Age-Banding” Concept Is a Beneficial Retirement Planning Tool

October 30, 2017

According to recent studies by the Insured Retirement Institute and GoBankingRates.com on how the ‘Baby Boomer’ generation (those born in the years 1946 – 1964) is prepared for retirement, 30% of this US demographic have no retirement savings whatsoever, 26% have less than $50,000 saved and a full 74% have insufficient retirement funds to sustain their accustomed lifestyle in retirement to supplement Social Security income.   These sobering statistics suggest that retirement income planning will be critical for this generation to attain as much “financial efficiency” as possible from their limited resources.

Over the past two decades, both academics and professionals in the financial planning community have sought to refine retirement income planning methods to help retirees and their advisors better forecast what finances may be required to fulfill retirement goals.   Differing research often results in debate about how much in retirement savings may actually be required (answering the proverbial “What’s my retirement number?” question) and unfortunately, with changing paradigms to the retirement income landscape, (including pension underfunding or elimination, rising medical costs, increased average longevity, etc.), finding accurate planning tools seems to be a never-ending moving target.

Over the past years, two findings on retiree spending habits have emerged from statistical research that may help the Baby Boomer retirement dilemma.  Since the 1970’s, the prevalent view of retirement was that of stable spending at 70-80% of pre-retirement lifestyle.  In fact, much of today’s financial planning software still utilizes this stable spending as a core component.  By the 1990’s, the concept of William Bergen’s 4% rule took hold, suggesting that retirees must incorporate inflationary increases into their planning.  Thus, the static flat pension payout was not sufficient to carry the retiree through decades of retirement life.

Later, author Michael Stein suggested that most retirees actually go through three general phases of spending; the “Go-Go” years (age 65-75), the “Slow-Go” years (age 75-85) and “No-Go” years (age 85-95).  As you can imagine, the early years are generally more active with more spent on travel and leisure, whereas in the late years, spending habits change and often decrease over time.  This concept of “age-bands” was further refined by researcher and author, Somnath Basu, who suggested that retirement income analysis should not only include age-band spending, but also break down spending into categories, then assign changes in spending levels through each age band to reflect statistically-supported changes on what a typical retiree spends during each phase of retirement. 

As an example, Basu broke down retiree spending into four segments; basic living expenses, taxes, leisure and medical.  In the first band (age 65-75), leisure spending may be elevated to 50% more than in the second band (age 75-85) and perhaps 25% in the last band of life.  In contrast, during the early retirement years, medical expenses may be much less than in the last third of life, and therefore some adjustment for that category in the spending analysis may reflect more realistic eventual outcomes.

Unfortunately, little of today’s financial planning software utilizing these interesting tweaks, so pre-retirees and their advisors may have to create their own adjustments to incorporate age-banding and spending category changes.  For now, it’s worthwhile to still consider such retirement spending changes for your own financial future.