How to Get More Pleasure Out of Retirement Spending

More money isn’t the answer. Spending it differently is.
Shlomo Benartzi

When I came back from a trip recently, I surprised my 6-year-old daughter with a box of chocolate truffles. In return, she surprised me with an insight into retirement planning—and why we’re doing it all wrong.

Maya inspected the truffles and announced that, since she could only have one every night, she was going to start with the white chocolate, “because I like it the least. That way I can save the best one for last.” Maya then went on to observe that other children might have different preferences, and choose to start with their favorite truffle instead.

That’s a pretty reasonable—and sophisticated—approach for a child confronted by a box of delicious chocolate. But what does this have to do with retirement planning?

Obviously, retirement planning is far more complicated than choosing which chocolate to eat. Yet, they do have something important in common: in both instances, we’re trying to maximize the pleasure of a scarce resource. 

For Maya, this meant structuring the experience of eating her chocolates, so that the pleasure gradually increased over time. In retirement, of course, the scarce resource is money. And though we may not realize it consciously, many of us feel the same way about money that Maya does about chocolates.

Research shows that people feel happier when the rewards they get change over time—in most cases, when the rewards start low and get progressively higher. Yet most retirement plans are set up to give us the same amount of money every month, year after year. This is the equivalent of having the same truffle every day, without the option to eventually get ones that you like more.

These are supposed to be the golden years, a time for cruises and grandchildren, but due to a mistaken assumption of accounting, we’ve failed to maximize the pleasure we get out of them. By offering people alternative structures for drawing down their retirement savings, we can increase its impact.

To be clear: It’s not about making do with less. It’s about finding ways to enjoy what we have even more.

Anticipation brings joy

The typical American life goes something like this. We spend the first third accumulating human capital—we go to school, learn various skills, develop our talents. The next third is about the accumulation of financial capital. We buy a house, fill it with stuff and save money for the future. Then comes the final third of life, or the drawdown, as we spend what we’ve saved in retirement. This is the grown-up equivalent of eating our chocolates.

Yet when designing an income plan for retirement, we fail to consider Maya’s insight into truffles. Instead, we offer people plans that distribute the same amount of money every month. Put another way, the shape of their drawdown plan is a flat line.

However, as Maya knew, this approach can limit the pleasure we get from our money. The behavioral science behind this idea comes from Christopher Hsee of the University of Chicago—in particular, his work on hedonomics, which is the application of economic principles to the study of happiness.

In one paper, Prof. Hsee and co-author Robert P. Abelson showed that our satisfaction with a given outcome—and it didn’t matter if it was a student’s grades or the result of a series of gambles—depended largely on the velocity of change, not just the final position. Although we fixate on the quantity of a particular reward—how much money or chocolates we have—what makes us feel best is when things are getting better, not when we have the most. As Prof. Hsee puts it, “people adapt to states but react to changes.”

This research has big implications for the distribution of rewards. Instead of making us happy, the flat drawdown that most retirement plans offer has a numbing effect, generating smaller amounts of pleasure over time.

In informal surveys of what drawdown strategy financial advisers would prefer for themselves, I found that the least popular drawdown approach, by far, is the flat line. In contrast, the most popular alternative drawdown method is the upward slope, or increasing income over time. This is analogous to Maya saving the best chocolate for last.

Such a plan might be especially useful for people who are worried about running out of money, perhaps because they expect to live a very long time. The upward slope would allow these retirees to turn their anxieties into a drawdown strategy with potential hedonic benefits. Instead of worrying about not having enough, they can enjoy the expectation of better times ahead.

It’s worth noting, though, that for roughly a third of individuals, the downward slope is more appealing. These people want to eat their best chocolates first.

Although this strategy might seem less prudent—it increases our risk of running out of money—it’s a logical approach if you’re worried about not being able to enjoy your savings later in life, typically because of health issues or fear of an early death. Is it better to go on a safari before your hips start to give out? Why save our biggest retirement payouts for our sickest years? Life is short and uncertain; if you end up dying early, you might not even enjoy your best chocolate, so you might as well eat it now.

These gradually increasing, or decreasing, spending plans are not the only ways to draw down a resource. Consider those chocolate truffles: Although Maya was limited to one truffle every night, she’s allowed to indulge her sweet tooth on special occasions, such as Halloween. I refer to this as the “spike” approach, and it could be easily applied to retirement as well.

Instead of gorging on candy, people would receive larger sums of money at various intervals, before resuming their regular payment schedule.

For instance, clients might enjoy a “luxury summer,” featuring higher levels of spending that allow them to travel around the world first class. Although very few financial plans offer such a feature, people seem to know they’d like it. According to a survey by researchers at Harvard Business School, a majority of people want a retirement distribution featuring a “bonus month” every year.

This method provides an important psychological benefit. Because the higher drawdowns are a special treat, we never adapt to the elevated level of consumption. The luxury summer feels like a special reward, the grown-up version of the extra candy that Maya gets on occasion.

Knowing what we want

Of course, once we start allowing people to deviate from the flatline drawdown plan, we need to help them make the right choice. This again brings us back to those chocolate truffles. While much research remains, I think it’s possible that asking people how they’d structure everyday pleasures could uncover important preferences relevant to our retirement, allowing us to predict which drawdown structures will leave us happiest. By discovering who we are, we can learn what we really want.

When the Social Security Act was enacted, in 1935, it wasn’t technologically possible to personalize the payouts of each individual. However, the digital age turns mass personalization into a trivial problem. Just as Netflix and Amazon tailor their recommendations based on our individual preferences, so could the government, or an insurance company, customize our retirement payouts to suit our drawdown preferences. Digital technology could be used to refine these recommendations based on constant feedback.

For instance, if a client has started piling medical expenses on his credit cards, then his drawdown slope could be adjusted to increase his available cash. Or perhaps a client has become less mobile, at least as measured by her smartphone usage. She might benefit from a bonus month so she can take her grandchildren to Disneyland before her arthritis gets worse.

The digital tools underlying these proposals are already being used to improve our online lives in other domains, from book recommendations to suggested television shows. It’s time for the financial-services industry to play catch up.

Too often, we obsess over getting more of what we want: more money, more friends, more chocolates. But the unfortunate truth is that we will never have enough.

That’s why I think it’s time to adopt a different approach, applying the lessons of behavioral economics to our mature years. Instead of seeking ever larger rewards—an approach that comes with diminishing returns—I want to figure out how to squeeze more happiness from what we already have.

The Wall Street Journal