Older Americans’ spending habits can change quickly as their financial circumstances evolve—say, from paying off a home mortgage or due to a spouse’s retirement—but new research finds that many retirees and retirement savers don’t adjust accordingly.
Using data from the University of Michigan Health and Retirement Study, the nonprofit Employee Benefit Research Institute found that retirees typically spend less as they age, but their spending patterns may change over time. The findings suggest that following “the 4% rule”—where you withdraw 4% of your portfolio during the first year of retirement, with annual adjustments for inflation thereafter—may not be wise advice for many seniors with shifting spending priorities, says Dr. Zahra Ebrahimi, the EBRI research associate who wrote the paper.
“It’s usually assumed that retirees will spend the same amount of money, adjusted for inflation and market conditions, throughout retirement, but our research and other research shows that that’s not necessarily the case,” Ebrahimi said.
Instead, older Americans and their financial advisors should factor spending patterns—and possible changes to those patterns—into their financial planning, she said.
The institute used study data to separate older Americans into four spending profiles: typical spenders, home spenders, health spenders and discretionary spenders. Here’s a brief rundown of each:
• Typical spenders: households with no distinct, large spending in any specific category. Typical spenders account for 56% of Americans ages 55-64, a figure that decreases to 50% for those ages 65-74 and 45% for those ages 75-85.
Typical spenders may become health spenders as they age. In the youngest group, only 18% of typical spenders say a household member is in poor health, but that percentage climbs to 21% and 24% for the older age groups.
Typical spenders ages 55-64 have a median annual income of $56,000 and average annual spending of $47,000. Their spending decreases to about $40,000 for those ages 65-74 and $35,000 for those ages 75-85.
On average, typical spenders nearing retirement spend $17,000 on housing expenses, $6,000 on transportation, $5,000 on food, $4,000 on out-of-pocket health care, $3,000 on entertainment, and $2,000 each on clothing, gifts, and charitable contributions. Decreased spending on transportation as typical spenders retire is a major reason why they spend less as they age.
• Discretionary spenders: households allocating 25% or more of their spending to entertainment, gifts, and charitable contributions. Only 13% of Americans ages 55-64 are discretionary spenders, but that percentage increases to 18% for each of the two older age groups.
Discretionary spenders are more likely to be part of a couple and to hold a college degree, they typically have higher levels of income and wealth, and they’re the least likely to report being in poor health. They are the most likely to have pension or annuity income and are more likely to claim Social Security benefits at older ages.
Discretionary spenders across all age groups had the highest median wealth. They are essentially richer typical spenders, with the average discretionary spender in the 65-74 age group having $644,000 in assets, compared with $174,000 for the average typical spender in that age group.
Typical spenders and discretionary spenders are the most likely groups to remain in the same category as they age, the research found.
• Home spenders: households that allocate 60% or more of their total spending to housing expenses. This group includes 21% of Americans ages 55-64, but that figure dips to 17% for each of the two other age groups studied—65-74 and 75-85. As home spenders pay off their mortgages or downsize their homes in retirement, many become typical spenders, the research found.
Home spenders are far more likely to be single and have low levels of income and wealth, and they’re the least likely to hold a college degree. They’re also more likely to be unemployed or unable to work due to disability. Home spenders are the least likely to have pension or annuity income and are the most likely to claim Social Security benefits early.
• Health spenders: Households allocating 20% or more of their spending to out-of-pocket health-care costs. Health spenders account for only 10% of Americans ages 55-64, but that figure climbs to 14% for those ages 65-74 and 20% for those ages 75-85. They are the second-most likely group to claim Social Security benefits early.
About 45% of health spenders in the youngest age group will become typical spenders in the older age groups, the research found.
One possible explanation, according to the research, is that younger health spenders are more likely to buy their health insurance from private sources other than employers, resulting in higher out-of-pocket costs. When these health spenders transition to Medicare, their health-care spending may go down, making them typical spenders.