When working with a client on a financial plan, one of the most difficult decisions that we have for a client is “what percentage of your pre-retirement income do you expect to live on in retirement?”
Most financial planners use a fairly well accepted percentage like 70% for folks who are comparatively well off and 80% for folks who have saved more modestly for retirement. For these folks, Social Security often makes up a larger percentage of their retirement income.
Generally these percentages work but they don’t explain much about the differences in their expenses that most retirees actually face.
A professor from California Lutheran University, Somnath Basu, created an interesting “age banding” framework to try to explain how retirees in different age bands (65-74, 75-84 and 85-94) spend differently in retirement as they move through these age bands. His analysis had two very useful assumptions:
1) That the basic inflation rate for some expenses during retirement – taxes and basic living needs – is relatively modest, just 3%.
2) That the basic inflation rate for other expense categories like leisure and health care in retirement is higher – approximately 7% each year.
Basu’s research showed that the amount that retirees spend on each of these four sets of expenses (taxes, basic living needs, leisure and health care) often also varies from age band to age band.
For example, retirees from 65-74 are no longer earning paychecks, and they are relatively healthy so they spend more on leisure activities.
| Age Range | Type of Spending | Spending Level Compared to Pre-Retirement | Assumed Inflation of Spending |
| 65-74 | Taxes | 50% | 3% |
| Basic Living Needs | 70% | 3% | |
| Health Care | 115% | 7% | |
| Leisure | 150% | 7% |
In the second decade of retirement (ages 75-84) this spending pattern changes and spending on leisure dramatically drops while taxes and health care costs rise:
| Age Range | Type of Spending | Spending Level Compared to Pre-Retirement | Assumed Inflation of Spending |
| 75-84 | Taxes | 100% | 3% |
| Basic Living Needs | 80% | 3% | |
| Health Care | 120% | 7% | |
| Leisure | 50% | 7% |
Finally, from age 85-94, this trend continues and leisure costs drop again. Here is how spending looks during this decade within this framework:
| Age Range | Type of Spending | Spending Level Compared to Pre-Retirement | Assumed Inflation of Spending |
| 85-94 | Taxes | 100% | 3% |
| Basic Living Needs | 90% | 3% | |
| Health Care | 125% | 7% | |
| Leisure | 25% | 7% |
The most important point of this analysis is that retirees should understand that their costs will change throughout their retirement years and their personal rates of retirement inflation might be very different from that of a friend or close relative—especially if they have a variety of health-related issues. Thus, it’s misleading to apply a rule of thumb like 70% or 80% of pre-retirement spending to a retirement that could last decades and have very distinct stages with changing expenses.
~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA
Forward to a friend
