Monday, March 12, 2012

How Do Spending Needs Evolve During Retirement?

My new monthly column is now available at Advisor Perspectives. It is, "How Do Spending Needs Evolve During Retirement"

A lot of retirement withdrawal rate research uses the assumption that retirees wish to maintain constant inflation-adjusted withdrawals throughout their retirements. Spending does not either tend to increase or decrease as they age.  Ty Bernicke challenged that in a 2006 article, and one point I make in the article is that with Bernicke's spending assumptions, the worst-case historical sustainable withdrawal rate increased from 4.15% to 5.55%.  But I think he is going too far in the "retirees reduce their spending" direction as a general baseline assumption. My article explores more about the assumption and also talks about Somnath Basu's age banding research.

And for my blog readers, I have an exclusive deleted scene :) Actually, the article was getting to be on the long side, and I just had trouble finding a way to fit in the following section in a manner that flowed well with the rest of the article.  Here it is:

William Bengen and a Prosperous Retirement
For one other look at this issue, we can refer to William Bengen, whose follow-up studies on safe withdrawal rates do touch upon many important issues. In his article “Sustainable Withdrawals” from Harold Evensky’s and Deena Katz’s Retirement Income Redesigned, he investigates the inflation-adjusted spending assumption by considering an active phase for retirees between 65 and 74, then a transitional phase from 75 to 84, and a passive phase after age 85. In the active and passive phases, retirees maintain constant inflation-adjusted withdrawals. But in the transition phase between 75 and 84, retiree spending trails the CPI by 3 percentage points each year.  By spending less later in retirement, retirees should be expect to spend more early on, and William Bengen shows that with these spending reduction assumptions, the initial SAFEMAX (lowest sustainable withdrawal rate in history)  withdrawal rate increased from 4.15% to 4.59%. For a retiree planning to use the appropriate SAFEMAX, this implies a 9.6% reduction in the required retirement date nest-egg to fund retirement expenses.