Why Is It So Hard to Spend Money in Retirement? The Shift From Saving to Spending

Part 1 of a 7-part series on retirement income in Canada

For thirty or forty years the rules regarding money were simple: you earned your income, saved as much as you could, and each dollar went in one direction, into your accounts. Advancement meant seeing the balance rise, and each statement proved that you were doing things correctly. Then the cheque stops coming, and the plan asks you to reverse a habit built over an entire working life: to take money out, on purpose, month after month, and to feel comfortable doing it.

People generally find that they cannot, at least not right away, and it is this gap that forms the basis of this series. Retirement income planning is only partly a mathematical issue. Although the math is important, the following five posts will go into it in detail, looking at things such as the timing of CPP and OAS, the order of withdrawals, and what happens when you own a corporation. However, the mathematical aspect is the simpler part. The more difficult part is gaining the necessary permission. Since most people have developed the saving habit so thoroughly that spending seems like a failure, retirement won't feel secure until they once again obtain the permission to spend.

The first of these posts examines why the move from saving to spending is so uncomfortable, what research reveals about the actual behaviour of retirees, and what is necessary to create a plan that a real person will actually follow.

The problem is the direction of the money

Saving for retirement and receiving income from one's retirement savings seem to be two parts of the same thing, but they are based on opposing instincts.

During the time you were working, uncertainty led to one course of action: saving more. Whether the markets fell or you weren't sure about the cost of retirement, you saved more. This was an appropriate response to nearly all situations and it did work. It also came with a kind of scoreboard, since the balance had only one purpose, namely to grow.

When people retire, the scoreboard is taken away and substituted with one that is much less pleasant. It is then expected that the balance will fall in at least some of the years, and there's no clear way of telling whether the decline is part of a planned reduction or the beginning of an actual problem. A fall in the market while you were putting money into the account seemed at the time like buying at a discount; but if the market drops during the years when you're withdrawing money it can seem as though the entire plan is falling apart, even though the plan had anticipated such a drop.

People end up delaying their decision. I see this all the time in my experience, and it turns out to have only a small connection with the size of their portfolio. Even when people have more than enough money and their retirement plans show that their funds will last well past the age of 100 under conservative assumptions, they still put off taking the trip, continue to keep their car which is fifteen years old, and live quietly on an amount that is less than what the plan provides. Having developed over many years the habit of not spending money, that discipline does not automatically turn off on the retirement date by checking the calendar; it has to be replaced, and the task of replacing it is what constitutes actual retirement income planning.

These conversations follow a familiar shape in my office. The plan gets reviewed, the projections hold up, the person across from me agrees that the money is there, and then the same question comes back in a slightly different form: are you sure we can afford this? The question is rarely about the numbers, because the numbers have already been answered. It is a request for permission, and in my experience it takes more than one meeting, and usually more than one market decline survived on plan, before the answer starts to be believed.

What the research shows

This reluctance has been well recorded. It is known as the retirement consumption puzzle among economists. According to the standard theory, individuals should maintain a steady level of spending throughout their lives and withdraw their savings in retirement approximately as they had planned. In reality, retirees act differently. Research by Arna Olafsson and Michaela Pagel, using detailed records of personal finances, is among the work documenting this, and studies have repeatedly shown that a large number of retirees spend considerably less than their assets would allow and that a significant proportion still hold most of their original savings after twenty years in retirement. A few of them end up with more than they originally had. Work by Johan Bonekamp and Arthur van Soest points to part of the reason: retirees treat a lifelong stream of income and money sitting in an account as two very different things, and they hold on to the latter.

Some of this is intentional. Many people do wish to leave behind an estate or set aside money for health expenses later in life. However, when researchers examine the situation more closely, they find that a great deal of the underspending is not actually a deliberate decision. Research by David Blanchett and Michael Finke found that retirees who hold a larger share of their wealth as guaranteed income, whether from a workplace pension, an annuity, or government benefits, spend considerably more than those with the same total wealth held in investment accounts, with their estimates suggesting roughly twice the spending for each dollar of wealth. The money involved is the same, but the behaviour is entirely different, since a monthly deposit carries a kind of built-in permission that a lump sum never does. People spend from their income and keep their balances intact, even though the difference is artificial.

Studies into the way spending flows through retirement introduce another complication. Research by David Blanchett into what has become known as the retirement spending smile found that spending is generally highest during the early, active years, decreases in the middle years as travel and activity naturally decline, and then increases again in later life due to rising health expenses. When left to their own devices, many retirees do the opposite in those first years; they spend less precisely when their health, energy, and time are at their peak, saving the money for a future version of themselves who will have fewer ways of spending it. The true cost of this delay is not reflected on a balance sheet; instead, it appears in the years of full strength that are lost while waiting.

Permission is obtained, not experienced

It is commonly thought that comfort will eventually come on its own, with the withdrawals beginning to seem normal after a year or two. For the majority of people this does not happen, since the feeling is shaped by the structure rather than the other way around. Waiting until you are ready is not a strategy; in my experience permission to spend is based on three things.

