Retirement – From Saving To Spending

During our working lives there is a trade off between saving for our future self, for example for retirement, and spending for today.

Of course, we have to pay our bills – we need to put a roof over our heads and food on the table but it is also important to enjoy ourselves and to spend time with our friends and families.

Preparing For Retirement

For many people, as they get older, the children leave full-time education and the mortgage is paid down, the emphasis is on saving for retirement and the focus turns to maximizing pension and ISA contributions.

This is often the time when they engage the services of a financial planner. Many of my clients are in the process of planning for their retirement and they value having a sense check as to whether they are on course for a comfortable retirement.

In the years before retirement, most people are very much focused on saving and accumulating sufficient capital to have a comfortable and enjoyable retirement.

Switching From A Saving To A Spending Mindset

As clients transition into retirement there does seem to be a difficulty in adjusting from a ‘savings’ to a ‘spending’ mindset. This is known as the retirement consumption puzzle.

Morningstar have looked at this in a recent article – ‘The Psychology of Retirement Income: From Saving To Spending’ (Samantha Lamas – 3rd June 2024) and have come up with a number of possible explanations.

Spending Less

One reason is that people don’t need to spend as much in retirement, for example, they are more likely to have repaid their mortgage. Also, they don’t have to commute to work and they may also spend less on eating out at the office and instead they make more meals at home.

Switch Away From Fixed Incomes

Another reason (and, for me, this seems more plausible) points to the fact that more and more people are now responsible for funding their own retirement because of the shift away from Defined Benefit pension schemes to workplace pensions and individual personal pensions.

The Morningstar article (albeit based on US research) suggests that those on fixed incomes from pensions or annuities tend to spend more as they have a guaranteed level of income each month.

Those people who are reliant on their individual pensions, for example by way of Income Drawdown, may be more concerned about how much they can withdraw especially if markets are volatile or there is a market correction.

This can then lead to them being more conservative with their spending habits and ultimately not spending on things such as holidays and other experiences that they can look back on with fondness in future years.

‘Active’ Retirement

From my conversations with clients, I think that we are terrible at understanding the relatively short window we have to do all of the things we want to do whilst we still can and there is a tendency to put things off.

We tend to under-estimate how long we, or those we want to spend time with, will remain healthy and have the energy to do the things we want to do in retirement.

As people get older they do invariably slow down and spending will often decrease. Therefore it makes sense to spend more early on in retirement instead of accumulating more for later life.

Being Financially Prepared

Being financially prepared is a crucial first step in overcoming the retirement consumption puzzle. Knowing that you have enough money to do all of the things you want to do is incredibly liberating.

By having a financial plan in place, we can stress-test market falls and build ‘what-if’ scenarios that can show the impact of spending more early in retirement and less in later retirement.

The financial plan can be regularly updated providing the peace of mind that you will continue to be financially comfortable in later life.

This is incredibly important as it is the early years of retirement that most people will spend making the memories that they will look back upon in later life.

It can be difficult to shift our mindset from saving to spending and a well-designed financial plan, based on conservative assumptions, can provide the reassurance that you can spend more and still be financially comfortable, whatever happens.

During our working lives we are effectively trading our time for money. In retirement it’s the other way round and so we need to ensure that we have sufficient money to spend more doing the things we want to do.