Spending and saving habits in the US: lessons for the UK

id

Emergency savings, spending behaviours during retirement, why some really retirees return to work, and how retirement products can cater for the “100-year life”.

How people save and spend money is changing, due to recent financial turbulences, new technologies, social changes and increased longevity.

It’s vital that employers, and pension providers, understand these changes to ensure the support they provide is as effective as possible.

To apply an international lens to these issues, we spoke to an international expert on pensions and retirement, David John, a senior strategic policy advisor at the AARP Public Policy Institute in the US.

Below is a summary of John’s thoughts on the range of topics discussed. (You can watch the full video here.)

 

Emergency savings – how much is enough?

In the US, emergency savings accounts are growing as an employer-based benefit. In one AARP poll, 70% of people said it was something they wanted. 

And it’s been found that if people use emergency savings, it’s likely to stabilise their household finances for up to four years. 

What works especially well for emergency savings is payroll deduction – for example, 3% from a person’s salary each month.

But the nature of this payroll deduction is crucial. If people have to set up a bank account or some other way of starting the process, they often never get around to doing it. 

But with an automatic enrolment mechanism, into a separate emergency savings account, participation increases by around 50 percentage points. It also increases the amount of emergency savings people have. 

The way emergency savings are “framed” also matters. A general rule of thumb accepted by financial advisers is that you need roughly three months of emergency savings. But what they're doing is conflating two separate risks.

One risk is what happens if, for example, your car engine needs sudden repair. The other risk is what happens if you lose your job. 

If you lose your job, you may need the three months savings. But for other types of unexpected expenses, having as little as about one month's earnings is usually enough.

In fact, when it was suggested to people that they try to save three months’ worth of salary for emergencies, a lot of them threw up their hands and said, “Well, I can never do that – so I'm not even going to try.” 

 

Spending less (and less) in retirement 

There’s understandably a lot of talk about how much money people need to save for their retirement. But there’s perhaps less discussion about how much people actually spend in retirement, and when.

The Rand Corporation (a nonprofit global policy think tank) researched spending behaviours during retirement, and found two key trends. 

1. Many people in the first year of retirement spend as much or even more than they did before retiring, because they're rewarding themselves for their years of work. 

2. As time goes by, people in retirement spend less. This decline is somewhere between 1.5% and 2% a year, year-over-year. And it’s true across all income groups, ethnic groups, and genders.

Part of this second trend is due to changed circumstances or health issues. For example, more expensive tourism costs could affect a person’s travel plans as they move through retirement. But another factor is that people just don't enjoy as much the experiences they previously spent their money on. In particular, this is seen in things like car trips and eating out. 

So an individual who retires in the US at age 65 will spend about half as much as they did when they reach age 85. That said, the desire to make gifts, donations and contributions to charitable groups starts to increase in these later years. 

Because most Americans don’t receive guidance on how to use their retirement savings, many retirees underspend. One major reason is that they fear facing some severe financial costs – often health-related – later in life, and if they spend a lot of their savings, they won’t have enough to meet that expense.

And even among those who do spend a fair amount, but also continue to invest some of their retirement savings – which is a lot of them – many may actually die with more money than they retired with.

 

Back to work 

Recently there’s been an uptick in retirees who are returning to work. So AARP surveyed retirees to find out their reasons for doing so. Insufficient income was expected to be the principal reason, but this was only the case for about half of people. 

The other half returned to work for social and psychological reasons. Their social network was connected with work, they got bored, and they needed a sense of purpose. 

The retirement industry tends to consider retirement as a financial decision. But it's just as much a psychological decision. Ultimately, retirement is a foreign country and you really don't understand it until you get there.

 

The 100-year life 

In the US, in most jobs you don't have a forced retirement age. But many employers are becoming more considerate of the potentially long duration of jobs, changing cognitive ability, workers’ financial wellbeing, and ensuring that people can have a phased retirement, if they want one.

It’s also increasingly appreciated that one aspect of the 100-year life, for many people, is that making complex decisions about their future income needs will be easier when they still have more flexibility. And this is when retirement begins. 

A mixture of products are being developed in response to these trends. One popular new product combines retirement investment with the gradual purchase of an annuity, starting at roughly age 45. This reduces interest rate risk for the saver. And they can decide at retirement whether to actually buy the annuity or decline it with no penalty. 

Another development is the deferred income annuity, which you might buy at age 65, but would start to pay income around age 80 or 85. This product is less expensive than some others and gives a person two things, if they have a 100-year life.

1. They know for how long they need to manage their savings – or use other types of products that do so. 

2. They don't have the worry that they're going to run out of money at a very advanced age. This removes one of the larger worries for the retiree and their family. 

Deferred annuities are starting to be folded into the different combinations of retirement income strategies. One option uses a managed payout fund, where investments are professionally managed, and the retiree receives a monthly cheque that can vary from year to year, depending on how the portfolio performs. In one product type, if a retiree’s assets run out, they would continue to receive the same amount of income – or close to it – for life.

New ways to use retirement savings for secure income are developing all the time. And it’s a challenging time for both employers and their workers, both of whom need to figure out what products, or combination of them, best meet their needs. 

 

Next steps

For further discussion on what the UK can learn from other countries' pensions systems:

• Watch our video on Saving habits: what can we learn from the US?
• Or listen to our podcast on What the Australian pensions system tells us about future reform in the UK
• Or read our article on New Zealand’s KiwiSaver: a template for auto-enrolment reform in the UK?