If you rely on one of the many online retirement planning tools to figure out how much money you'll need to live comfortably in retirement, you are probably overestimating what it will take by as much as 20 percent, says David Blanchett, head of retirement research for Morningstar Investment Management.
Blanchett came to his conclusions after reviewing "replacement rate" models utilized by these calculators. Blanchett says the calculators, which usually conclude that you'll need 70 percent to 80 percent of pre-retirement income, rely on the same basic spending assumptions for everyone. But not every retiree will spend money in the same way or on the same things. Also, the calculators don't take into account how life changes over time.
He thinks these calculators do a particularly bad job predicting 20 or 30 years of spending in retirement on health care. He also questions whether they accurately reflect how inflation affects retirement budgets.
"The spending on health care does rise," Blanchett says. "But if you spend more on health care, you spend a lot less on other things. If you're spending more on going to the doctor, you're spending a lot less on cruises."
He also believes inflation doesn't take as big a bite out of most retirement budgets as calculators predict, because over the course of the lifespans of both a husband and wife, spending drops -- and then drops some more. He finds that budgeting an average annual 1 percent increase for inflation is sufficient for many couples -- at least, over the long haul -- because of the slowdown in spending as both age and one dies.
Blanchett warns against using his theory as an excuse to save less and spend more without understanding your individual situation. He suggests that a couple preparing a retirement budget look hard and as realistically as they can at what factors in their lives will likely change over time. He also recommends front-loading the budget. "It is probably OK to plan to live better when you are younger," he says. "There is a risk that if you don't spend it at 65, you won't get a chance to spend it."
Most advice about spending money in retirement emphasizes "saving, saving saving," he says. "But recognizing when, where and how to spend money is also an essential component of a well-planned retirement."