Traditionally, many retirement plans use an inflation adjusted spending approach. You start with a certain amount of spending, say $100,000, and adjust that base number for inflation every year. But research by David Blanchett in “Exploring the Retirement Consumption Puzzle”, shows that retirees' spending follows a slightly different pattern.
Instead, retirees often actually experience what's called the Retirement Spending Smile. Here’s how it works:
Base Retirement Spending / Left Side of the Smile
When you first retire, your spending might be high as you enjoy new adventures and activities. However, over time, retirees spending tends to decrease in real dollars. This is due to factors like less travel, reduced activities, and changing lifestyle needs. So, if you start with spending $100,000, you might see your spending increase with inflation, less 1%. Ex: Inflation is 4%, your assumed spending would only go up 3%.
Late Retirement Costs / Right Side of Smile
As you get older, healthcare and long-term care costs start to rise. This creates the upward slope of the "smile" in your spending pattern. These costs can be unpredictable, varying greatly from person to person.
Source of Images: https://retirementresearcher.com/retirement-spending-smile/
Why This Matters
Realistic Projections: It provides a more accurate reflection of how you'll likely spend money over time.
More Spending Early: By anticipating a natural slowdown of spending in retirement, you can bring forward more spending to enjoy it earlier in retirement.
Retire Earlier: As illustrated below. The commonly used 4% rule, for defining when you can retire, changes to more of a 4.7% rule. This then reduces the assets you need to retire by roughly 15%, which could help many retire a year or two earlier.
*For Illustration purposes only! Not Investment Advice!
Practical Tips for Your Planning
If you’re planning to retire early, say at 50 or 55, you should not apply the Spending Smile right away. Younger retirees often have higher spending abilities that keep up with inflation. But, as you approach say 65 or 70, this approach becomes more relevant.
For those who want to front-load their retirement spending—meaning you want to enjoy more of your money earlier when you're more active—this approach is especially useful. It aligns with your natural spending patterns. As always, you can take the “Retirement Income Style Assessment” here to find if you prefer front-end or back-end loading of your retirement spending.
Real-Life Impact
To give you a real-life example, I use a software called RightCapital for retirement planning. Based on the two random plans I looked at I saw one probability of success increase from 87% to 93% by applying the Retirement Spending Smile. Another random plan’s probability jumped from 47% to 76%. These changes highlight how significant this approach can be. Note: As probability of success scores approach the extremes, 0% or 100%, the less impact changes to the plan have.
If you have any questions or want to discuss how this can fit into your retirement plan, feel free to reach out. I'm here to help you navigate retirement with confidence.
Take care
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