Say you spent $50,000 in your first year of retirement. How much would you expect to spend in Year 2? Year 3? If you're like most people, you said that you'll probably spend a little more each year, simply because of inflation. You would be in good company, because most estimates of how long our money will last in retirement make the same assumption.
But it may be wrong. And if it is wrong, you may be able to retire earlier – or with a smaller nest egg – than all the retirement calculators are telling you.
A financial planner by the name of William Bengen did the original, groundbreaking research back in 1994 to answer this all-important question: If I have X amount of money, how much can I spend in retirement?
His research determined that 4% was the highest sustainable withdrawal rate – the greatest amount that you could withdraw from your savings and investments in Year 1 of retirement, that would allow you to increase your withdrawal amount each year to keep up with inflation, and give you a reasonable expectation that your money would last for at least 30 years.
He assumed that we would all want to maintain our standard of living throughout retirement. Therefore, we would need to give ourselves a "raise" each year to keep up with inflation.
Almost all of the online calculators that tell you whether you have enough money to retire are using a similar approach – and making the same assumption.
But another financial planner by the name of Michael Stein noticed something interesting about his clients as they entered retirement. Their spending was higher in the initial years of retirement, which he labeled the Go-Go years – the healthy, active years that might include golf, travel, looking after grandkids, or volunteering. Spending dropped when their energy declined and they reached the more sedate Slow-Go years. When they became frail and had more medical expenses in the No-Go years, there was a significant uptick in their expenses. He described this phenomenon in his 1998 book titled The Prosperous Retirement: Guide to the New Reality.
More recently, David Blanchett (Head of Retirement Research with Morningstar Investment Management) conducted a careful research study that largely confirmed what Michael Stein had observed. Rather than increasing in a straight line, the change in retirees' expenses over the years is more like a smile, decreasing in the earlier years and increasing in the later years.
If this is true, it could mean that you can spend more in the early years of retirement, without jeopardizing your long-term financial security. As a result, you might need less savings in order to retire. David Blanchett's work suggests that we might be looking at a 5% initial withdrawal rate instead of the 4% rule – which means you might need 20% less money in order to retire.
Who is right? When I teach workshops about this, I jokingly tell participants to check back with me in 30 years, because then we'll know what the right answer was. Retirement income planning is a young, dynamic, changing field. I expect we'll continue to gain more insights into the question about how much we need to save for retirement, and how much we can spend. And we'll see changes in how online calculators and financial planners approach this question. In the meantime, I hope this will give you food for thought.