Tuesday, February 14, 2012
Plan on Spending Less, and Less
Household spending falls at a constant rate with increasing age, according to a new study by the Employee Benefit Research Institute (Expenditure Patterns of Older Americans, 2001-2009). Compared to how much householders aged 65 spend, those aged 75 spend 19 percent less, those aged 85 spend 34 percent less, and those aged 95 spend 52 percent less. "Future retirement income adequacy studies should explicitly take account of this declining expenditure pattern," says EBRI.
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Although the EBRI estimate is correct, it is highly misleading as a guide for retirement planning. It is based on their plot of household expenses vs. age (their Figure 1), a plot that has two astonishing features:
(1) a 20% reduction in spending from age 50 to 62, the prime income years; yes, we have a growing recognition of the need to save for retirement during these years, but this surpasses even the advice!
(2) the largest financial event of adulthood – retirement (usually at ~62) – does not even have a visible effect on expenditures.
Another surprise in their Figure 1 is the almost constant decrease in spending from age 50 to 95, which they show persists in every category except health care.
These observations suggest that there may be an unconsidered dominating variable. I think the problem is that older households have fewer householders and therefore less expenditures. A better measure is expenditures per person. The 2010 census of household size vs. age lists household size for ages 50-54 (2.65), 55-59 (2.35), 60-64 (2.07), 65-74 (1.91), and >74 (1.58). Using these data, I converted EBRI’s data to expenditures per individual: on average, individual expenditures rise slightly in the decade before retirement, decrease 6-7% in the decade after retirement, and decrease ~10% after that. This decrease is remarkably close to the 20% reduction that is often quoted as a retirement planning guideline.
This decrease is much less than EBRI’s calculations: “with the age 65 expenditure as a benchmark, household expenditure falls by 19 percent by age 75, 34 percent by age 85, and 52 percent by age 95.”
The apparent weakness in my argument is that retirees and households do not budget and spend individually and independently; they spend as a household. The largest expense, housing, is certainly a group household expense, although expenses such as health and clothing are arguably independent and individual. The unfortunate point of the overall spending decline of their Figure 1 remains, though, that it results mostly from fewer spenders rather than from belt tightening.
The main EBRI conclusion should be changed to: retirees who survive reduce overall expenditures slightly, despite increased health care costs, mainly through reduced home-related expenses. If I and my spouse are thinking of adopting the EBRI numbers for retirement budgeting, then maybe we should qualify them as follows: “We can expect much lower household expenditures when we are 75, 85, and especially 95, because one of us probably will be dead!”
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