Retirees are reluctant to spend savings. Researchers say that's a problem

In the world of retirement plans, all income is not equal. That's the newest finding from research looking at the spending habits of some 2,500 U.S. households.

The report, authored by David Blanchett, head of retirement research at PGIM DC Solutions, and Michael Finke, professor of economic security research at The American College of Financial Services, found that retirees are far more comfortable spending income from things like Social Security and pensions compared to withdrawing cash from their investments.  Blanchett and Finke say that's a problem for retirement planning.

Defined benefit pensions have witnessed a steady decline over the past four decades as employer-sponsored 401(k)s and IRAs became the common path to retirement savings. Retirement research typically assumes that retirees are largely indifferent about the sources from which they derive their income in retirement, according to Blanchett. But the numbers from the study show something quite different.

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On average, Americans spend roughly 80% of their available lifetime income — including Social Security, pensions and annuities — throughout their retirement. Meanwhile, retirees consume only about half of their available savings. Blanchett and Finke's data show that households with married 65-year-olds withdrew just 2.1% of their savings on average over the course of one year, far below the general guidance on portfolio withdrawal rates, they wrote.

"We find pretty significant evidence that retirees are a lot more comfortable spending lifetime income than withdrawing from savings," Blanchett told Financial Planning. "This is pretty intuitive if you talk to retirees, since it's behaviorally difficult to spend down savings when you don't know what future market returns are going to be, how long you're going to live, etc., but it's not something that's typically considered when thinking about optimal retirement income planning."

Dipping into Social Security early can have compounding consequences for retirees, advisors say. Doing so not only limits Social Security payments through retirement, but it can also lead to bigger tax hits as retirees delay withdrawing from qualified savings accounts until required minimum distributions (RMDs) begin to take effect.

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"This behavior is absolutely emotional," said Jeremy Bohne, founder of Paceline Wealth Management in Boston.

Research findings on the ground level

For some financial advisors who work firsthand with retirees, the researchers' findings are hardly a surprise. 

According to Christopher Briscoe, director of financial planning at Girard Advisory Services in King of Prussia, Pennsylvania, clients accustomed to regular paychecks often underspend in retirement, leaving unintended bequests due to discomfort with withdrawing from their retirement accounts.

"I find that the conversations have become much more behavioral, like changing their mentality … on spending," Briscoe said. "And that does prove difficult at times because people are just so conditioned to save."

Across their dataset, Blanchett and Finke found that the median retiree spent significantly below their available income, especially during earlier years of retirement. But "spending efficiency" can vary significantly from one individual to the next. 

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Nicholas Bunio, a financial advisor at Retirement Wealth Advisors in Berwyn, Pennsylvania, said that he more often sees retired clients overspend rather than underspend. Such retirees are a minority; data shows that about one in 10 households spends nearly twice their total spendable income throughout retirement.

The research is clear — an average retired American prefers to spend money from lifetime income over their savings, but clients are people, not statistics. For Briscoe, making a retirement plan with a client isn't just about optimizing for gains and taxes, it's a conversation with a client about how they see money.

"The more you have conversations to get to know your clients, the more you can decide what would help them feel financially secure in retirement," Briscoe said. "And for some people, it's the 'I want a monthly income,' right? 'I want a set amount and kind of budget that way.'"

Planning around less than optimal spending behavior

Advisors and policymakers can play a big role in guiding retirees to spend their money more efficiently. Data shows that RMDs, for instance, have a clear effect in driving spending from IRAs. 

"The government isn't telling you to spend it, but people do," Finke said. "In a way, the government has essentially created a spending rule based on current assets and expected longevity that many Americans use to pay for their lifestyle."

Government officials could encourage retiree spending by lowering the distribution age, but policy changes from the Secure 2.0 Act are set to do just the opposite. The act raised the RMD age from 72 to 73 beginning in 2023 and is set to increase it again to 75 in 2033. Blanchett and Finke suggested that such changes could lower spending levels even further.

But regardless of changing RMD policy, researchers say that financial advisors can still improve spending behavior for their clients by leaning into the behavioral side of retirement planning.

"What this research really demonstrates is that retirement isn't just a math problem that can be solved with an efficient portfolio," Blanchett said. "Financial advisors who aren't actively discussing options to generate lifetime income may not really be helping their clients have the best retirement possible."