Smiles & Smirks

As she entered her ninth decade, the author Ursula K. Le Guin began a blog. She wrote pithy pieces about, among other things, getting old. In ‘The Sissy Strikes Back’ she takes aim at glossy images of super-fit seventy-somethings and points out how capricious quality of life in old age can be. All the leafy greens and workouts in the world matter not a jot if you “run into some bad luck along the way”. Old age is unpredictable and that matters for the financial judgements we make about it.

Financial planning has its own tidy visions of later life. The best known is the 'retirement spending smile', popularised in 2014 by the American researcher David Blanchett. It divides retirement into three phases, sometimes called the ‘go-go’, ‘slow-go’ and ‘no-go’ years. Spending starts high as the newly retired travel and do the things they have been putting off, eases through the quieter middle years, and turns back up at the end as health costs arrive. Plot it on a chart, and it looks like a smile.

It is an appealing idea with a practical consequence. Most retirement projections assume you will want to spend the same inflation-adjusted figure each year until you die. If spending naturally falls through the middle of retirement, that assumption is too cautious, and people may be denying themselves in their sixties to fund an eighty-year-old who won't want the money.

This year Blanchett revisited his own work. Other researchers had found that American retirees' spending simply keeps falling with age, with no upturn at the end: less a smile than a smirk. His reconciliation is instructive. The typical retiree follows the smirk. The smile only appears when you average across everyone, because a minority face large health costs late in life and those costs drag the average up. The upturn of the smile at the end, in other words, is a picture of other people's bad luck. On his numbers, planning around the smirk rather than a flat line would support a starting income roughly a fifth higher.

Before anyone plans a splurge, this is American data, and the UK looks different. The most thorough study, by the Institute for Fiscal Studies (IFS), examined the spending of British retirees between 2006 and 2018. It found that spending per person stayed broadly flat in real terms, edging up until around 80. For households with above-average incomes, spending even rose through their sixties and seventies. The IFS drew the obvious conclusion: planning on the assumption that your spending will fall in later life risks leaving you short.

What does change is what the money is spent on. Spending on food at home and on motoring falls steadily. Spending on holidays keeps rising into the early eighties. Household bills and help around the home rise later on. And when one partner dies, the cost of running a home does not halve; the IFS found that housing costs per person roughly double for the survivor. The total may hold steady while the contents change completely.

There is a further lesson in how the IFS reached its conclusion. A simple snapshot of retirees showed spending falling sharply with age. But the oldest retirees in the IFS data weren’t spending less because they were old; they were born in the 1920s and 1930s, and had less throughout their working lives than younger generations. By accounting for the different wealth through life of different age cohorts, the drop in spending evaporated. Two respected studies of British retirees even reached different conclusions largely because they used different measures of inflation. As with many uses of statistics in finance, we need to be wary of drawing too firm a lesson.

For an individual, averages only take you so far. Nobody lives the average. What you know about yourself, including your family's health and longevity, is a legitimate source of information for planning; it shouldn't be dismissed as anecdote. However, it does need some calibration. IFS research has found that people in their fifties and sixties underestimate their chances of reaching 75 by around 20 percentage points. Their expectations do reflect real risk factors, such as smoking and the age at which their parents died, but they are too gloomy overall. The family story deserves a place in the plan, but so do actuarial tables of morbidity and mortality.

The same logic applies to care. On average its cost is modest, but for a minority it is very expensive; government estimates cited by the IFS put the share of adults in England facing lifetime care costs above £100,000 at around one in seven. That is not a reason to hold spending flat for thirty years. It is a reason to set something aside for that risk, whether equity in the house or a ring-fenced portion of savings, and to spend with more confidence on the things that have a shelf life. The holidays that need good knees belong in your sixties and seventies.

There is one more caveat, and it may be the most important. The retirees in the IFS data disproportionately held secure incomes that would never run out: defined benefit pensions, often with provision for a surviving spouse, or annuities that pension savers were usually required to buy. Since the pension freedoms of 2015, most people draw on their pension pots directly. The risk that used to sit with an employer or insurer now sits with the individual. How patterns of behaviour change as a result is an open question.

We can look at this positively. Staying invested for longer creates the opportunity to enjoy the upside of financial markets later in life and to build greater wealth, though that exposure cuts both ways. More importantly, there is far greater flexibility to bring spending forward, or to give money to family while you can see them enjoy it. From April 2027 most unused pension funds will fall within the scope of inheritance tax, which removes much of the old logic for leaving a pension untouched.

Of course, this also reinforces the need for a plan. It is much harder to autopilot a sustainable retirement now. A plan built around your own circumstances rather than an average, and revisited as those circumstances change, is the best way I know to guard against both bad luck and a life spent saving for an old age that never needed the money.

If you would like to think through what this means for your own plans, you can get in touch here.