Recent research on the psychology of spending reveals a new perspective in the psychology of retirement income satisfaction. Renowned retirement planning researcher Dr. Michael Finke, CFP®, Chief Academic Officer at The American College of Financial Services, offered critical insight into the data, including tips for advisors to help clients get optimal enjoyment and fulfillment from their retirement years.
Studies comparing the levels of satisfaction among retirees with different levels of guaranteed retirement income found those with higher levels of guarantees were more satisfied than those with less. What is rather surprising, however, was the revelation that a retiree’s income satisfaction does not have a linear relationship with the amount of wealth he or she has saved for retirement.
The Case for a Mental Separation of Wealth and Income
Dr. Finke highlighted that an important distinction exists between wealth and income: People have trouble spending their assets, not spending their income. “Once we start viewing money as wealth, as a stock of money and not necessarily as a flow, then we seem to get less happiness out of spending it than we do from money that’s automatically turned into a flow,” Dr. Finke said.
In fact, data shows an inflection point when individuals have somewhere between $3 million and $4 million saved. Finke explained that people will naturally focus on a number — for example, $500,000 saved by the day they retire — and become negatively affected when that number decreases, even if it does not decrease until years after retirement.
What can advisors do to help dissuade their clients’ anxiety about spending down assets during retirement? One tip is for advisors to help clients reframe their retirement income perspective to focus more on the “income” aspect and less on the amount of money saved.
Spend Income, not Assets
In addition to refocusing their clients’ retirement income perspectives, advisors have a variety of investment vehicles and products available to help them turn pools of wealth into guaranteed streams of income for clients during retirement. Two of the most common sources of guaranteed retirement income are Social Security and pension plans.
The percentage of retirees covered by a defined-benefits pension plan has been steadily declining for 25 years, but Social Security remains a source of guaranteed retirement income for 97 percent of the elderly population aged 60 to 89. In fact, 61 percent of elderly beneficiaries depend on Social Security as the majority of their cash income.
When retirees spend their assets and see their retirement savings decrease, they become negatively affected. Alternatively, spending income, not assets, has no negative effect on the mental or emotional state of retirees. By taking a portion of a client’s retirement savings and purchasing investment vehicles that create guaranteed revenue streams, advisors can help clients maintain feelings of security and satisfaction directly correlated with guarantees.
Strategies for Turning Assets into Guaranteed Income
When approaching the topic of creating retirement income with clients, advisors should frame the conversation in a way that keeps retirees focused on the “income” component of the recommendation. A variety of products and investment vehicles exist that can provide fixed income for retirees as part of a complete retirement plan.
- Building a bond ladder. Bonds are tied to the federal interest rate and can provide a reliable stream of retirement income while managing interest rate risk. One strategy to create sustained retirement income streams is called “bond laddering,” and involves purchasing multiple bonds with staggered maturity dates. Bond ladders are used to provide consistent amounts of income over long periods of time. The idea is to diversify risk due to dips in the federal interest rate by owning multiple types of bonds. If yields drop before one bond matures, the other bonds will not be affected because they were locked in at a higher interest rate. The types of bonds that a client needs will depend on their specific needs, goals, and risk tolerance.
- Annuities pay dividends. Whether clients have a defined-benefits plan or not, annuities are another option to help retirees secure a guaranteed stream of retirement income. There are different types of annuities, just like there are different types of bonds. There are immediate annuities, fixed annuities, fixed and variable annuities. Annuities also provide certain tax benefits because the money invested in them grows tax-deferred until the retiree cashes out, taking either a lump-sum payment or choosing to set up guaranteed payments over a period of time.
- Pensions can be annuitized, too. Retirement planning expert Dr. Finke said that retirees who turn their pension plans into annuitized streams of income are happier in their retirement than those who try to maintain an income from a lump-sum of money. When given a choice between having a fully annuitized retirement income, partially annuitized retirement income or non-annuitized retirement income, survey respondents opted for retirement income with 70 percent annuitization.
This peek into the psychology of retirement satisfaction shows that retirees are more comfortable when they have guaranteed retirement income. Advisors can help their clients by teaching them how to view their retirement savings as a flow, as income, and not as a lump sum. Once they become accustomed to viewing their retirement assets in this way, retirees will be able to enjoy feelings of security and positivity, leading to overall satisfaction and a healthier client-advisor relationship.
Interested in learning more strategies to help create guaranteed retirement income for your clients?
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