The New Finance Of Longevity

The Impact of Financial Decision Making in Retirement

The first few years of retirement tend to be the most expensive

A new study from the Consumer Financial Protection Bureau (CFPB) analyzes how spending habits can affect the retirement savings of older Americans. Access the complete report here.

In a new Issue Brief, Retirement Security and Financial Decision-Making, the Consumer Financial Protection Bureau (CFPB) indicates that the first few years of retirement tend to be the most expensive, and many retirees are not spending less over time, which is what is typically expected.

By analyzing a retiree’s total income, value of all non-housing assets, and the average spent in the first five years of retirement based off of spending in year one, the CFPB found that a retiree is likely to be able to maintain that spending level if their total income and value of assets remains higher than what they are spending. Additionally, a retiree receiving defined benefit pension income increases the likelihood of being able to maintain spending habits into retirement.

The CFPB also found that the ability to maintain spending levels varies by several demographic factors, including race, gender, health status, and education. Veterans, retirees with a college degree, retirees in excellent or good health, and white retirees have a higher likelihood of maintaining spending levels in the first five years of retirement.

Excerpts from Retirement Security and Financial Decision-making: Research Brief

The first years in retirement are, on average, retirees’ most expensive years. Furthermore, a growing number of retirees are not experiencing the expected gradual reduction in spending after they retire. The Consumer Financial Protection Bureau commissioned a study to identify ways to increase retirement preparedness and protect retirees from overspending their savings in early retirement. The study examined the financial resources and expenses of people who retired between 1992 and 2014 to assess whether they were able to maintain the same spending level on key categories for five consecutive years after retiring

The study examined how the ability to maintain the same spending level varies by sex, race, marital status, health status, educational attainment, and generation, as well as financial circumstances and retirement decisions. This report describes the findings of the study, and highlights decisions to consider for protecting financial security before retiring.

Key Measures & Concepts

Given that a growing number of retirees are not experiencing the expected gradual reduction in spending after they retire, the study measures retirees’ ability to maintain the same spending level for five consecutive years after retiring. The ability to maintain the same spending level is determined by comparing:

  • (a) the total income and the value of all savings and non-housing assets with,
  • (b) the total amount that the retiree would spend if the retiree spent the same amount in each of the first five years of retirement as the retiree spent in the first year of retirement.

The study determines that a retiree has the ability to maintain the same spending level for five consecutive years after retiring if (a) is greater than or equal to (b) – that is, if the total income and the value of all savings and non-housing assets is greater than or equal to the total amount that the retiree would spend if the retiree spent the same amount in each of the first five years of retirement as the retiree spent in the first year of retirement.

Measuring Income, Savings, Non-Housing Assets And Spending

The first years in retirement are, on average, retirees’ most expensive years. Furthermore, a growing number of retirees are not experiencing the expected gradual reduction in spending after they retire...

The income and assets component of the measure includes the value of all household income sources, savings, and non-housing assets specified. For non-housing assets, such as vehicles and real estate, the measure uses their liquid value. The cost and relative difficulty of liquidating these assets are not considered when determining their liquid value.

The spending component of the measure includes the retirees’ total spending in common and regular categories. They include: (1) housing; (2) transportation; (3) utilities; (4) health, (5)food, (6) clothing, (7) hobbies, and (8) durable goods, but exclude spending on travel, charitable contributions, and gifts. By excluding spending on these categories, the measure removes common sources of volatility in early retirement, and sources that may not necessarily occur consecutively for five years. Because of these exclusions, the measure is likely to overestimate the percent of retirees who are able to maintain the same spending level for five years.

Key Assumptions About Spending

To establish the total spending for the five-year period, the study uses the spending level in the first year in retirement and assumes it to be constant for another four years. This constant spending assumption is necessary to test whether retirees are financially prepared if their expenses do not gradually decline as they expected.

Because the study does not seek to draw conclusions regarding retirees’ financial preparedness for an entire retirement lifespan, the study makes a limited 5-year constant spending assumption. This assumption is consistent with the data showing that retirement spending patterns are similar when examined for limited age bands or specific stages of retirement.

Nearly half of all retirees did not have the ability to maintain the same spending level for five years after retiring
The Bureau found that 51 percent of people who retired between 1992 and 2014 had income, savings, and/or non-housing assets to maintain the same spending level for five consecutive years after retiring.

The analysis shows that of the 51 percent, 27 percent of retirees had the ability to maintain the same spending level with income from pensions, Social Security, annuities and/or other sources of regular income. The other 24 percent of retirees had the ability to maintain the same spending level after adding the value of retirement accounts, savings, mutual funds and/or other non-housing assets, such as vehicles or businesses.

The First Five Years

Two-thirds of younger retirees did not have the ability to maintain the same spending level for five years after retiring
The Bureau found that the ability to maintain the same spending level in the first five years in retirement varies significantly by sex, race, marital status, health status, educational attainment, and generation.

More specifically, the ability to maintain the same spending level for five years after retiring was higher among retired: men than women, whites than non-whites, married than non-married, and with a college degree than without a college degree. Furthermore, a greater percent of retirees born before 1946 than retirees born between 1946 and 1964 (baby boomers) had the ability to maintain the same spending level for five years after retiring.

 

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