New research from industry experts analyzes how behavior influences spending patterns and fuels underconsumption in retirement.
The findings, posted in the CFP Board’s Financial Planning Review journal and co-authored by experts David Blanchett and Michael Finke, use data to understand how defined contribution (DC) plan participants and retirees spend lifetime income, wage income, capital income, qualified savings, and nonqualified savings to fund retirement spending.
It found that 80% of lifetime income is spent on average by retirees compared to approximately half of other available savings and income sources. Further, the research reports that an average 65-year-old couple will have a withdrawal savings rate of 2.1% while a single person household will withdraw at a rate of 1.9%—significantly lower than the popular 4% rule. This highlights how framing language, or the word “income” in this case, could impact retirement spending for participants and retirees.
Blanchett and Finke touched on how a lack of financial knowledge, coupled with longevity uncertainty and the overwhelming number or complexity of retirement assets, could prompt retirees to spend less of their savings. This action could spur unfulfillment or dissatisfaction in retirement and could unintentionally leave a larger legacy to inheritors, the researchers said.
They also observed how the shift from defined benefit (DB) to DC plan administration has powered changes in behavior. Not only are DC participants responsible for funding their own retirement, but they must also understand their longevity risk and the appropriate amount they should spend annually.
All these uncertainties thus lead individuals to underspend throughout retirement, they remarked.
“Estimating how much income can be withdrawn from investments in retirement, particularly when paired with limited financial knowledge, an unknown lifespan, and an array of available financial resources to consider including Social Security, pension, wages, and investment assets inside and outside of retirement accounts, is far more complex than the consumption decision of younger households who rely primarily on wages,” Blanchett and Finke wrote. “This complexity may lead retirees to spend less than life cycle theory would predict, resulting in reduced well-being and higher unintended bequests.”
While the researchers noted that retirees should spend less from non-annuitized assets due to the likelihood of living longer, they commented that individuals “appear to spend significantly less from non-annuitized savings than economic theory would predict,” due to “aversion to uncertainty and complexity and the tendency to view a withdrawal from savings as a loss.”
Using their model, Blanchett and Finke estimate that consumption could grow by 80% for retirees if assets were converted to lifetime income streams.
Savings could also be reframed as income when transferring assets in retirement accounts to liquid taxable accounts through required minimum distributions (RMDs), an action that researchers say supports spending. Blanchett and Finke commented that retirees were likelier to increase their rate of spending from qualified investments after government intervention requires them to apply a distribution.
In such cases, government policies that either incentivize or annuitize retirement assets could support spending and consumption, Blanchett and Finke conclude.
“A comparison of spending from qualified and non-qualified accounts shows that exogenous RMD rules unrelated to uncertainty related to longevity and asset returns appears to cause retirees to frame distributions as income resulting in increased consumption,” the researchers wrote. “This suggests that policy can significantly raise rates of spending among retirees resulting in increased welfare and higher aggregate consumption among older Americans.”
Additional findings from the research can be found here.
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