Three is the magic number
There is a financial planning benchmark that says that in retirement you will spend about 75 per cent of what you spent before retirement. I have always had my doubts regarding this number, because retirement is usually for a long time with many changes over that period.
In fact, people preparing for retirement can probably plan to spend significantly more than this 75 per cent figure early on in retirement. This is because as retirement goes on, their expenditure will almost inevitably fall.
Retirement is not just one phase – it is a series of at least three phases, each with its own financial requirements.
The Americans have given names for these three phases: the first phase from age 65 to 75 years is called ‘‘all go’’; the second phase up to 85 years is ‘‘slow go’’ and the final phase beyond 85 is, rather unkindly, called ‘‘no go’’. In New Zealand, the Commission for Financial Literature has, more politely but less descriptively, named the phases as Discovery, Endeavour and Reflection.
I was interested to see a study from the USA that was reported by variable annuity provider Lifetime Income.
This study showed people’s expenditure on average peaked in their 50s at US$65,000 p.a. It then went into decline, so that by age 75, the average person is spending less than US$37,000 p.a. Things like eating out, alcohol and clothing showed some of the biggest falls in spending.
It may be that expenditure starts to rise again as people move into their 80s: health care and living support costs will rise for many and this needs to be planned for. Nevertheless it is fairly clear to me that averages of expenditure are not helpful for planning purposes.
Given the likely fall in spending in the later parts of retirement, you can probably afford to spend more of the nest egg at the beginning of retirement.
There is another rough financial planning benchmark. You should be able to draw 4 per cent p.a. from a balanced portfolio in retirement for 30 years. If you recognise that you may want to spend more at the start and less at the end, some people should draw 5 or even 6 per cent in the earlier years, while committing to have much less in the later years.
This is with the caveat that we are all different. If you are planning to rival Madam Calment’s longevity record of 122 years while carrying on your daily bottle of champagne habit, higher drawings would not be a good idea. But most of us should plan to spend more early on, as the chances are we won’t be around or able to spend it later on.
Martin Hawes is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.