1 How does spending change in later life?
Understanding how much income you will need when you retire requires a good estimate of how much you will be spending. This may seem to be an impractical exercise as your planned retirement date may be many years or even decades away. During these intervening years prices of goods and services will change. However, it is possible to do this forward planning exercise using current prices of goods and services, if it is assumed that the pension income you will receive in the future roughly rises in line with price inflation.
When forecasting spending you need to decide whether to look at the individual or the household. The danger of basing your retirement planning on the household is that many households change over time as, for example, children grow up, couples split up, family members and friends decide to share a home or leave, or people die.
Traditionally, partners have adopted the household approach. However, the resulting financial plans for retirement have often proved inadequate in the face of death, divorce or separation. This is a key reason why women account for such a high proportion of the poorest pensioners today.
The advantage of a retirement plan based on the individual is that each member of the household has their own pension arrangements, which they retain even if the make-up of their household changes.
Spending in retirement can be estimated from the individual’s or household’s current level and pattern of spending. Yet, as you can see from the list below, there are some good reasons to think that spending in retirement may be different from spending while working, and that spending needs in early retirement may differ from those later on.
- By retirement, most – but not all – homeowners will have finished paying off any mortgage, so the amount that these pensioners spend on housing may fall.
- Pensioners often spend more time at home, so bills for gas and electricity could rise.
- There will be savings on work-related costs such as pension contributions and commuting.
- There may be an increase in travel to see friends and relatives, but pensioners often qualify for reduced-rate or free travel, especially on public transport.
- Pensioners may spend more on holidays, especially in early retirement, but may save money by going away at off-peak times.
In later retirement particularly, pensioners may have to spend significantly more on health-related items such as help with personal care.
Activity 1 Spending in retirement
Think about your own current spending. How might your own spending change when you reach retirement (or, if you are already retired, over the next ten years)?
Your spending could change for reasons of both necessity and choice, as you saw in the list. One thing to remember is that these are only estimates – no one can be sure of the spending they will need to undertake in retirement, because personal circumstances at the time may differ from those anticipated beforehand.
You can also use the downloadable budget grid [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip)] to start building your forecast expenditure and income in retirement. Work out your current spending first and then adjust it for life in retirement using the list above to guide you.
With your forecast of spending prepared, the next stage is to check what pension arrangements you already have in place, how much income these are expected to produce by the chosen retirement age, and whether this forecast income covers your forecast spending.
In the next section you’ll start your forecast of pension income by looking at how much state pension you expect to receive.