Wednesday, December 4, 2013

Does Retirement Get Cheaper as We Age?

A reader noted last week that living expenses tend to decline as we age and suggested that tendency offers some comfort as we look at the cost of a long retirement. That is true in one respect, but there are a couple of important considerations to keep in mind.

First, let’s look at the true part. Expenses typically decline with age, even when we include health care costs.

According to a 2012 study, Expenditure Patterns of Older Americans, 2001‒2009 by Sudipto Banerjee, Employee Benefit Research Institute, "Household expenses steadily decline with age. With the age 65 expenditure as a benchmark, household expenditure falls by 19 percent by age 75, 34 percent by age 85, and 52 percent by age 95.

Here’s a chart of household expenditures by age from the study1. It's almost linear.
What doesn’t get cheaper as we age? Health care. The cost of every other category in the study (home, food, clothing, etc.) decreased with age.

According to Banerjee, “Health-related expenses are the second-largest component in the budget of older Americans. It is the only component which steadily increases with age. Health care expenses capture around 10 percent of the budget for those between 50–64, but increase to about 20 percent for those age 85 and over.

Health care expenses probably won't steadily decline with age. They're more likely to come in bunches. Studies have shown that many retirees will spend most of their total lifetime medical expenses near the end of their life.

So, yes, living expenses tend to decline as we age but growing healthcare expenses offset those savings to some degree. 

The real wild card among retirement expenses is long term care. 

It is estimated that about 60% of Americans will need some form of long term care in their lifetime and this care is not covered by Medicare. That’s the scary number LTC insurance providers use to sell insurance policies but, in reality, the costs of long term care range from several thousand dollars that might be easily covered out of pocket all the way up to "catastrophic".

As I showed in a previous blog on Long Term Care Insurance, more than 40% of retiree’s can expect no long term care costs at all and another 19% can expect costs less than $10,000. An additional 8% can expect costs between $10,000 and $25,000. So, arguably about 70% of retirees will have LTC costs that might well be managed without insurance.

Still, that leaves 30% of retirees that can expect to have very large, perhaps catastrophic long term care costs.

The following chart shows the percentages for those who will need long term care at various cost levels.
You may not have long term care needs at all, or you may only need care for a short time and experience manageable costs, but the possibility remains that you or your spouse might have catastrophic long term care needs that will destroy your financial plans for late retirement. 

LTC insurance is available, but costly. Wealthy people can self-insure. Those with scarce resources won’t be able to afford it. That leaves a group in the middle with a decision to make about purchasing insurance.

There is another major unknown factor in the cost of our retirement, of course: how long we will live. A shorter retirement will cost less, perhaps far less, than one that takes us into our late nineties. While you might derive some consolation from the fact that expenses tend to decline as we age, the factor that really increases or decreases the cost of retirement is longevity. 

Given the possibilities of a very long life and catastrophic LTC costs, expenses in retirement can be wildly unpredictable. Part of that risk depends on how you choose to finance it. Those who choose to forgo (or cannot afford) LTC insurance and choose to fund retirement with a stock and bond portfolio will have little control over those risks. The range of potential outcomes is quite large.

Households that insure against LTC and longevity risk by purchasing LTC insurance and life annuities will have less money to spend elsewhere, but will avoid the worst-case outcomes and have more predictable expenses.

So, will your total expenses decline as you age? If you stay healthy they probably will.

If you have high health care costs and uninsured long term care costs, expenses can explode.

1A lot of retirement income calculators treat income and expenses as static throughout retirement. "You need to replace 70% of your pre-retirement income." As this chart shows, expenses are not static, and income isn't typically static, either. A good retirement plan takes these changes over time into consideration. I prefer a consumption-smoothing tool like E$Planner.


  1. Excellent post! Yes, the big potential cost for most people in their 80's and 90's is their care. As I work with my clients, who are primarily middle class, their consumption goes down dramatically in their later years, in my experience. They still have fixed costs, however most have paid off their homes, which was their largest expense.

    Also, they are just not getting around or are as interested in new purchases as they were at earlier stages in their life. They begin to enjoy life in a different way than they did in the past, and it generally involves less consumption. Clearly, more and more "retirees" are finding a place for work in their later years as well.

    I think many of the growth estimates used by financial planners of retirees' consumption needs are way off base. They use simplistic assumptions that do not factor in the behavior of real people. They are also used to sell products to the consumer. (After 17 years of working at a large broker/dealer which promoted this approach, it was way past time to get out and work as flat fee only advisor and give up my licenses.)

    The big cost, and big risk, is needing expensive care. If it happens, then an individual will experience a massive increase in their expenses. This, instead of their lifestyle, is the real threat to their wealth.

  2. This is a brilliant question, I am sure I am not the only one except the author who has this question in mind. I m quite impressed the way the author has explained everything. Thanks for sharing.

  3. This is fascinating information. Do you know if there are updated numbers? These look like they are from 2005 and I wonder if there has been any significant changes.

  4. Google David Blanchett, The True Cost of Retirement.