Retirement saving: Don't shortchange the later years

NEW YORK (CNNMoney) -- Many people think they can plan on spending less later in retirement since they'll become less active as they age. But if their health declines, they may actually shift spending rather than reduce it. Do you think it's risky to plan as if one's expenses will go down later in retirement? --Tim, U.K.

Yes, I do think it's risky but I understand why people mistakenly think it's safe.

In the 1990s, financial planner Michael Stein wrote "The Prosperous Retirement" in which he laid out three stages of post-career life: the go-go, or earliest stage, when people are most vigorous and eager to make the most of their newfound freedom from the daily grind; the slow-go phase, when people remain active but not quite as much as during their initial retirement years; and the no-go phase, when old age kicks in and people retreat to a more sedentary life.

Many people assume that their spending will drop in that final stage -- one financial planner has estimated that retirees over 75 spend about 25% less than those aged 65 to 74 -- but Stein himself says that the no-go phase is actually the most uncertain as far spending goes.

Much of that uncertainty surrounds your health. If you're lucky enough to have no major medical issues and remain relatively fit throughout retirement, your overall spending may drop once you shift to a stay-at-home lifestyle.

If you end up requiring expensive medical care or need assistance because you're physically unable to care for yourself, your outlays could rise dramatically depending on how much of your care is covered by programs like Medicare or insurance.

But medical costs aren't the only potential surprise factor. Regardless of whether your expenses go up or down, you could end up living longer than you expect, and have to fund more years in retirement than you anticipated.

A 2006 Society of Actuaries report found that only 29% of retirees and 30% of pre-retirees thought they would live longer than the average life expectancy. In reality, closer to 50% will outlive the average.

The upshot: During your career and maybe even well into retirement, it's extremely difficult to tell how much you'll spend in retirement and whether your spending will rise, drop or remain relatively constant throughout retirement.

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Given that, I think it would be unwise to count on your living costs going down late in retirement. If you rely on spending less and you're wrong, you might have to make unpleasant cutbacks in your final years in order to avoid running out of dough. That could make for an anxious, and grim, retirement.

When you're still many years from retiring, the most important thing is to make sure you're saving enough for a long retirement. And in estimating the appropriate level of savings, it's prudent to assume that you'll want to maintain your purchasing power throughout retirement -- and that you'll live several years beyond life expectancy.

A tool like T. Rowe Price's Retirement Income Calculator can help you arrive at an appropriate savings rate based on how much you've already got socked away, the age at which you plan to retire and how you invest your savings.

The calculator assumes inflation will run at 3% a year and assumes your spending will increase at that rate. If you think that assumption is too low (or too high), you can always save more (or less).

As you get within five to 10 years of calling it a career, you should have a better sense of how much you'll probably spend in retirement. To get an even clearer picture, do some "lifestyle planning" -- thinking seriously about how you'll live once you stop working full time.

Will you start traveling to visit far-flung relatives and friends? Relocate to an area that offers lower costs or a more pleasant lifestyle (or both). Pursue a hobby or avocation you've always been interested in? Do volunteer work? Maybe start a part-time business?

Put dollars and cents to these plans. Before you retire, make a budget to have a realistic sense of how much you'll need to live, and how long your savings are likely to last.

The interactive budgeting tool within Fidelity's Retirement Income Planner allows you to divvy up your spending among more than four dozen separate categories. You can earmark categories that are essential, to give you an idea of how much wiggle room you have should you need to pare your spending.

Finally, periodically revisit and update your budget, as your spending will likely deviate from projections, at least in some categories. Plug this new spending information into the Fidelity or T. Rowe Price tool to estimate your chances of outliving your money.

Based on this assessment, decide whether it makes sense to adjust your spending levels. Or you can just plan as if your spending will drop as you slow down later in retirement. And hope that if it does, it's because you don't want to spend more, not because you can't afford to.

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