David M. Blanchett, head of retirement research for the Morningstar Investment Management Group, feels retirement planning needs a new look.
Blanchett is being honored by the Financial Planning Association for writing the most thought-provoking article for the FPA’s Journal of Financial Planning.
Financial planners often use a model for their clients’ retirement planning that includes a constant dollar amount adjusted each year for inflation. Blanchett has determined through his research that retirees often do not increase spending as much as inflation rises, at least in the beginning and middle retirement years.
He laid out his findings in “Exploring the Retirement Consumption Puzzle” published in The Journal in May 2014.
For his efforts he has been awarded the 2015 Montgomery-Warschauer Award for the article and will be given the award at FPA's 2015 BE (Business and Education) conference in Boston in September. The Montgomery-Warschauer Award honors the paper published in the Journal that provides the most outstanding contribution to better the profession in the preceding year.
The paper’s conclusions have important implications for advisors because advisors may be overestimating how much money retirees need in retirement, Blanchett says.
“It may be that many retirement modeling tools are overestimating the cost of retirement. Empirical data on actual retiree spending suggests that retiree consumption does not increase annually by inflation,” says Blanchett in the paper. “While it is difficult to determine whether this real reduction is due to a lack of retirement resources or active choice (or some combination of the two), the ‘retirement consumption puzzle’ appears to be a very real phenomenon.”
“Retirees may be able to spend more, especially early in retirement when they are healthy enough to enjoy it,” Blanchett said in a recent interview. The time when mandated spending may go up is late in retirement when health-care costs escalate. Therefore retirees may be better off planning for more optional spending early in retirement and more spending late in retirement for health care, while planning for less spending in the middle years, he said.
The result plotted on a graph would look like smile, rather than linear spending adjusted for inflation.
In addition, the choice of an annuity for retirement may be affected, he says in the paper. Inflation-adjusted single premium immediate annuities, which hedge both inflation risk and mortality risk, may not be the best choice. Instead, if retiree spending does not increase annually by inflation, it may be that some combination of a nominal annuity and inflation-adjusted annuity would be a more optimal combination of guaranteed income, Blanchett says.