How Much Will You Need to Retire?

Are you saving too much for retirement? A recent study by financial planner Ty Bernicke suggests you might be. Using data from the 2002 Consumer Expenditure Survey, Bernicke concluded that investors might be overestimating how much money they'll need in retirement, since spending decreases as we age from our 60s to our 80s and beyond. Is that true? To partly answer the question, we are republishing this Motley Fool article that examined the same data but published last year.

Retirees and future retirees have one big question: Which will last longer -- me or my portfolio? The answer depends on many factors, including your asset allocation, your withdrawal rate, your other sources of income, and your health -- topics I regularly discuss in my Rule Your Retirement newsletter.

But there's also the question of how much you'll need from your portfolio, Social Security, pension, and online accordion lesson business (Polka.com). In financial planning circles, this is known as "replacement income," and you've probably heard that you'll need approximately 70% of your pre-retirement paycheck to maintain the lifestyle to which you're accustomed.

But is that true? Will it be enough to pay for your cross-country jaunts and your surgically replaced joints?

To answer that question, let's see what real retirees do. The good folks at the U.S. Census Bureau ("You're more than a number ... except to us") collect household income and spending data every year, and publish the national averages in the riveting Consumer Expenditure Survey. The information is broken down into many categories, including by age. I've put some of the highlights for 2002 in the chart below.

Now, let's see what this research can teach us:

Income before taxes. Wow, look at that drop-off. If you're in your late 40s or early 50s, enjoy it while you have it, since it seems those are the peak earning years. Perhaps most shocking is that the average household led by someone 75 or older lives on $23,890 a year. Is that due to an inability to do part-time work, or depleted savings? The survey doesn't say, but my guess is both. According to some studies, more than half of the people who retire are forced to do so beause of health problems, not because they want to. But don't tell that to my mother-in-law -- she's 76 and runs her own bookshop on Chincoteague Island.

Average expenditures. Notice that there's a $16,226 gap between the income and the expenditures of the average household headed by 45- to 54-year-olds. That gap serves as extra reserves that could pay for unforeseen large expenses. Now, notice that those gaps are $2,875 and $131 for the older age groups, respectively. That's not much of a cushion. A failed jalopy, damage from a string of hurricanes, or out-of-pocket medical expenses could easily cause expenditures to exceed income.

Food. Keep in mind that these numbers are by household and the average household led by someone in the 45-54 group has 2.7 people, whereas the 75 and over household has just 1.5. So that's the biggest reason for the decline in food expenditures. But notice that at-home food declined by 38% from the youngest group to the oldest, yet dining-out expenses declined 59%. What will that mean for the future of restaurants such as Darden's (NYSE:DRI) Olive Garden? Will Yum! Brands (NYSE:YUM) benefit as diners seek cheaper options?

Housing. The kids are grown, so there's no need to maintain a four-bedroom house with a playroom in the basement. Also, older folks are more likely to have paid off their mortgages. According to the survey, average annual mortgage costs dropped from $4,061 for the 45-54 crowd to $408 for those 75 and older.

Apparel and services. A big 67% drop in this category. Again, it's partially explained by having fewer bodies in the house to clothe. But it's probably also the result of no longer having to maintain a work-related wardrobe.

Transportation. The costs of buying a vehicle drop more (about 72%) with older consumers than the costs of maintaining one (a 62% decline for gas and a 52% drop in repairs). The conclusion is that the more mature motorists don't drive as much -- partially because they no longer have a daily commute -- and thus they don't have to replace their vehicles as often.

Health care. No surprise here. Expenses actually increase as we age. The average 75-and-over household spends 41% more than the average 45-54 household, even with fewer people under the roof. As the cost of health care keeps rising, this will prove to be the Achilles heel of many retirement plans.

Entertainment. This is a fuzzy category. It included admissions, pets, audio-visual equipment, and playgrounds (sadly, an expense that declines as people age). But people have different ideas of what constitutes "entertainment." Indeed, many people have told me that their expenses increased after they retired because the time they used to spend working was now filled with playing -- which can be expensive, depending on your toys. I couldn't find "travel" or "airfare" or "cruise" or "parachuting" in the Consumer Expenditure Survey. However, I can tell you that spending on alcohol declined 69%, while spending on books remained fairly constant. As a former English teacher, I am heartened.

Insurance and pensions. These expenditures dropped a whopping 87%. The main reason: Non-workers no longer have to pay Social Security taxes, which are considered an insurance expense. After all, those taxes are known as FICA taxes, named after the Federal Insurance Contributions Act.

Personal taxes. This category saw the biggest decline from the 45-54 group to the 75-and-older group -- an 88% drop. That's because work-related income is taxed at a higher rate than many forms of retirement income, such as capital gains and Social Security. Plus, most retirees are in lower tax brackets.

What does this mean for you?
I started this column mentioning your portfolio, and I think these spending patterns will affect your investments. Since consumers drive more than two-thirds of the economy, I wonder what will happen as older folks -- who don't, or can't, spend as much -- make up a greater proportion of the population. What will happen to the revenues of Kohl's (NYSE:KSS) and Sears (NASDAQ:SHLD)? Will stores like Hot Topic (NASDAQ:HOTT) have to start marketing to grandmothers? Since the only category that rises as people age is medical expenses, should everyone just invest in Merck (NYSE:MRK) and Pfizer (NYSE:PFE)? It's something to consider -- a topic for a later column.

As for your spending, many expenses do drop in retirement as a natural consequence of not working, such as Social Security taxes, commuting costs, and wardrobe upkeep. As for other costs that are more discretionary, such as entertainment and dining out, I suspect those drop primarily out of necessity, rather than choice. If your income is just $23,890 a year, something has to go.

Of course, these numbers are national averages. The important numbers are what you will spend in retirement. Look those categories over again. How much change do you expect? Do you think your entertainment budget will drop 65%? Do you want it to? Knowing exactly how much you will spend and comparing it to the income you expect will answer the question of whether you're ready to retire.

Robert Brokamp is the editor of the Motley Fool Rule Your Retirement newsletter service. Order a free trial today and receive the "8 Ways to Supercharge Your Retirement" special report free. The Motley Fool is Fools writing for Fools.