Jonathan,

Ask Bud

John: “Do you believe that we should base our plan on a budget that goes down as we get older? I just read an article in a financial magazine that said we should plan on spending less as we age because national statistics show that’s what the elderly do.”

There are TWO general principles that relate to how much older retirees spend.

1. Most older retirees have little savings left, so their ability to spend more is reduced. I see this very clearly with many of my friends. (Remember that virtually all of my friends are in their seventies, eighties and nineties at this point of my life.) They are now afraid to delve into their principal even though the theory says they could. Inflation has reduced the apparent size of the remaining principal that once looked generous to an amount that could be obliterated by any number of things including long-term-care costs.

Statistics that show older retirees spend less do not demonstrate that they are inclined to spend less. They merely reflect the fact that they have less than they are willing to spend considering all of the future uncertainties. If you gave almost any one of them an extra million dollars, they wouldn’t have any trouble spending it.

I firmly believe that if older people had the money, they would lead a more active lifestyle. My wife and I provide some modest assistance to older people who have to live on very little. They become couch potatoes and watch TV incessantly because they can’t afford to do anything else.

It would be interesting to look at the TOTAL cost at older ages, even for couch potatoes. I’ll bet that if you added Medicare and Medicaid costs that even these people would be spending more as they aged. That may not seem important to planners right now, but in a decade or so, the government is going to have to get people to pay more of their own medical cost considering the sorry state of Medicare and social security funding.

2. The planning methods used by virtually all professionals get retirees to spend too much too early. This is not just because they are too optimistic in projecting returns. It’s due to at least two other things:

(1) Retirement plans seldom ask retirees to set aside some reserves for unforeseen events and replacement budgeting. Instead they base spending projections on the total of the retiree’s investments. That’s foolish. No one knows how much to set aside for unknowns, but the math for replacement budgeting is very simple. Example: A $20,000 roof that will last for 20 years requires setting aside $1,000 this year. If the roof is already five years old, the reserve should be $5,000 this year, and that amount should NOT be used in a normal expense retirement calculation. The alternative is debt financing the roof when it needs to be replaced. Retirees should avoid buying almost anything on credit because they need to be earning interest, not paying interest.

(2) The planning process needs a life-expectancy estimate. But even pros often forget that life-expectancy is a 50/50 projection for the population as a whole. Not only is that number subject to a person’s current age, sex, race, genes, lifestyle, etc., it’s still only a 50/50 number. You have a 50% probability of living longer than life-expectancy.

Further, when retirees get within ten years of so of the estimate that they made at, say 65, they start to realize that they are going to have to plan on a longer life. Their resources will have to be stretched further. This is illustrated in the graph below for a person who retired in 1955 with $500,000 and made a new calculation each year using the IRS life expectancy tables plus another 5 years to provide for living beyond the life-expectancy.