Life After Full-time Work Blog

… but we seem to appreciate it more

Let me start by giving you some quick conclusions from studies on retirement spending and satisfaction. Then I’ll explain where those findings come from. Do the relevant studies constitute good scientific, or at least economic, proof? No, but it all seems very reasonable. That’s why I’m writing this.

I’ll explain the conclusions, the evidence on which they’re based, and why I think it all seems very reasonable.

The first conclusion: retirement spending drops in retirement. I’m not sure which of two things this means (and quite possibly it means both). It could simply reflect that typically a number of long-term outgoings stop around then, or continue at a reduced level. For example, much of our saving stops, like saving for retirement, or making mortgage payments (or moving to a smaller home). Expenditure on children tends to drop. But shorter-term expenses also tend to drop, like work commuting, eating out at lunchtime, work-related clothing.

Dr David Blanchett (a huge source of information and data) finds that actual spending on consumption tends to decline by 5% to 20% on retirement, and thereafter declines by roughly 1% a year in real (that is, inflation-adjusted) terms. On average, across all households in the US, in a couple’s 80s there’s an increase in spending, not because all families experience this, but because some families incur increasing medical expenses, and that increases the average across all families. In fact Dr Blanchett has coined the lovely phrase “the retirement spending smile,” reflecting a curve that gradually decreases and then increases, just like the shape of a smile. (See his paper if you want lots of detail.)

Of course that late increase, and its extent, will vary enormously from country to country; Dr Blanchett’s evidence reflects the healthcare system that prevails in the US.

This seems to me to confirm what I’d expect. In other words, no surprises here, for me.

The next conclusion is less obvious: even though we retirees spend less than before, our satisfaction is higher. One aspect is reasonably obvious, in a sense. Our satisfaction with life tends to increase anyway from some midway point in life (the “U-curve of happiness,” as it’s called). But Dr Blanchett’s conclusion seems to go further. He looks at a study conducted every two years by the University of Michigan, where respondents express significantly greater life satisfaction at older ages than workers at the same level of spending. As a specific example, he says: “… while only 45% of respondents consuming between $20,000 and $30,000 per year between the ages of 50 and 54 are satisfied with their financial situation, approximately 84% of those 80 or older  consuming [between] $20,000 and $30,000 per year are satisfied with their financial situation (or roughly double the amount).” Of course, he allows that there may be other lifestyle elements that contribute to their satisfaction, like more spare time; and, also of course, this may reflect the U-curve of happiness generally. But it’s sufficient for him to draw the general conclusion that “retirees do better with less.”

I want to draw attention to one more conclusion. And this has to do with lifetime income streams that are guaranteed, about which I’ve written recently.

I’ve explained in the past that the financial uncertainty associated with longevity uncertainty starts out small, but increases as one ages (because the standard deviation of one’s remaining lifetime, expressed as a percentage or fraction of one’s future expected lifetime, increases as one ages); and by age 75 (male) or 80 (female) it is even larger than the financial uncertainty caused by being 100% invested in equities – a risk virtually nobody is willing to be exposed to, at those ages. And so it becomes sensible to hedge the financial effects of an extremely long lifetime; and that is done by purchasing a deferred annuity from a life insurance company (in countries where these contracts are offered). That ensures that, if you can make it to the starting date of the deferred annuity payments, your remaining payments become guaranteed lifetime income. (Always assuming solvency of the insurance company, of course.)

Why is this relevant? It’s because the certainty of lifetime income tends to dramatically change how one spends money. When income isn’t guaranteed for life, one tends to underspend, to make sure that one doesn’t run out of money before running out of life. But certainty removes the need for that caution. And, sure enough, that’s exactly what research finds. Dr Blanchett called a recent session he conducted at an AICPA and CIMA (never mind what those stand for: they’re related to accountancy) conference “Lifetime income: a license to spend,” as he explained in a research paper for the Retirement Income Institute, co-authored with Dr Michael Finke.

They state that “investment assets generate about half of the amount of additional spending as an equal amount of wealth held in guaranteed income. In other words, retirees spend twice as much each year in retirement if they hold guaranteed income wealth instead of investment wealth. Therefore, every dollar of assets converted to guaranteed [lifetime] income could result in twice the equivalent spending compared to money left invested in a portfolio.”

That’s a big difference! And the direction of greatly increased spending is corroborated in Australia in a piece by Ben Hillier in partnership with AMP (formerly the Australian Mutual Provident  Society), expressing it very colloquially as follows:

“Pleasingly, our analyses show that advised clients in MyNorth Lifetime [pension accounts designed to provide a rate of income in retirement that never runs out] are spending roughly 69% more than they previously did – once clients overcome FORO (the fear of running out), they are empowered to confidently enjoy retirement by spending in a more optimal manner.”

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So that’s what studies show, as summed up in the Takeaway.

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Takeaway

Consumer spending drops in retirement, but retirees get more satisfaction despite this lower spending. And when some level of spending is guaranteed for life, the amount of capital required to guarantee that spending leads to spending at a much higher level than the same amount of capital invested in a portfolio.

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