Jess Chapman: For Morningstar.ca, I'm Jess Chapman. You can expect your income to change in retirement and you can also expect having to make some changes to your spending. I'm joined by Morningstar's Director of Personal Finance, Christine Benz.
Christine, people often hear that they will spend 75% or 80% of their working income when they retire. Where did that rule come from?
Christine Benz: Well, there are a couple of key things that tend to bring down income needs and tend to bring down spending in retirement. One is that you're simply not saving anymore. So that means that many people can get away with less income in retirement than they had while they were still accumulating assets for retirement. There also will not be payroll taxes anymore in retirement. Those are the two key things that tend to translate into retirees needing less income in retirement than they needed during their working years. And then there may be also some smaller bore items that can reduce expenses, so things like no commuting costs, no dry cleaning bills, no lunches out, those sorts of things.
Chapman: Now that 75% or 80% number, that's a blunt instrument and that number changes depending on how high or how low your income was before. What are some differences we notice in the spending patterns between higher and lower-income retirees?
Benz: Our colleague David Blanchett from Morningstar Investment Management, he is the Head of Retirement Research there, he did some really interesting research that showed that higher-income retirees will actually spend a significantly lower percentage of their working income than lower-income retirees. So, the key reason is that the higher-income retirees were saving more during their accumulation years and they also have more discretionary expenses that may go down during retirement. The opposite is true for the lower-income retirees. They were not saving as big a percentage of their paychecks during their accumulation years -- of course, some lower-income retirees are able to do that but many are not -- and they have fewer discretionary expenses, so they are having to spend more of their income. So, they will see less of a drop in their income needs when they finally do become retired.
Chapman: We can expect retirees to change their spending patterns as soon as they stop working, but that's not the end of the story. That's not the only change they are going to make.
Benz: Right. It's not a static level of spending throughout the retirement years. There's a lot of research that points to generally speaking retirees spending less as they age. So, it stands to reason that many retirees start out very active. They are doing a lot of travel. Those are their peak spending years shortly after they retire. Then as they age and maybe move into their, say, mid-70s, and of course, this is not true for all retirees, but many stick a little closer to home, do not spend as much and then spending may continue to trail off throughout the retirement years.
Again though, referencing some research from our colleague David Blanchett, he looked at what he calls the retirement spending smile where he actually showed that many retirees do start out with pretty vigorous levels of spending, again because they are doing travel or just having fun in their early retirement years. Then that spending kind of levels off. It actually declines in the mid-70s and then picks up a little bit later on in life in part because many retirees are contending with higher out-of-pocket costs at that point. So, he calls that the retirement spending smile. You sometimes hear retirement researchers talking about the phases of retirement in terms of spending as go-go, slow-go and no-go. So, the idea is that people are either spending less as the years go by or maybe spending a little bit more in those very late retirement years on healthcare-related expenses.
Chapman: Well, if our viewers want to check out more of David Blanchett's research, they can click on the link below this video. Christine, thanks for breaking this down for us.
Benz: Jess, it's great to be here. Thank you.
Chapman: Visit Morningstar.ca for your investment news and updates.
