(Photo Details: Big red chair overlooking Manhattan from Governor's Island)
I read a lot of studies and articles about retirement. The results of some of those studies don’t make any sense to me, so I tend not to write about those. For example, last year, there was a lot of press about several studies indicating that people who retire earlier die earlier. Having retired at 44, that’s the kind of study I don’t like.
Part of the reason for this result makes sense. People who retire early because of health issues retire with health issues--putting them at a disadvantage right from the get go. But even setting aside those unhealthy retirees, there seems to be some evidence that retiring, even in good health, puts you at a disadvantage in terms of longevity. One study found that the longer a person has been retired, the more likely they are to be clinically depressed. And certainly depression can affect your health.
Which leads me to believe that if you retire young and you are very happy with your decision, you will probably be part of the group that doesn’t die earlier than if you retired later. They didn’t say how many years you stand to shave off your life with an early retirement. But my personal feeling in the matter is that I would rather die after 30 years of an early retirement than work another 20 years and earn a few more years of life. At least I will have thoroughly enjoyed the final three decades of my life. Not to mention, I’m not sure I would physically enjoy the same activities in 20 or 30 years that I do now, while I'm enjoying relatively good health. So that’s all I have to say about those studies.
But another couple of studies show some results that I really like, so I would like to spend a little time on those. The upshot is that it may cost less to retire than you’ve been led to believe.
First, you know how much I hate the rule of thumb that says you need 80% (or any percent for that matter) of your current income in retirement. I have always said that I think it’s better to calculate your own estimated budget in retirement. A recent Morningstar study illustrates exactly why that kind of rule of thumb is flawed. As this article reports, the study found that “the actual needed replacement rate varies from under 54 percent to over 87 percent.” That’s a pretty big swing.
Even more important, the study found that as we age, we spend less. By the end of a 30-year retirement period, based on your initial spending rate, retirement expenses tend to go down on average:
First-Year Retirement Spending Inflation-Adjusted Decrease after 30 Years
Which is similar to the findings of retirement expert Wade Pfau. He found that retirement expenses decrease with age:
Age Group Decrease
65-74 20% less than the 55-64 group
75+ 40% less than the 55-64 group
As Kelly Green reported last month in the Wall Street Journal, what all this data means is that applying an historical inflation rate to project out expenses in retirement may overestimate your actual retirement needs. David Blanchett, the author of the Morningstar study points out:
"Pretty much every paper you read about retirement assumes that spending increases every year by [the rate of] inflation," Mr. Blanchett says. But when he analyzed government retiree-spending data, he found otherwise: Between the ages of 65 and 90, spending decreased in inflation-adjusted terms.
Most models would assume that someone spending $50,000 the first year of retirement would need $51,500 the second year (if the inflation rate were 3%). But Mr. Blanchett found that the increase is closer to 1%, which has big implications over decades, "because these changes become cumulative over time," he says.
As Mr. Pfau points out, discretionary spending on things like travel, dining out and entertainment, decreases with age. So the larger the percentage of your retirement budget that is devoted to discretionary items, the less likely you will be impacted by inflation’s bite as you scale these items back in later life.
When Mr. Blanchett ran Monte Carlo simulations with actuarial life expectancies, his research showed that retirees might actually be able to safely withdraw 5% or more from their retirement assets each year, rather than the traditional 4% that is the standard advice.
Of course individual results may vary. At the very least though, it should give some additional comfort to those of us that are relying on the 4% rule. And even more comfort to those of us that have shorter life expectancies due to our early retirements.
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