The first element is a floor, meaning that the basic expenses of life, such as housing, food, utilities, and insurance, are paid for by income that comes in regardless of what the markets do. In Canada, this floor begins with CPP and OAS, and the choices regarding when to start each of these benefits are among the most valuable in retirement planning, and also among the most rushed. Part 2 of this series looks at them in detail. For certain individuals, the floor also consists of a workplace pension or an annuity. In Canada, Moshe Milevsky and Alexandra Macqueen made the case for this directly in Pensionize Your Nest Egg, arguing that converting part of a nest egg into pension-like income that lasts for life is what turns a pile of savings into an actual retirement. Whatever the way in which it is put together, the result is the same: once the basic needs are met by a steady income, the investment portfolio no longer carries the weight of survival and can therefore return to the role it was really intended to play, which is funding the life you originally planned.

The second element is a paycheque, meaning a regular pattern rather than a job. After forty years of receiving a monthly income, there has developed a strong association between deposits and being allowed to spend the money, and one of the most useful things that a retirement income plan can do is to restore that routine. In practice, this involves setting up automatic monthly transfers from the portfolio to the chequing account in accordance with the plan. The same amount of money which had previously felt inaccessible when it was kept in an RRSP now seems spendable once it arrives in the chequing account on the first day of the month. This is not simply a gimmick but rather an acceptance of the way people are naturally inclined, and it works better than just advising someone to become used to withdrawing money. The process of converting an RRSP into this type of income and the RRIF rules associated with it are dealt with in Part 3.

The third element consists of guardrails. A well-thought-out plan does not simply give you a single figure for spending and then say good luck. Instead, it sets out a range and clearly states in advance what will happen at the extremes. As long as your spending remains within this band, if the markets are weak for an extended period then there is the specific adjustment that we had agreed upon, and here is the amount of decline which calls for no action at all. Guardrails are important since they deal with the question which is really what keeps retirees awake at night: not how much they can afford to spend, but how they will know when things have gone wrong. By defining in advance what constitutes a problem, a normal market decline no longer seems like a judgment on the entire retirement. The sequence in which you withdraw money from your accounts is also subject to these guardrails, and making a mistake in this regard can result in actual tax costs over the years. That is the subject of Part 4.

The identity underneath it

There is one further aspect that deserves to be mentioned since the discussion about money generally overlooks it. For a great many people, saving has never been merely a financial habit; it has formed part of their identity. To be a saver meant being responsible, disciplined, and a good provider, and withdrawing funds from the portfolio can make one feel as if they are giving up that identity. No projection, however careful, can argue someone out of a feeling like that.

What helps is recalling the original reason for having the money, and this is where the planning work goes deeper than accounts and tax. The balance was never the object; it was always merely a means by which to achieve the end, which is to live your retirement on your own terms, with the people you care about, as long as you have the health to enjoy it. In my work, the permission problem is usually solved at the point where three things line up: what you want your retirement to be, what your money can actually do, and a clear way of doing it. When any one of the three is missing, spending feels unsafe. When all three are in place, spending stops being a withdrawal and becomes the plan working. Spending according to a well-constructed plan completes the responsibility that built the portfolio in the first place. The discipline is not abandoned in retirement; instead it is redirected from a focus on maximizing the amount put in to one that is mindful of what comes out and of what it actually buys.

To describe that way of thinking is easier than actually living it, and that is precisely the reason why the structure is important; the floor, the paycheque, and the guardrails are there so that the reframe doesn't have to rely solely on willpower. That, in practice, is how I work with the people who come through my door: the projections are the quick part, and most of our time together goes into building those three things and then living with them until spending feels allowed.

Where this series goes from here

Each article in this series is independent, but it is intended that they should be read in order.

• Part 2 deals with the income floor, CPP and OAS, specifying when to begin each benefit and what actual value deferral has.

• Part 3 looks at converting an RRSP into income, the move to a RRIF, and explains why the minimum withdrawal is usually not the correct amount to take.

• Part 4 addresses the order of operations, that is, which accounts to draw from first and how to manage tax brackets during retirement, together with an explanation of why the usual advice often ends up costing money.

• Part 5 completes the income floor beyond the government pensions, covering workplace pensions, annuities, and GIC ladders.

• Part 6 is aimed at incorporated professionals and business owners, as their retirement income situation involves a corporation and a different range of decisions.

• Part 7 examines the risks that affect all these aspects, including the sequence of returns, longevity, and inflation, and how a retirement plan can cope with them.

The decision to take from this first post is a straightforward one: treat the shift from saving to spending as one of the real decisions in front of you, not just an entry on a calendar. When retirement is near or has already come and spending still seems more difficult than saving ever did, this is not a sign of a weak character or a mistake in the math. It is the expected outcome of years of good habits coming up against a job which those habits were not meant for. The solution is to draw up a plan that includes a floor, a paycheque, and guardrails, after which the permission usually follows.

The next post starts where the floor starts, with the two government pensions almost every Canadian retirement is built on, and the timing decisions that are worth far more than most people realize.

Sources

Blanchett, D. (2014). Exploring the Retirement Consumption Puzzle. Journal of Financial Planning, May 2014.

Blanchett, D. and Finke, M. Guaranteed Income: A License to Spend. Retirement Income Institute, Alliance for Lifetime Income. https://ssrn.com/abstract=3875802

Bonekamp, J. and van Soest, A. (2022). Evidence of behavioural life-cycle features in spending patterns after retirement. The Journal of the Economics of Ageing, 23. https://doi.org/10.1016/j.jeoa.2022.100408

Milevsky, M. and Macqueen, A. (2015). Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income for Life. Second edition, Wiley.

Olafsson, A. and Pagel, M. (2018). The Retirement-Consumption Puzzle: New Evidence from Personal Finances. NBER Working Paper 24405. https://doi.org/10.3386/w24405