Why many advisers need to rethink retirement income

Retirement income is an issue that advisers have been grappling with for some time now, but quite often advice given to clients has been based on broad assumptions and generalizations of how individuals spend post-retirement.

Only recently have we been able to effectively parse real-life data to fully understand how individuals actually spend. At J.P. Morgan, our analysis of the actual spending behaviors of more than 62 million U.S. households has revealed a number of surprising insights that can help inform retirement income planning strategies.

INCREASED SPENDING

While older households tend to spend less in real terms in retirement, we are now able for the first time to view total spending for age 80-plus affluent households. Spending reverses and begins to steadily increase around age 80. We see this increase primarily in checks written (as is the preference for this generation), but is most likely attributed to increasing health care, long-term care and housing needs.

For advisers, the focus should be on carefully addressing their clients’ long-term care planning needs, considering incorporating gradually higher spending beginning at age 80 or maintaining a reserve of assets to cover these expenses if they are needed. 

STABLE VERSUS FLEXIBLE

In speaking with advisers over the years, I've often heard how difficult it is to undertake detailed cash flow planning in support of the "guarantee the floor" approach to retirement income, particularly with couples who can’t agree on which of their expenses are "must-haves" versus "nice-to-haves." The reality is that for advisers, trying to divide expenses into discretionary versus nondiscretionary is an uphill battle, with many spending categories hard to define and highly subjective. For example, I defy anyone to try and tell a dog owner that a vet bill is discretionary!

While this approach is often used to identify the level of post-retirement spending that should be covered by a consistent source of income, this clearly doesn’t work when you take into account the lumpy nature of nondiscretionary costs like health care. Therefore, we think it makes much more sense for advisers to work with their clients to quantify their “stable” expenses that they are spending every month or year, and instead align this to a guaranteed source of income, such as an annuity.

RETIREMENT PAYCHECK

Much of our recent research into the spending of those in retirement has found that many individuals aren’t spending enough in retirement, and are effectively sacrificing their quality of lifestyle. Our analysis calculated “total retirement wealth,” a combination of the value of investment accounts and the present value of retirement income sources, and found that the higher the percentage of retirement income received, the higher the spending.

The implication for advisers here is clear. As many households appear to find the shift from growing wealth to spending it to support their lifestyles very difficult, creating a paycheck-like experience can help clients carefully consider how much of their portfolio to systematically draw down and operationalize it in a way that they can spend with greater confidence. 

This can be achieved through solutions like annuities or monthly account transfers from their near-term “bucket” to a checking account, creating a valuable paycheck-like experience.

While traditional retirement income advice has often been based on arbitrary processes such as splitting discretionary and nondiscretionary spending, and estimating spending patterns later in life, real-world data can provide us with insights to construct a more informed retirement income strategy. Our recent research demonstrates that incorporating long-term planning to take into account higher spending after 80, quantifying stable spending patterns and incorporating a paycheck-like experience can help clients retire with the quality of life they deserve while ensuring they don’t run out of money.

 Katherine Roy is chief retirement strategist at J.P. Morgan Asset Management.