Retirees with guaranteed income spend more.

David Blanchett and Michael Finke penned a June 2024 research paper for the Retirement Income Institute that shared insight into why retirees with a guaranteed income spend more. They deem guaranteed retirement income a "license to spend."

The study's results make sense from a behavioral perspective. After all, if a retiree is guaranteed a set income level every month, wouldn't they feel comfortable spending all the proceeds knowing that future income isn't dependent on changing investment prices or market cycles?

What if you didn't need to worry about outliving your nest egg? What if you knew that money deposited into your account tomorrow would also be there forty years from today? In that case, you'd most likely feel comfortable spending more freely monthly.

Indeed, cash flow certainty is the ultimate 'Snuggie' for retirees. Let's explore why those contemplating a secure retirement income should take notice of this study.

First, at RIA, we consider cash flow the 'lifeblood' of retirement.

Naturally, portfolio growth is essential to keep up with inflation over a lifetime in retirement. However, inadequate income for retirees is like a constriction of blood flow.

RIA's financial guardrail outlines how retirees who receive less than 50% of their retirement income from guaranteed sources such as Social Security, pensions and income annuities will encounter fluctuation in their portfolio withdrawal rates.

For example, the coveted 4% portfolio withdrawal rule, popular since the 1990s, shrunk to 2.4% during the recent pandemic. Imagine the conversation with your advisor when he or she informs you that your monthly income needs to be cut by 40%. This is life-altering news for retirees who depend on a baseline level of household cash flow.

With at least 50% of retirement income from guaranteed sources, retirees are more protected from fluctuating withdrawal rates. In addition, retirees are behaviorally responsive to spending more when at least half their income is derived from sources they cannot outlive. According to the study, retirees who are behaviorally resistant to spending down savings may better achieve their lifestyle goals by increasing the share of their wealth allocated to annuitized income.

Interestingly, per the paper, a retiree with similar annuitized wealth will spend more than a retiree with an equal amount of non-annuitized wealth. Economists refer to the lifestyle that retirees forfeit by giving up or failing to annuitize as the "annuity puzzle."

How do you apply the study results to your situation?

First, take the emotions out of it.

Retirement is stressful enough. After all, it's a new world. For some, the crossover is intimidating. However, the transition has become an exciting new chapter for those creating financial and lifestyle plans. And it all begins with elementary math—retirement spending analysis in the form of fixed and variable expenses.

Some pre-retirees intuitively sense their spending habits. Others resort to Excel spreadsheets and micro-budgeting, which I recommend, especially the year before retirement. From there, your fiduciary planner can help you build a framework to match future spending with the assets accumulated to generate retirement income.

Second, are you spend-down or legacy-minded?

Retirees spend years planting seeds and growing trees; now, there's fruit to pick in retirement. The problem is that they fear the tree will die once they begin picking fruit and taking sustenance from it. Granted, the tree is no longer as robust as before. However, the smaller tree continues to provide fruit for the owner's changing needs.

Psychologically, it's a mental challenge for retirees who benchmark to a specific account balance throughout their lives. They don't like the term 'spend down' as it feels scary and unstable. In other words, if I retire in 2026 with a million bucks, I expect to maintain that balance for three decades, which is unrealistic.

In addition, I'm not considering the effects of inflation and my personalized spending behavior. For example, at an average inflation rate of 3%, my million will be worth roughly $412,000 in thirty years. You see, retirees in spend down cannot benchmark to the balance they started with and need to understand rationally and unemotionally that the tree isn't dead, it's just smaller.

Retirees with legacy intentions who benchmark their assets to what they started with look to spend less and work longer. Some will employ life insurance to maintain the required legacy. Some decide to forgo insurance and curtail their lifestyles in retirement, which is not a good idea. Also, most adult children are absolutely against this idea. Independent heirs want their parents to enjoy their retirements and not stress over leaving them a tidy sum.

Clients with strong philanthropic intentions can establish charitable remainder trusts and collect tax-favored income for a lifetime, leaving the remainder to a favorite charity.

Legacy planning is another reason to consider why retirees with guaranteed income spend more.

Legacy planning requires time, attention, and a bit of art.

Either way, legacy planning requires time, attention, and a bit of art to juggle the goals of current income and future wealth for heirs. In retirement, spend down, assets for income are there until you're gone. Whatever's left goes to heirs and charities. Frankly, it's common for retirees to plan not to be a burden on loved ones and then leave what I call a remainder inheritance. And if there isn't an inheritance, that's okay with this group, too.

However, as planners, we need to 'lockbox' the funds away from spending on retirement expenses for retirees with a specific legacy intent. Thus, funds earmarked initially for retirement are no longer available for spending. Consequently, the assets that would have been spent in retirement are safeguarded and removed from generating income. In these cases, something's got to give. The retiree considers a more modest lifestyle, or looks to life insurance and annuities to ensure that spending, especially in the more active years in retirement, may continue. Retirees who receive guaranteed income spend more since they can leave a significant portion of their investment portfolios to family or charity. Don't be afraid of annuities if they're needed.

Third, underspending is common.

When markets are volatile, variable portfolios such as bonds and stocks can distress retirees in income mode. In my experience, clients look to increase portfolio withdrawal rates during active retirement years. However, if markets are not cooperating, retirees will underspend and deprive themselves of experiences. In some cases, retirees wait so long that their active years go by, and they can no longer fulfill their lifestyle goals, like travel.

Retirees with guaranteed income spend more because many feel uncomfortable spending down their assets. As the study ascertained, annuities are a psychological license to spend their retirement savings. Surveys reveal a clear preference among retirees to live off their income. They hesitate to do so when it requires distributing cash flow from investment portfolios.

Back to the study.

In fact, the authors' analysis outlines that retirees spend twice as much each year in retirement if they hold guaranteed income wealth instead of investment wealth! Thus, every dollar of assets converted to guaranteed income could result in twice the equivalent spending compared to money in an investment portfolio.

Fourth, establish spending guardrails.

One way we attempt to alleviate the underspending issue is to create retirement spending guardrails. At RIA, we establish a middle lane of retirement spending based on a client's total income, which includes Social Security. The middle lane spending number outlines how much a client can spend monthly. We create right lane (a spending reduction) and left lane (a spending increase) guardrails that trigger depending on changing portfolio balances over time. Last, we stress test these guardrails through turbulent historical events like the Great Depression.

Fifth, longevity risk is a significant risk.

Based on my experience, clients have an uncanny ability to predict when they will die, but they don't honestly know! If you live longer than mortality tables dictate, plan to ensure that your retirement assets last longer than you do.

In the 1920s, the average life expectancy was less than 60 years. Today, it's 77 years old. In 2060, it's estimated to be 85 years. Americans are living longer, and breakthroughs in health AI will assist in the process. Thus, preparing for longevity risk must be included in financial plans. A financial plan can expose the impact of longevity on income sustainability. From there, a fiduciary financial planner can provide solutions such as guaranteed income enhancements and long-term care coverage.

At RIA, we instruct clients to complete the livingto100.com calculator. The Living to 100 Life Expectancy Calculator, developed by Dr. Thomas Perls, employs medical, scientific, and lifestyle data to estimate one's life expectancy. We use that age to create realistic plans. After all, not everyone will live to 100.

Finally, it makes intuitive sense that retirees with guaranteed income spend more. A guarantee minimizes under-spending and provides a sense of emotional relief at a time when retirees feel most vulnerable. However, multiple guarantees are not necessary for everyone. Many retirees can get along successfully with Social Security and investment portfolios, especially with modest goals.

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