How does the "Age-Based" income path work?

The Income Path setting includes the default Age-Based option. This option implements the concept that is sometimes called the "Retirement Smile" or the "go-go, slow-go, no-go" periods of retirement spending. This pattern helps plan for:

• Higher (and even rising) income early in retirement
• Decreasing real spending through the middle of retirement
• A rise in real spending late in retirement (for some plans)

This pattern takes the form of a wave when viewed in today's dollars (real dollars):

However, when viewed in future dollars (nominal dollars), which are the only dollars any person ever uses in the real world, the curve typically does not decline - it merely rises at a rate lower than inflation for a significant portion of the plan.

The increases and decreases in real income modeled through the Age-Based Income Path option are based on a wide range of research in actual retirement spending patterns. Perhaps the deepest and most mathematically explicit account of this pattern, which we use as the basis for the Age-Based path in the Income Lab app, can be found in Blanchett (2013), Estimating the True Cost of Retirement (Morningstar): 

 

The equation that produces the "Retirement Smile" shape for any given plan is:

Where Age is the age of the client (or the combined average age for joint plans) and ExpTar is an independent expenditure target. You can think of this as a stand-in for 'standard of living'. This second variable means households with different overall plans and resources (standards of living) will have different age-based spending curves, even if they are the same age.

The reason that the expected/target standard of living matters is that higher resource/income households tend to have larger changes in income over time. That's because if a household has higher income and spending, more of this tends to be discretionary, and so that discretionary spending can change quite a bit with age. Conversely, if a household has very low spending, most of it will be non-discretionary and therefore will not change (much) as the clients age.

To produce a target spending level (ExpTar) in Income Lab, the software looks at the resources that are included for the entire plan (including preretirement) and figures out how much the household could spend with a flat income path starting today. This means that those with more resources, including higher incomes in preretirement, will have higher target incomes (they will be more accustomed to higher spending levels) and therefore different age-based income paths than those with lower overall resources. If your plan includes a preretirement period and you are using the age-based path, you will want to include preretirement income to get a better estimate of that household's age-based path. Because of the way Income Lab calculates ExpTar, adding resources to the plan, including in preretirement, will affect the Income Path and Spending Capacity/Retirement Paycheck.

If you would like to avoid any complexities caused by these calculations when comparing two plans, you may want to use the Custom income path option, which does not take Age or expected target income (ExpTar) into account.