Guaranteed Income: A License to Spend

Prior research finds that retirees don’t spend nearly as much as they could from their investments. Economic theory provides both rational and behavioral explanations for under-spending among retirees with high non-annuitized wealth. Longevity risk will result in lower spending among rational, risk-averse retirees. Retirees may also exhibit behavioral preferences that make them far more comfortable spending from income than assets. We explore how the composition of retirement assets is related to retirement spending and find that retirees who hold a higher percentage of their wealth in guaranteed income spend more than retirees whose wealth consists primarily of non-annuitized assets. Marginal estimates suggest 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 will spend twice as much each year in retirement if they shift investment assets into guaranteed income wealth. The size of the effect suggests that the explanation for under-spending non-annuitized savings is likely both a behavioral and a rational response to longevity risk.