How Exactly Do Retirees Spend Their Money?

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How do retirees spend their money? You might have visions of drawn-out Italian holidays or season tickets for your favorite team, but outside of our daydreams the actual ins and outs of retirement spending are tough to gauge. 

It's hard enough trying to figure out how much you'll need to save -- how on earth are you supposed to know what you'll be spending? 

A report by Sudipto Banerjee of the Employee Benefit Research Institute sheds some light on the issue. Looking at households either about to retire or in retirement across two major government surveys, his study reveals the major changes your spending might undergo in your golden years. 

Incomes fall in retirement
First and most importantly, Banerjee found that while expenditures fall as retirees get older (we'll get to this below), income falls even faster. Whether this is caused by low retirement funds or something else is unknown, but, looking at cross-sectional data, "average household income is 20% less by age 75 and 50% less by age 85." 

Overall, income is still higher than expenditures for retirees under 89 years old, so this doesn't mean that people in different age groups are literally running out of money. However, it's still cause for concern if it means your flexibility to meet important expenses, like those for healthcare, start getting squeezed.

Housing is a key spending category
In terms of expenditures, "home-related expenses [are] the largest spending category for every age group." While the dollar amount drops over time, it stays put at about 40% to 45% of total expenses throughout retirement. This means that the housing decisions you make will be a major part of your retirement outlook and budget.

In this vein, you might do well to be more conservative on the housing front. Not only could it free up income for other uses, but it will help you face the major finding about health costs.

Medical expenses rise in retirement
While housing stays pretty constant in terms of proportion of income, out-of-pocket healthcare costs tend to grow. Banerjee found that "households with at least one member between ages 50 and 64 spent 8% of their total budget on health items, while those ages 85 [and above] spent 19% of their budget on health" in 2011.

"By age 90," the report continues, "health care expenses account for more than 20% of the households' entire budgets."

That is a huge difference, and one that you need to account for well ahead of time. 

It gets even more costly if you take into account the potential for costly end-of-life care. People in the 95th percentile of healthcare spending in 2011 spent $28,339, while those in the 25th percentile spent only $858. It's another distribution that gives you an indication of the uncertainty of healthcare costs facing retirees.

Not only do they grow over time, but their actual magnitude is really hard to gauge. 

Transportation and entertainment costs fall 
Over time, retirees tend to spend less money on transportation and entertainment. That makes sense, of course, considering that you probably won't be commuting every day once retired -- and as people get older, they tend to do less running around altogether. 

On the other hand, Banerjee found that people spend pretty much the same amount on clothing (about 3%-5% of expenses) and food (around 12%-13%) over time.

How will you spend in your golden years?
A key lesson from this data is that the more you can prepare for the immense uncertainty everyone's facing on this front, the better. To do that: 

  • Remember that your income might fall as you get older. Living firmly below your means from the outset is probably, in that light, a very wise choice. 
  • Don't underestimate the significance of housing costs in retirement. I was surprised at what a large chunk of spending housing took up, and if you can help it this might be a good category to try to whittle down. Maybe a condo doesn't look so bad anymore? After all, if you can find ways to lower your housing expenses early on, you could have a lot more money later to adapt to any changes that arise. 
  • Be ready to adapt. The thing most likely to change in retirement is your healthcare expense. Regardless of your health today, your healthcare costs are very likely to rise over time. It's a fact that you simply can't afford to ignore. 

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