Research shows that providing clients with guaranteed income can encourage them to spend their nest eggs more freely.Creativeye99/iStockPhoto / Getty Images
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Investors often save for decades to accumulate a retirement nest egg. But once they retire, many resist spending, unnecessarily curtailing their retirement lifestyle, according to recent research.
Fortunately, there are ways to help retirees loosen their purse strings appropriately.
In 2021, David Blanchett, managing director, portfolio manager and head of retirement research for PGIM DC Solutions in Lexington, Ky., and Michael Finke, professor of wealth management and Frank M. Engle Distinguished Chair in Economic Security at The American College of Financial Services in Philadelphia, analyzed data from the U.S. Health and Retirement Study to examine the relationship between what investors hold in their portfolios and their spending in retirement.
They found retirees consistently spend approximately 75 per cent of what they could afford to based on available assets, with underspending increasing as retirees get older. Yet, they also found that after controlling for different levels of wealth, retirees with a larger proportion of guaranteed income spent more each year than retirees with a larger proportion of investments.
The researchers concluded that “[r]etirees will spend twice as much each year in retirement if they shift investment assets into guaranteed income wealth.”
“I had expected some difference in spending, but it was larger than we’d anticipated,” Mr. Finke says. “There is a rational reason why people who have guaranteed income spend more, and that’s because you bear this risk of not knowing how long you’re going to live. … But there’s also a behavioural factor that people just feel more comfortable spending money out of a paycheque than they do spending it out of savings.”
For example, Mr. Finke says, a 65-year-old woman could be expected to spend more if she can depend on a pension paying her a guaranteed $21,000 a year for life than she would if she had an additional $300,000 in retirement savings.
Holding onto more savings than necessary makes sense if retirees want to leave a big legacy to their heirs. But Mr. Finke says that isn’t the top priority for most retirees he speaks with. Instead, underspending is often driven by a fear of outliving savings and a habit of avoiding spending capital.
“The problem today is that people retire with this lump sum, and they don’t always have a clear notion of what they’re going to do with it,” Mr. Blanchett adds. “Virtually every retiree should have all of their essential expenses covered with a lifetime [guaranteed] income. … If we create expectations before you retire and when you retire that, no matter what happens, you’re going to have all of your essential expenses covered for life, it can change the way people view spending.”
Jonathan Rivard, financial adviser with Edward Jones in Toronto, says it’s “very typical” for retirees with resources to spend less than they can afford. He attributes this to three factors: their values around money, fear of the unknown and reprioritization as people age and are less interested in materialism.
He agrees that portfolio composition makes a difference in the degree of underspending that occurs. Specifically, Mr. Rivard has found that annuities can give retirees confidence to spend because they know with certainty the income stream will keep flowing.
“There are ways of creating an income stream off of an equity product, but the value of an annuity … is the guarantee that an annuity provides in terms of steady cash flow. That guarantee can’t be provided from an equity product, including a dividend, because those are not guaranteed,” Mr. Rivard says.
Susan Latremoille, partner with Next Chapter Lifestyle Advisors in Toronto, notes that underspending in retirement is a “major problem.” She describes the mindset shift at retirement as a “psychological about-face” when the paycheques from work or a business stop flowing in.
“The goose that laid the golden egg is gone,” she says. “They get into this fear factor that prevents them from enjoying the wealth they’ve worked so hard to create.”
Ms. Latremoille, a former adviser, focuses on lifestyle planning that shifts the emphasis from the pot of money clients have accumulated to what they want to spend their money on. The lifestyle plan informs a financial plan, which in turn drives the need for specific financial products. She says planning toward a time horizon of 100 years of age can give clients confidence.
A separate fund of “freedom money” that can be spent on a whim can help, she says. Money deposited monthly into a bank account to mimic a paycheque can work well, too. Even better is to combine strategies like these with open conversations involving family members.
Ms. Latremoille recalls facilitating a family meeting with a client in his early 80s and his two children. The client had always aspired to own a Bentley but hadn’t allowed himself to buy one. The children reassured him they were financially independent and didn’t need him to save money for them. In the end, with their encouragement, he got his dream car.
“Underspending is rampant with a lot of wealthy people, and nothing works in my mind like the good financial plan that, even with all the ‘what if’ scenarios built in, projects the wealth out to life expectancy,” she says. “That’s what gives people more psychological permission to enjoy their wealth.”