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Spending in retirement doesn’t fall as much as expected

Paloma Kubiak
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Paloma Kubiak

Pension savers are warned that their overall spending in retirement won’t fall as much as they expect, if recent trends are anything to go by.

Based on the spending patterns of current retirees, pension savers are advised “not to plan their retirement saving on the basis that their overall spending will fall sharply during retirement”.

According to a report by the Institute for Fiscal Studies (IFS) which looks at how spending changes through retirement, it found that on average, retirees’ total household spending per person remains relatively constant in real terms.

It found spending increased slightly at ages up to around 80 and then remained flat or falling thereafter.

As an example, for those born between 1939 and 1943, spending at the age of 67 came in at £245 a week, rising to £263 at age 75. For someone born between 1924 and 1928, spending fell from £197 per person per week at age 82 to £185 at age 88.

It cited a recent study in the US which found that while spending falls sharply at retirement for about a quarter of households, it increased for a quarter of them and remained unchanged for the other half of households.

As such, Heidi Karjalainen, research economist at IFS and an author of the report, said: “As retirement incomes are increasingly funded by defined contributions pots, which can be accessed flexibly, more and more retirees face complex and consequential decisions about how quickly to draw down their pension wealth.

“If the spending patterns of current retirees are a good guide to how people in the future will want to spend, planning drawdowns on the basis of reduced spending needs in later retirement may not be wise as it may result in unexpected shortfalls in living standards at older ages.

“While average pension incomes have grown strongly with age in recent years, leaving many retirees with more resources than they chose to spend, high inflation is reducing retirees’ spending power and – along with the more uncertain outlook – makes careful financial planning all the more important.”

Spending on food, holidays and home help

The IFS noted that the composition of spending changes as people age, with per person spending on food inside the home and on motoring falling steadily, while spending on holiday increased up to the age of 80 before decreasing again.

But spending on household services, such as home help and cleaning increased in later life.

It added that for later-born generations, they spend more at the start of retirement on categories such as leisure services and holidays (which make up 7% of total spending at age 65 for the 1924–28 birth cohort compared with 11% for the 1944–48 birth cohort), which tend to increase with age, and less on categories such as food inside the home, which tend to decrease with age.

Incomes and partner death

Further, those households with above-average incomes “have an increasing profile of spending in their 60s and 70s”, the IFS said. Meanwhile those on the lower income scale report lower spending in their 60s and mid-70s with spending remaining flat at older ages.

The IFS said that in order to have an income profile which would match the typical age profile of spending through retirement seen from earlier pensioners, “people should aim for a total income profile that is roughly constant in real (CPI-adjusted) terms through retirement.

The report read: “Given that policy is for the state pension to rise faster than prices over time, this suggests that, at least among current retirees, a declining profile of income from private sources might, on average, be appropriate – and particularly so for those with lower incomes, who are more reliant on the state pension in retirement.

“However, for those largely reliant on private pension income, a non-index-linked annuity would leave them more exposed to inflation and they may not be able to maintain the level of spending they would like in retirement.”

The report also looked at the death of one member of a couple and the effect on per person spending as many shared expenditures, such as housing costs “will not fall when a partner dies”.

Its authors stated: “When thinking about future spending needs, households thus need to consider how changes in circumstances, in particular the death of a partner, will affect income and spending in order to ensure that resources are available to fund increases in per-person spending. Future retirees, who are less likely to have occupational or state pensions with a survivor’s benefit, will have to decide how to take this into account when deciding speed of drawdowns and whether to buy an annuity that provides survivor’s benefits.”

‘New and unpredictable requirements to spend’

Becky O’Connor, head of pensions and savings at Interactive Investor, said: “Hundreds of thousands of newly retired people every year must try to predict what they are likely to spend when they retire. As many will choose income drawdown over an annuity, second guessing what they are likely to need to spend on is almost a full-time occupation.

“There’s a risk people assume they won’t spend as much as they enter their seventies and eighties, which turns out to be false.

“People imagine they won’t want to go out as much and won’t be going on as many holidays. Even if that is true, new and unpredictable requirements to spend can come in later in life and blow the budget.

“If people end up spending more than they expected as they age, there is a chance they could exhaust their pension pots too soon.”

O’Connor added that the findings suggest people should “err on the side of caution” and plan as though they will always need the same amount of income each year, rather than based on spending going down dramatically.

“Rises in the state pension from the triple lock are there as an essential backstop. This research reveals how important the triple lock is to allowing retirees, who reach retirement age with an average of £132,464, to manage their living costs in later life.

“The report may also support the case for a comeback for annuities, which pay a guaranteed income for life, but have fallen out of favour for over a decade as low rates meant they are often seen as an unpopular option,” she said.