Wade Pfau, Ph.D., CFA

What Is Age Banding And What Does It Mean For Retirees?

Another important contribution in the area of retirement spending patterns is Somnath Basu’s 2005 article “Age Banding: A Model for Planning Retirement Needs.” Though it provided a comprehensive retirement planning framework, I want to focus specifically on the findings that covered post-retirement spending patterns.

For simplicity’s sake, Basu divided a thirty-year retirement into three ten-year intervals. Rather than assuming a constant rate of inflation for expenses during retirement, he divided spending into four general categories: taxes, basic needs, health care, and leisure.

Within these categories, he investigated the spending patterns by age and made allowances for differential inflation rates between these categories. For instance, he noted that retirees spend more on leisure in the early part of retirement and more on health in the later part of retirement.

Exhibit 1 details how the approach works in four spending categories and three time segments (65-74, 75-84, 85-94). The numbers are not calibrated closely to data, but are illustrative for a typical retiree.

Exhibit 1: An Age Banding Illustration

  Inflation Rate Lifestyle Adjustment Factor at Age 65 Lifestyle Adjustment Factor at Age 75 Lifestyle Adjustment Factor at Age 85
Taxes 3% 0.5 1 1
Basic Living 3% 0.7 0.8 0.9
Health Care 7% 1.15 1.2 1.25
Leisure 7% 1.5 0.5 0.25
Source: Adapted from the stylized example in Somnath Basu’s “Age Banding: A Model for Planning Retirement Needs”

The inflation rate for taxes is 3%. At age 65, the lifestyle adjustment factor for taxes is an assumed drop to 50% of their pre-retirement level, as payroll taxes are no longer paid. The lifestyle adjustment factors are progressive—a value of 1 at age 75 means tax amounts will not change relative to real values at age 65, but may only grow with inflation. The same is the case for taxes at 85. Overall, taxes drop by 50% at retirement but then stay at this same inflation-adjusted level.

Basic Living Expenses

Basic living expenses—always adjusted for 3% annual inflation—are assumed to fall by 30% at retirement, then another 20% at age 75, and another 10% at age 85. Thus, by 85, real spending on basic expenses has fallen to about 50.4% of its pre-retirement level (0.7 x 0.8 x 0.9 = 0.504).

Health Care

Health care has an inflation rate of 7% instead of 3%. Health care expenses also increase with age, adjusting upward by 15% at 65, 20% at 75, and another 25% at 85. By 85, real health expenses are assumed to be 3.7 times larger than their pre-retirement value (1.15 x 1.2 x 1.25 x 1.07^20 / 1.03^20 = 3.7), assuming a somewhat simplified overall inflation rate of 3%.


Like health care, leisure carries an inflation rate of 7%. It increases by 50% at retirement as retirees set out to enjoy their new freedoms, then drops by 50% at 75 and another 75% at age 85. By 85, even with the higher inflation rate, leisure spending is only 40% of its pre-retirement level in terms of the overall price index (1.5 x 0.5 x 0.25 x 1.07^20 / 1.03^20 = 0.4).

By capturing both the differential inflation rates and the changing dynamics by age, age banding provides a useful tool for planning long-term client budgets. With this approach, however, it is not obvious that retirement spending will decline with age. It may, but rapid growth in health care expenses could potentially lead to an overall increase in spending needs at the highest ages.

Next, read How Long Can Retirees Expect to Live Once They Hit 65.

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