As you plan for retirement, two of the most important questions you can ask are “How much money will I need to maintain my standard of living?” and “How long will I need to live on that amount?” Age banding is a concept that can help you answer these questions with greater accuracy, enabling you to plan a more secure retirement.
What is age banding?
Often, people planning for retirement are advised to make a budget for those years so they’ll have a realistic picture of their future financial needs. Some advisers recommend budgeting based on a “replacement ratio” — the idea that you’ll need to replace 70 or 80 percent of your annual income for each year of retirement.
However, the theory of age banding complicates this advice. Writing for Investopedia, financial planner Ben Harvey describes age banding as the idea that annual spending levels tend to vary throughout a person’s retirement years. So, the amount of money you’d need to live on at age 70 might differ significantly from what you’d need at age 85.
The stages of retirement
According to Kiplinger contributing editor Susan Garland, age-banding theory tends to split retirement into three stages (although these will occur at different times for different people).
The first stage is the “go-go years.” During these years, retirees are frequently healthier and more active, spending a larger amount of money on travel, recreation and leisure activities — but not much on health care. The second stage is the “slow-go years.” As a retiree ages, he or she is likely to spend much less on travel and recreation — and a little more on health care. The final stage is the “no-go years,” in which discretionary spending is typically very low but health care spending rises more significantly.
Overall, spending decreases slowly in the first stage, more quickly in the middle stage and slowly again in the final stage. Harvey writes that when these stages are plotted out on a graph, they form what researcher David Blanchett calls the “retirement smile.”
Planning for retirement stages
Age banding will affect everyone’s retirement spending projections differently, but there are a few overarching ways to account for it during the planning process.
The easiest step is to simply take age banding into account while planning. On his website, financial writer and planner Michael Kitces suggests categorizing expenses more specifically for each stage as a way to more accurately reflect declines in spending along with differing inflation rates for each. For example, a retiree’s budget for travel at age 82 would decline sharply compared to age 68, but spending on everyday necessities would decline much more modestly and health-care spending might even rise sharply.
Kitces also recommends projecting retirement needs based on a slow decline of spending throughout the three age bands. In real life, a shift to the next stage might actually happen abruptly, so planning on a smooth, very gradual decline in spending can help retirees foresee the overall effect of spending cuts without relying on dramatic shifts.
Incorporating the insights of age banding into retirement planning can be an effective way to project costs more accurately. In this way, future retirees can get closer to saving the right amount — avoiding oversaving and underspending as well as their opposites.