When a client expects a retirement spending smile with symmetrical peaks, they keep too much in reserve for an end-of-life spending surge that rarely materializes.akinbostanci/iStockPhoto / Getty Images
Words matter when planning for more than 30 years of retirement. So, what if the metaphor used to describe how retirees spend their money sets the wrong expectations?
David Blanchett, head of retirement research at Prudential Financial Inc., coined the term “retirement spending smile” in a Journal of Financial Planning paper published in 2014. The idea is that retirees spend heavily in their early years, less in the middle, and then costs spike again at the end of life, forming a curve that resembles a smile.
It’s become the go-to phrase to describe how spending changes as we age. The problem is, while everyone remembers the smile, that’s not what the research shows.
Mr. Blanchett’s paper also points out that retirement spending declines at a rate of 1 per cent a year throughout retirement. And that’s where the confusion begins. If spending declines consistently, how does it form a smile?
Instead of higher spending in the early years with a return to the same level later in life, the “smile” comes from a slight uptick at the very end, when health care needs increase. But even with that uptick, spending later in retirement remains far below what it was at the start — resembling a smirk more than a smile.
Mr. Blanchett’s central point was that because spending tends to decrease during retirement, retirees may be better off spending more at the beginning. Yet, the “smile” remains the main takeaway.
The distinction between a smile and a smirk has real consequences for Canadians planning their retirement. When a client expects a retirement spending smile with symmetrical peaks, they keep too much in reserve for an end-of-life spending surge that rarely materializes at the level feared.
The result is underspending during their 60s and 70s, precisely when they’re most capable of enjoying retirement. By planning for peaks that don’t exist in the data, they’re living more conservatively than necessary during the years that matter most.
It’s also worth noting that Mr. Blanchett’s research is based on U.S. retirees, who face significantly higher out-of-pocket health care costs than Canadians. If the spending pattern is already a lopsided smirk in the U.S. system, then a spike at the end is even less of a concern for Canadian retirees who benefit from public health care. Yet, many Canadians still plan as if they’ll face U.S.-sized medical bills in their final years.
By being overly cautious about future health care costs, clients might inadvertently create the symmetrical spending smile pattern they feared, only with too little spending early when they’re healthiest. And that’s nothing to smile about.
The good news is that understanding the actual shape of retirement spending can liberate clients to enjoy early retirement more fully. Front-loading travel, hobbies and time with family is easier when they understand that they’ll spend less later in life.
If spending naturally declines with age as activity decreases, there’s less reason to hoard assets for a dramatic end-of-life surge. That doesn’t mean ignoring health care costs or long-term care needs, but it does mean the typical pattern shows declining spending, not escalating expenses.
The retirement spending smile has become shorthand for how we age financially. But if we’re going to use a metaphor to plan decades of retired life, we should get it right. It’s not a smile. And for most retirees, that’s a good thing.
Adam Chapman, CFP, is the founder of YESmoney in London, Ont.