As the traditional retirement option, an annuity provides a stable and regular lifetime income. You’ll know exactly how much you are due to receive each month, and aside from a potential rise in line with inflation, the amount will stay the same throughout your retirement. This regular income makes budgeting simple in many ways. But will your outgoings remain this regular and static throughout retirement?

The answer is likely to be “no”

This is why combining a traditional annuity – or the stable income of the State Pension – alongside a flexible option is often a good choice

Your expenditure will change throughout your retirement, possibly following the so-called “retirement smile,” a concept introduced by financial planning expert David Blanchett in 2014

What is the retirement smile, and why does it matter to your finances?

Many people struggle to estimate how much they will spend in retirement. A common rule of thumb suggests you will spend about 80% of your pre-tax retirement income. However, research shows that spending is not consistent throughout retirement. It also shows that spending lifestyle choices, affluence, and health directly impact spending

Conventional thinking assumes retiree expenditures, or consumption, increase annually with inflation during retirement. The retirement smile argues otherwise. It suggests higher spending as retirement starts, a drop in spending when you settle down, and an increase as healthcare-related expenses rise

NMTBP walks through the different stages of retirement so you can better understand the connection between your retirement spending and where the term retirement smile comes from

Everyone has a different retirement path, so you should create a financial plan based on your situation. Broadly speaking, your retirement has three phases. For most, these are as follows:

• The Early Years: Anticipation and Adventure (Ages 60-70)
• The Dip: Settling Down (Ages 70-80)
• The Rise: Healthcare Considerations (Ages 80+)

The Center for Retirement Research at Boston College explored consumption rates during retirement. It found that inflation-adjusted (actual) spending by retirees fell by 1.5% -1.6 % every two years throughout retirement. This means that 20 years into retirement, consumption could be 12%- 13% lower than at the beginning of retirement. Not surprisingly, it was also discovered that health and wealth were two factors impacting how much retirees decreased spending later in retirement

While consumption tends to decline initially, it often increases at later ages, mainly due to increased healthcare expenses. Income level also has an impact. Those with higher expenditure levels tend to experience higher declines. (This can likely be attributed to higher discretionary spending levels)

Phase 1 of the Retirement Smile: The Early Years

Sometimes referred to as the go-go years, the retirement smile’s first phase typically begins as you enter retirement. During this period, you’re healthy and eager to do everything you’ve been waiting to do

After working for many years and saving hard toward your pension, you might be retiring with big plans

These early years of your retirement are often considered the “active” years. Free from the shackles of work and hopefully in good health, you might use the first few years of retirement to undertake large-scale projects

You might use a portion of your pension lump sum to renovate your house, or you might have spent the last few years of work planning for a world trip

For these reasons, the active years of retirement can be expensive

Phase 2 of the Retirement Smile: The Dip

The second phase of retirement spending is also called the slow-go years. You have done many of the things you always dreamed about. Your bucket list has probably gotten shorter. You might have less energy, too. This causes you to spend less. Leisure still represents a big part of life, but spending may decrease during this period

As retirees settle into their new lifestyle, their spending tends to dip. The initial excitement of retirement may subside, leading to a more stable and predictable financial routine. During this phase, individuals often find contentment in the familiarity of their chosen activities, leading to a temporary decrease in discretionary spending

Phase 3 of the Retirement Smile: The Rise

Not surprisingly, some call retirement’s third phase the no-go phase. You rarely travel. You consume less. While you still enjoy leisure and time with loved ones, healthcare expenses significantly affect household spending

With life expectancies rising, your retirement could last for 30, even 40 years. It makes sense that your expenditure will be different over such a long period and that your needs will change

As you head into the later years of your retirement, you might find that you begin to need domiciliary care. This might be followed by full-time care in a nursing or residential home

A recent report confirmed that 27% of over-60s don’t know how they will pay for care, while 18% admit they haven’t planned that far ahead.

If you do need care, though, your expenditure in later life could rise rapidly, completing the retirement smile.

Understanding the Retirement Smile

The retirement smile can have implications for your financial life. You want to consider it when preparing your financial plan. It impacts your investment strategy as well. Your financial plan must also exhibit both flexibility and adaptability

Financial Planning Implications

Recognising the retirement smile stages is crucial in effective financial planning. During the early years, retirees may need to allocate additional funds for travel, leisure, and new experiences. As the dip phase approaches, budgeting grows increasingly important as you want to ensure financial stability during the transition to a more settled lifestyle. In the rising phase, having a robust healthcare plan and addressing potential long-term care needs become paramount

Investment Strategy

Tailoring your investment strategy to accommodate the retirement smile is essential. Throughout retirement, you don’t want to have a too conservative portfolio. Not having enough money leads the way when thinking about the risks you can face in retirement. Beyond that, consider the sequence of returns risk and longevity risk

The sequence of returns risk refers to the risk of negative returns occurring late in your working years and early in retirement. Longevity risk refers to the risk that you outlive your money. Either can result in significant financial setbacks.

Many suggest simply lowering your allocation to stocks as you age. (For example, subtract your age from 100 or 110 to determine what percentage of your portfolio to allocate to stocks.) But a better option could involve building a bond position as retirement approaches and then spending down that bond reserve in the early retirement years. This approach allows equity exposure to return to normal

Flexibility and Adaptability

The retirement smile underscores the importance of flexibility in your financial plan. Life is unpredictable, and unexpected expenses may arise. While you may have good intentions when you plan, everything won’t go exactly as expected. Having the flexibility to adjust your budget, revisit investment strategies, and adapt to changing circumstances is crucial for maintaining financial security throughout retirement

Understanding the retirement smile offers valuable insights into the dynamic nature of financial needs during different stages of retirement. By acknowledging the anticipated shifts in spending patterns, you can proactively plan for a comfortable and fulfilling retirement. Whether you’re savouring the adventures of early retirement, enjoying the settled routine of the dip, or addressing healthcare needs in the rising phase, strategic financial planning can help you navigate the retirement smile with confidence and peace of mind

Remember the importance of being tax-aware, too. Deciding when to start spending retirement savings strategically and choosing where to take the funds from can help you lower your lifetime tax burden and avoid complications later in life

Constant inflation-adjusted spending represents a simplifying and conservative assumption. Conservative assumptions are often preferred to aggressive ones. But you don’t want to penalise yourself unduly. Keeping the retirement spending smile in mind when working on your financial plan can help address this issue