Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How to Avoid the Retirement Spending Smile Trap
Transcript
- Lucas: Luna, I want to talk about something that sounds like a marketing gimmick but is actually a well-documented behavioral finance pattern — the 'retirement spending smile.' Luna: I've heard the term. It's the idea that spending in retirement isn't flat, it's U-shaped — higher at the start, lower in the middle, then higher again near the end. Lucas: Exactly. And if you're planning for early retirement — say you leave your job at 45 — you're looking at a potential 40 or 50 year horizon. The shape of that spending curve matters way more than most people realize. Luna: And it's not just a theoretical thing. The Employee Benefit Research Institute actually tracked this with real retiree data. Lucas: Right. EBRI's spending study followed households from age 65 onward and found that median spending dropped about 4.5 percent in the first five years. Then it stayed flat or declined slightly until about age 75, after which it started climbing again — about 2.5 percent per year — driven mostly by healthcare and long-term care costs. Luna: So the classic 4 percent rule — withdraw 4 percent of your portfolio adjusted for inflation — assumes you spend roughly the same amount each year in real terms. Lucas: Which is a terrible fit for that U-shaped reality. If you're spending more early, then less, then more again, a constant withdrawal rate either leaves you with too much money in the middle or too little at the end. Luna: And if this is your angle for today, I can already see where it hits early retirees especially hard. If you leave your job at 40 or 45, your 'early retirement' bucket might be a lot longer than a traditional retiree's. Lucas: That's the whole episode. But before we dive into the mechanics, I want to mention something about this show itself. You and I have been doing these conversations for a while now, and one of the principles we've held to is keeping the episodes ad-free. Luna: Yeah, no prerolls, no midrolls, no 'this episode is brought to you by' anything. Just the topic. Lucas: And that's a deliberate choice. It means the only way the show sustains itself is if listeners who find value in it decide to support it directly. If that's you, the link is buy me a coffee dot com slash fexingo. Low key, no pressure, just an option if the conversations here have helped you think about your own plan differently. Luna: It's a good way to keep the focus where we want it. Now back to that spending smile — because the shape of that curve actually changes what the safe withdrawal rate is for an early retiree. Lucas: Exactly. So let's put some numbers to this. Say you're 45, you have a million dollars, and you plan to withdraw 4 percent — $40,000 a year — adjusted for inflation. But in real life, you might spend $50,000 in the first few years because you want to travel, pick up hobbies, maybe renovate the house. Luna: Then by year 5 or 6, you've settled into a routine. You're spending less — maybe $35,000. The portfolio is still there, but you've been withdrawing at a higher rate early on. Lucas: And that's exactly when sequence of returns risk is most dangerous. If the market has a bad year right when you're drawing down that extra money, you're locking in losses. The classic study by Bengen — the guy who proposed the 4 percent rule — assumed constant spending. Variable spending changes the math completely. Luna: So what's the fix? Do you just budget for the U-shape explicitly? Lucas: That's one approach. Some planners recommend building a 'spending bucket' for the early high-spend years — maybe 5 years of expenses in cash or short-term bonds — so you're not forced to sell stocks in a downturn. Then after that, your portfolio can be more equity-heavy for the long haul. Luna: That's essentially a bond tent, but tailored to the spending shape rather than just sequence risk. Lucas: Right. And there's research by Michael Kitces and others showing that a rising equity glidepath — starting with a higher bond allocation in early retirement and gradually shifting to more stocks — works better than a static portfolio when spending varies. Luna: Because you're protecting the portfolio in the early vulnerable years, then letting growth catch up later. Lucas: Exactly. Kitces modeled a portfolio that starts at 70 percent bonds, 30 percent stocks in early retirement, then gradually moves to 30 percent bonds, 70 percent stocks over 15 years. That approach actually had a higher success rate than a static 60-40 portfolio, even though the average equity exposure was lower. Luna: That's counterintuitive. Lower average stock exposure, better success rate. Lucas: Because the critical period is the first 5 to 10 years. If you avoid a big loss then, the portfolio has time to compound later. The spending smile amplifies that — because you're spending more in those early years, the damage of a bad market is even worse. Luna: So the early retiree who spends $50,000 in year one instead of $40,000 is essentially increasing their withdrawal rate from 4 percent to 5 percent in that year. And if the market drops 20 percent that same year, the math gets ugly fast. Lucas: That's the double hit. And the EBRI data shows that for many retirees, the spending smile is actually deeper than the average suggests. High-income retirees — which includes many early retirees who were high earners — tend to have a more pronounced U-shape. They spend more in the go-go years of early retirement. Luna: And then the later uptick — the healthcare costs — those are largely unavoidable. The Fidelity Retiree Health Care Cost Estimate puts the average 65-year-old couple needing about $300,000 for medical expenses in retirement, not counting long-term care. Lucas: And for an early retiree who leaves a job at 45, you have to cover health insurance out of pocket until Medicare kicks in at 65. That's 20 years of premiums, deductibles, and co-pays. The Affordable Care Act exchanges help, but subsidies are income-based, so if you're living off your portfolio and managing your withdrawals, there's a whole planning layer there. Luna: Which brings us back to the spending smile. If you model just a constant 4 percent withdrawal, you might miss that your spending in years 5 through 15 is actually lower, but in years 20 through 40 it climbs again. Lucas: And if you're using a 4 percent rule that assumes constant real spending, you might think you're fine but actually be over-withdrawing early or under-withdrawing later. The fix is to build a more realistic spending forecast — one that matches the U-shape — and then stress-test it with historical sequences. Luna: And there are tools for that now. Some of the better retirement calculators let you input variable spending by phase. Lucas: Big ERN's spreadsheet is one. Michael Kitces has a good framework too. But the key takeaway is simple: if you're planning an early retirement, don't assume your spending will be flat. Assume it will be higher at the beginning — maybe 10 to 20 percent higher than your planned withdrawal — and higher again at the end for healthcare. Luna: And that middle period — the low-spend years — that's actually your opportunity to let the portfolio recover and grow. Lucas: Exactly. If you can keep your spending flexible during those early high-spend years — maybe pick up a side gig or cut back on travel if the market tanks — you dramatically improve your odds. The spending smile is a pattern, not a prison. You can plan around it. Luna: So the bottom line: know your own U-shape, build a bond tent or a spending bucket for the early years, and don't let a bad sequence of returns compound with high spending. Lucas: And if you want to model this yourself, try setting up a scenario with 5 percent withdrawals for the first 5 years, 3.5 percent for years 6 through 20, and 4.5 percent from year 20 onward. See how that compares to a constant 4 percent in a tool like cFIREsim. The difference can be striking. Luna: I like that. It's concrete and testable. And that's really the spirit of this show — giving you something you can actually apply. Lucas: Exactly. Thanks for the conversation, Luna. Luna: Thanks, Lucas. Talk next time.