While most working Americans worry about not having saved enough for retirement, many of financial advisers’ retired clients are reluctant to spend their accumulated savings. That has prompted some leading retirement income experts to question whether advisers should rethink their assumptions about spending when creating financial plans.
A new study from the Employee Benefit Research Institute finds great diversity in the way people live in retirement based on their financial status, retirement goals, demographics and spending habits. Following a survey of 2,000 retired households between ages 62 and 75 with less than $1 million in assets conducted in September, EBRI identified five retirement profiles: Average Retirees, Affluent Retirees, Comfortable Retirees, Struggling Retirees and Just-Getting-By Retirees.
The results for Affluent Retirees and Comfortable Retirees should be of most interest to financial advisers.
EBRI defined Affluent Retirees as those with high levels of financial assets, exceeding $320,000, and high annual income of $100,000 or more. Most of these Affluent Retirees were mortgage-free homeowners with no debt. The most common source of retirement income for this group was defined-benefit plans and personal savings. Most Affluent Retirees believe they have saved enough money for retirement, and only one in three said they plan to spend all or a significant portion of their retirement accounts.
Comfortable Retirees were more likely to have middle levels of financial assets of between $99,000 and $320,000 and annual retirement income of less than $100,000 per year. Half of them were mortgage-free homeowners, while 37% had a mortgage. One-third reported no debt and 42% had manageable levels of debt, including credit cards and auto loans. In this group, most retirees cited workplace retirement saving plans, such as 401(K) plans and IRAs, as their major source of income in addition to Social Security.
Almost three-quarters of Comfortable Retirees said their retirement savings are sufficient or even above their needs ,and more than half plan to grow, maintain or spend only a small portion of their financial assets.
With approximately 70 million baby boomers wending their way through retirement, EBRI found that this generation of retirees wishes to retain assets in retirement rather than spending them down.
“This could, in part, be due to the fact they are able to cover their expenses with Social Security or pension income alone,” wrote Zahra Ebrahimi, EBRI Research Associate and author of the report. “However, a behavioral bias could also contribute to an inability to switch gears from accumulation to decumulation.”
Ebrahimi noted that many retirees do not know how to determine a sustainable withdrawal rate that considers the uncertainties they may encounter over their remaining lifetime, making many of them extremely averse to spending their nest egg.
Separately, David Blanchett, head of retirement research at Morningstar Inc., and Warren Cormier, executive director of the Defined Contribution Institutional Investment Association Retirement Research Center, explored this concept of a retirement consumption gap in an article they co-authored in the February issue of the Journal of Financial Planning.
Only 18% of households have enough wealth to cover pre-retirement consumption when they retire. But the percentage of households that can fund their retirement consumption increases dramatically during the first 10 years of retirement, from 18% to 48%, primarily due to reductions in spending, Blanchett and Cormier found. This suggests households “right-size” their spending early in retirement to better align with available resources.
Although many well-funded households could increase consumption, they appear not to do so. Potential reasons include the desire to leave a bequest, uncertain medical expenses, especially late in retirement, or uncertain life expectancy.
“The noted reduction in real spending is somewhat at odds with common financial planning assumptions, where retirement spending is generally assumed to increase annually with inflation,” Blanchett and Cormier wrote. “The fact that spending declines for households — even for those who are not resource constrained — suggests that assuming retirement spending increases annually is something that should be reconsidered by financial planners.”
The idea that retiree households under-consume has important policy implications, as well as implications for retirement savings in general. What’s the point of saving for retirement if you’re not going to spend it?
“Taking into account each of these issues has implications for plan sponsors and advisers, ranging from the type of retirement products offered to providing necessary tools and education for retirees to manage their assets in retirement,” EBRI’s Ebrahimi wrote.
“This becomes even more crucial as the next generation of retirees rely on defined contribution plans in place of traditional pensions and need to generate a sufficient and sustainable retirement income from their retirement savings,” she concluded.
(Questions about Social Security rules? Find the answers in Mary Beth Franklin’s ebook at InvestmentNews.com/MBFebook.)
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