The Psychology of Retirement Income: From Saving to Spending

The narrative of a miserly, Scrooge-like figure hoarding his wealth for years instead of enjoying his retirement might seem unbelievable—but unfortunately, it isn’t relegated only to fiction. It’s a cold reality for many retirees.

Although most retirees’ stories aren’t as dramatic as Scrooge’s, it’s not uncommon for retirees to have more than enough to live comfortably for the rest of their lives but still think a vacation is out of the question. In fact, a number of retirees actually experience a sharp decrease in spending and increase in savings in retirement.

According to the Life Cycle Hypothesis, this shouldn’t need to happen. A retiree who is financially prepared for retirement should keep a consistent income in retirement, and her overall consumption should not change. So why does this conundrum—known as the retirement consumption puzzle—happen, and what can we do about it?

Who Is Struggling to Spend Their Retirement Income?

About 25% of retirees fall into the camp of people who decrease spending during retirement. So although this doesn’t impact a majority of retirees, it’s still a meaningful number, and it’s concerning to see so many people not enjoying the fruits of their labor.

Moreover, research suggests this problem may worsen. Researchers found that the issue was most pronounced with individuals who use their own savings for retirement income—whereas people with guaranteed sources of income, such as annuities, Social Security, and pensions, were more likely to spend their income.

Thus, as more retirees (in some cases unwillingly) use financial accounts for their retirement savings, the group of “decrease spenders” may grow.

Why Do People Have Trouble Shifting From a Saving to Spending Mindset?

The idea of a person hoarding their money in retirement is not new, but researchers still haven’t been able to pinpoint the exact cause. There are plenty of theories, though—some with more support than others.

One line of thinking posits that people simply don’t need to spend as much in retirement. For example, when people retire, they may experience a drop in work-related expenses. They may be able to spend more time doing things they had to pay for in the past—now making meals at home or mowing their own lawn—and searching for the best deals for their purchases. And they may pay off their mortgage, thus decreasing their expenses.

Another line of thought points to more psychological reasons behind a change in spending patterns.

Before retirement, a person may be more susceptible to present bias (the tendency to focus more on the present situation at the expense of long-term planning) because their future labor income is uncertain, and they don’t yet feel an ownership of that money. That uncertainty gives them the flexibility to think things like, “I’ll work more hours next month to make up for this trip,” or “My boss will cough up that bonus soon.”

However, after retirement, they are on a fixed income and the money they are spending is coming from their own pocket. This shift triggers loss aversion—that is, the desire to avoid losses outweighs the desire to experience gains. In retirement, we know that overspending today will result in a sure loss in future consumption. In a world where that future you is 85 years old and unable to work, that future loss looms much larger than an extra extravagance today.

This bias may be further aggravated by the fact that though your future retirement income is certain, your future expenses are uncertain. These stressors may push retirees to remedy preretirement overconsumption, thus prompting them to spend less.

How to Manage Retirement Spending Woes

Each of these theories has some merit, but none of them completely solve the retirement consumption puzzle. I believe that there is no one culprit behind the retirement consumption puzzle because no one retiree is the same.

For example, for Scrooge, the loss aversion theory may fit the bill. He became so preoccupied with the dollar amount he has that he ended up drastically underspending in retirement. But because every retiree is different, and different explanations may ring true based on their personal circumstances, retirees may benefit from taking stock of their retirement spending.

This exercise may help you understand if your spending is lining up with your retirement funds and needs. In some cases, that might mean that not spending all of your monthly retirement allocation is “OK.”

Step 0 is to gauge your financial affairs and have a clear understanding of how much you can spend. Assuming Step 0 is complete, here are three ways to diagnose if you have a retirement underspending problem:

1. Refer back to your financial goals and life values (and if your financial goal was to retire on time, it’s time to set new ones). Consider: Are you meeting your financial goals given your current spending? Are you upholding your life values? If your life value is to experience new cultures, is your current spending allowing you to do that?
2. Try tracking your spending using an online tool that breaks down spending by category. It’s ideal to do this before you retire, but not essential. On a quarterly basis, check your overall spending and take note of any categories where your spending patterns have changed. Do these changes align with your financial goals? Did your spending on eating out suddenly drop, even though you love trying new cuisines with friends?
3. Take a moment to recognize your emotions when spending your retirement income. (Research finds that retirees who underspend are more likely to be worriers.) Are you constantly pinching pennies and afraid to spend?

The Pieces to the Retirement Income Puzzle

If you fall into the underspending camp, research suggests that people using guaranteed income sources are more willing to spend their income.

Although the causes of the relationship between annuitizing and spending are still up in the air, there are a couple of theories.

For example, maybe people with an annuity feel they have more of a “license to spend” because they know they will always have money coming in. Or, maybe this phenomenon relates to how retirees think of their payments: If a payment comes from an annuity, it may feel like it’s someone else’s money they are spending (akin to labor income they earned before retirement). Since it’s not coming out of their own pocket, they may not be as prone to loss aversion and thus more at liberty to spend.

If you don’t want to take the leap to guaranteed income sources, try reframing your retirement income as a paycheck that someone else is paying you.

You can also try refocusing on your financial goals and life values. Put your goals and/or values on a Post-it note and stick it on your fridge, put them in your wallet, or add them to the notes app on your phone. Constant reminders of why you need to spend money—whether it’s to buy a condo near your grandchildren or to book that trip to Italy to taste authentic Italian cuisine—can be the nudge you need to make sure you make the most of your retirement.

Although not spending enough money in retirement may not be a universal problem, it does represent a huge, missed opportunity for the retirees in question. It’s important to remember that this is the money you’ve spent years toiling over and protecting. Now, during a long and happy retirement, is the time to put that money and free time to good use, funneling both resources into your version of a life well-lived.