Tackling the complexity of retirement spending

IN CONVENTIONAL retirement planning, advisers often assume that their clients' annual expenses (adjusted for inflation) remain flat throughout their retirement years. Many retirement solutions and products are designed accordingly.

It is also easier to design retirement plans and products with a flat annual payout than one that can cope with fluctuating expenses throughout clients' retirement years. But what if retirees' expenses actually change at different phases of their retirement life?

Several years ago, when I was a member of the CPF Advisory Panel, we briefly discussed whether retirees will actually spend more or less in the later part of their retirement. But as this topic was not part of the terms of reference, we need not and did not land on a conclusion. We did recommend that CPF LIFE should have an option for escalating payout, and this has been implemented since 2016.

In January 2020, JP Morgan Asset Management (JPMAM) released a research paper titled "Three retirement spending surprises". Through its process of understanding the real-world spending patterns of more than five million JP Morgan Chase households to evaluate retirement behaviours, it uncovered three patterns: a lifetime spending curve; a retirement spending surge; and a high degree of retirement spending volatility.

A lifetime spending curve

JPMAM's research indicated that on average, spending steadily climbed in households between the ages of 20 and 40 and peaked in households in their late 40s and early 50s, after which, JPMAM observed older households spending less.

In addition, JPMAM also discovered that not only does spending shift with age, what people spent on also changed. Putting into numbers, say a 60-year old today spends $15,000 a month which included $3,000 for groceries and $1,000 for healthcare. A 70-year old today may spend less, say $10,000 a month which included $1,500 for groceries but $1,500 for healthcare.

The question then is, how much will the 60-year old need in 10 years when he turns 70? Conventional retirement planning simply uses the CPI as a proxy to maintain the purchasing power (of $15,000 monthly) of the 60-year-old in 10 years, but does not consider the scenario of lower expenses of a 70-year-old and what he spends on. This is important as inflation (or deflation) for different expenses can vary. JPMAM's research showed that this can lead to overstating actual spending needs by as much as 26 per cent by the age of 95.

A retirement spending surge

JPMAM's research also took a closer look at household spending during the critical five years around the retirement transition period - two years before and three years after retirement. They discovered that retirees' spending rose significantly and peaked in the month of retirement, and then slowly dissipated in the following three years as people moved into this new life stage.

JPMAM suggested that anecdotally this relatively short-term surge is frequently due to increased travel, housing-related changes such as relocation or renovation and other types of changes as people transit into retirement. The key takeaway from the research is that people don't reduce spending in retirement overnight and often use more capital earlier than might be expected as they prepare for a new life stage.

Retirement spending volatility

Finally, JPMAM also noticed that while there is a general spending surge at retirement, based on median behaviours, there is also wide variation in spending at the individual household level, particularly early in retirement.

They compared the average spending in the 12 months prior to retirement to annual spending in each of the three years after. They found that almost 80 per cent of the people experienced substantial changes in spending. About 24 per cent spent considerably more or less (+/-20 per cent) and 56 per cent experienced increased or decreased spending temporarily.

JPMAM concluded that its research showed that the vast majority of people do not start retirement and then immediately begin a new, static lower spend rate that continues throughout their non-working years. The key takeaway by the researchers was that spending volatility can remain prevalent early and throughout retirement, and this can have important ramifications for the appropriate risk and liquidity level.

What this means is that it is important to ensure that retirement and investment strategies designed for retirees will have to be able to cope with this spending volatility. Having too much equities in a retiree's retirement portfolio can be a problem in a down market when you need to spend, whether planned or unplanned. But having too much in cash or bonds may not yield enough returns to support the lifestyle aspiration of the retirees.

Although the findings of JPMAM did not surprise me, I was impressed with the granularity of the research. Since more than a decade ago, we have often said that the withdrawal phase of retirees is a lot more complex than the accumulation phase and conventional retirement planning approaches may not help prepare retirees adequately for retirement.

In our planning for our retiree clients, there is the need to help retirees mitigate the risks of longevity, inflation, investment (which includes volatility risk, sequence-of-return risk and the possibility of lower returns), overspending and the worsening of health during the retiring years.

Retirees' spending curve, spending surge and spending volatility add another layer of complexity to the plan. To top it all, we need to integrate all the retirement assets that the retirees have, which can include properties, pension fund (such as CPF), insurance endowments, annuities, equities, bonds and other investments such as managed funds and ETFs to meet their uneven income need in retirement.

And we have not even talked about balancing current spending needs with leaving behind a financial legacy. One thing is certain - there is a need to really listen to our retiree clients, to understand their money values, important relationships, hobbies, interests, purpose and life goals in order to develop that perfect spending plan.

But no matter how perfect the plan can be, it must be flexible enough to be adjusted. This is because spending during the retirement years is unpredictable and filled with uncertainties, particularly as one is spending over two to three decades.

During this period, the world will change and investment returns fluctuate. Clients' health, family situation and aspirations may change too. Therefore, conversations (at least once a year) with our clients is absolutely critical to respond adequately and effectively.

• The writer is CEO of Providend Ltd, Singapore's first and probably sole fee-only comprehensive wealth advisory firm. He can be contacted at chris_tan@providend.com