part D premiums.
Plan for spending volatility throughout retirement
Oftentimes an increase in spending isn’t a one-time thing. Retirees should also plan for the possibility of spending increases occurring at any point in retirement and persisting.
“Our analysis showed that a significant number of retirees experienced sizable, long‑lasting spending increases,” Banerjee wrote in his report. “For instance, 15% of households that experienced spending increases of 25% or higher were still spending at the same elevated level (or even higher) after four years.”
Given that, retirees should consider not over-annuitizing their portfolio. “If members of a retired household annuitize part of their assets to cover ongoing expenses and invest the rest in long‑term securities, they might need to liquidate those securities prematurely if a spending increase persists,” Banerjee wrote.
And liquidating those securities would come with all the aforementioned potential negative consequences.
Plan for nondiscretionary expense spending volatility
Lastly, Banerjee said households with income above $150,000 should set aside money for nondiscretionary expenses. “If it’s a priority for you, you should plan for it,” Banerjee said. “Don’t just wait for the portfolio to have a good year.”
Retirees should plan on spending that money knowing that it will lead to increased satisfaction.
This should not come as a surprise. “Taking a trip or vacation, giving gifts or money to family or friends, going to concerts, games, or even eating out are increasing your satisfaction,” Banerjee said. “It’s not surprising, right? So, the question is how to plan for it?”
Bottom line for Cybulski: “If you think you will just spend a flat amount each year on basic living expenses, you are in for a rude awakening,” said Cybulski. “You need to plan for 20 to 30% extra expenses from time to time.”