Retirement Income

Help Clients Navigate Spending Volatility in Retirement

Spending volatility is a challenge for retirees. Here’s how to prepare your clients for what’s to come.

Spending in retirement isn’t the same every year. In fact, there are sizable ups and downs along the way, new research from T. Rowe Price shows. You can help your clients by educating them about the sources of spending volatility, such as an unexpected home repair or a luxurious trip to Paris. It’s also vital to create financial plans that include spending strategies and investment portfolio solutions that are designed to help clients successfully navigate all spending scenarios.

Preparing clients for big swings in retirement expenses 

Your clients should realize that facing a big annual spending change in retirement isn’t a matter of if, but rather when. While the average household will spend about 2% less every year (after adjusting for inflation) in retirement, there will be years when spending needs increase dramatically, often forcing retirees to dig deeper into their savings to cover the added costs. There will also be years when retirees’ spending is much lower than expected, freeing up funds to help offset spikes in expenses in future years. 

In fact, one out of every two retiree households experienced a one-time annual spending increase of up to 25% at some point after they stopped working; one out of four saw a 25% to 50% rise in spending; and about one out of five retiree households experienced spending increases of 50% to 100%, according to T. Rowe Price’s recent white paper, “Planning for Spending Volatility in Retirement.” 

Spending can and does fluctuate in retirement

Odds that retiree households will experience a spending spike over a two-year period between ages 65 and 90

A bar chart shows that 50% of households are likely to see an annual spending increase of 0%–25%; 28% are likely to see an increase of 25%–50%; and 22% are likely to see an increase of 50%–100%.

Source: ISR, CAMS, 2005–2019. Data analysis by T. Rowe Price.

Actual outcomes may differ materially.

What’s driving spending volatility in retirement 

While most people assume health care is the main driver of spending volatility in retirement, it turns out that home-related expenses are five times more likely to be the source of spikes in spending than health care costs for retirees who reside in their homes. However, the source of spending spikes in retirement tends to differ based on income. 

For households with annual income of $150,000 or less, spending volatility is largely driven by “nondiscretionary expenses,” such as unexpected home repairs like replacing an aging HVAC system or a leaky roof, which require quick payment. For more affluent households, both dips and spikes in spending were due to changes in discretionary spending, such as outlaying cash for a luxury vacation, making a dream purchase, or donating to a favorite charity. The reality is that many clients, regardless of the size of their portfolios or investment income, will be faced with sharp fluctuations in expenses and spending during retirement. 

Discretionary expenses drive spending volatility for more affluent households

Percentage of annual spending variation based on type of spending and income level

A bar chart illustrates that as income increases, there is a greater likelihood that expense volatility will be driven by discretionary expenses.

Source: ISR, CAMS, 2005–2019. Data analysis by T. Rowe Price.

Actual outcomes may differ materially.

Helping clients plan for and manage spending shifts in retirement

As a financial professional, you can educate clients about both the concept and causes of spending volatility and the need to be prepared if they have to come up with money quickly to pay for an unexpected expense. You can also help them create optimized portfolio solutions that ensure they have adequate liquidity (e.g., accessible cash) available to meet spikes in short-term spending. The goal, of course, is to avoid negative portfolio or financial outcomes, such as:

  • Taking a large withdrawal from a pretax account, which increases a client’s income tax liability, pushes them into a higher tax bracket, potentially subjects more of their Social Security benefit to taxation, and/or increases their Medicare premiums.
  • Taking untimely distributions from long-term investment accounts.
  • Having to pay capital gains taxes on securities sales.
  • Forfeiting interest if they need to make a cash withdrawal from a CD before it matures.
  • Having to wait weeks or months to access cash from equity in their home.

In short, you want your client to have an adequate cash cushion to avoid having to fund occasional spending increases in retirement without derailing their long-term financial plan. Mapping out a plan before rather than after your client gets a $15,000 quote to replace a 15-year-old HVAC system is the way to go. Things to discuss with your clients include the following:

  • Take advantage of lower-spending years. Use dips in annual spending as an opportunity to build up funds for higher-spending years.
  • Emphasize emergency savings. Stress why it’s important to maintain an emergency fund that clients can access quickly that has an extra cushion built in to cover unexpected expenses.
  • Specify liquid investments to consider. Explain to clients why it is important to adequately fund so-called liquid investments, such as money market accounts, which enable them to access their cash easily and without penalties, fees, or negative tax consequences.
  • Quantify potential cash shortfalls. Provide examples of how much extra money they might need to fund unexpected jumps in spending. For example, if their normal annual spending in retirement is estimated at $40,000 and they suffer a spending increase of 25% in any given year, point out that they will have to access an additional $10,000 from their savings and investment accounts to pay for the extra expenses they incur. 
  • Help mitigate spending volatility. To avoid sizable home repair bills in retirement, discuss proactive solutions with clients, such as doing major repairs before they stop working or right-sizing to a new home that will require less maintenance and repairs. 
  • Plan for discretionary spending. For clients with incomes of $150,000 or more who may be better prepared to cover sizable jumps in discretionary spending or other emergency cash needs, impress upon them that it’s still better to plan for big upticks in expenses to avoid negative portfolio outcomes. And if spikes in spending are due to out-of-control discretionary spending, it might require sitting down with a client and discussing lifestyle changes and better budgeting. However, given that the T. Rowe Price study also found that increases in discretionary spending were associated with “higher financial satisfaction,” another solution is to aim to generate higher income and/or investment returns, which can help boost discretionary spending.
  • Adapt if higher expenses last longer. For the 15% of households who experienced annual spending increases of 25% or more that persisted for at least four years, it might be necessary to reevaluate their withdrawal strategy and adjust the asset allocation in their retirement portfolios.

The time to plan and prepare for spending volatility in retirement is before the big repair bill arrives and before the HVAC system needs to be replaced. Plan a meeting with your client to discuss ways to have adequate liquidity available before an emergency strikes.


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