Even if you’re nowhere near retirement age, chances are you’ve been — or have recently begun — preparing for the eventuality of leaving a working lifestyle behind. A lot goes into retirement planning, and knowing where to start or how to make sure everything goes as planned can be daunting. That’s where the concept of “age banding” comes into play. This easy-to-understand model can help you plan ahead for your retirement, and ensure you have plenty of money when you need it most. Whether you’re looking to start preparing for retirement, or have already begun that exciting new stage, consider this your guide to how age banding can help you prepare smarter.
Understanding age banding
Before you can fully understand how age banding benefits you, it’s important to first know what exactly this model is and what it means. Financial planner Ben Harvey, writing for Investopedia, defines age banding as the idea that annual spending levels will vary throughout a person’s retirement years. In other words, the amount a retiree might be spending at 65 will differ from what they spend at 75, 85, and so on. Many financial advisors warn people planning for retirement that a “replacement ratio” may be needed to ensure you have more money later into retirement, and the age banding model is an extension of this idea.
The model divides a person’s retirement into three distinct stages based on relative age and spending. The first stage is commonly referred to as the “go-go years,” during which time retirees are often healthy, active, and spending more funds on things like traveling than they are on health care. After that comes the second stage, called the “slow-go years,” and sees the retiree slowing down with recreational activities as they age. During this stage, the amount of money being spent on fun things and on health care tend to even out a bit more. The final stage is called the “no-go years,” and sees the balance fully tip in favor of health care spending. When this data is put into a graph, the result is a curve in which spending goes up in stage one, falls in stage two, and rises again in stage three.
Use this model to your advantage
With the age banding model now defined, the next big question to answer is how it can help you prepare for retirement. While age banding will affect everyone’s retirement spending projections a bit differently, there’s plenty you can do using this model to make your planning go smoother. First, understand the amount of money you are likely to spend in each stage. This may be hard to predict exactly, but having an understanding of the averages is a great help in understanding what your future may hold. There are many expenditures to keep in mind, including leisure activities, possible emergencies, and taxes. Wade Pfau at Forbes suggests that, thanks to a 3-percent tax inflation rate, “at age 65, the lifestyle adjustment factor for taxes is an assumed drop to 50% of their pre-retirement level.” By taking these expenditures into account early on, you’ll be better prepared for how each stage effects your life and finances.
It’s also important to monitor these expenses during your retirement years, and not just before. Financial writer and planner Michael Kitces states keeping track of spending during each retirement stage as its happening is a great way to combat spending decreases and changing inflation rates. He also recommends projecting your needs based on a gradual decline in spending, allowing you to better prepare for possible unforeseen shifts.
Now that you understand age banding and how it can help you plan smarter for your retirement, you’re better equipped to prepare for entering the next, exciting stage of your life, no matter how far away it might be.