Annuities Can Solve the Retirement Spending Dilemma

Published April 25, 2018
The habits that help us build our retirement nest-egg also prevent us from spending as much as we can in retirement. Annuities can help solve this challenge of underconsumption in retirement.
  • As people head into retirement, they must deal with balancing consumption (spending) in retirement with saving for future expenses such as healthcare
  • The behaviors that made you successful in saving enough assets for retirement may not serve you well in retirement, as you must transition from being retirement savers to retirement spenders
  • Annuities provide lifetime, guaranteed income to smooth long-term consumption, thereby allowing people to spend money today without worrying about meeting other expenses in the future

Academics have noticed a trend where many retirees who have saved enough for retirement choose to underspend in retirement. Some of the causes of this lack of spending, called underconsumption, are driven by a fear of running out of money (longevity risk) as well as a lack of financial planning and education. At a certain level, this trend makes sense. Retirees whose savings are primarily in a 401(k) or IRA must contend with the reality that a dollar spent today is one dollar fewer that they will have to consume in the future. This creates the retirement spending dilemma, where every dollar spent in retirement becomes a near zero-sum game between consumption today and consumption tomorrow. Annuities provide guaranteed, lifetime income that allows retirees to smooth long-term consumption, thereby solving the retirement spending dilemma.

Underconsumption in Retirement

Many wealthy households in the U.S are spending much less in retirement than they could, leading to a phenomenon called the retirement consumption gap. This gap was highlighted by Michael Finke of the American College of Financial Services in the Journal of Financial Planning. He found that the retirement consumption gap for wealthier retirees is “large,” and that for this segment “an overemphasis on shortfall risk may worsen retirement outcomes by encouraging conservative spending from assets saved to fund post-retirement consumption.”  

Other findings by Hung, Meijer, Mihaly, and Yoong in 2009 showed that suboptimal retirement spending decisions could be due to people not thinking about how to de-accumulate of their retirement savings, something most aren’t prepared for. Other studies have highlighted that retirees who feel that they have inadequate retirement savings may shift from de-accumulation to capital preservation. These studies seem to indicate that the retirement consumption gap could be traced to challenges in preparing for retirement and, as a result, these retirees then default to the safest option that they can think of – reducing spending and making overly safe investments. This behavior encapsulates the retirement spending dilemma: concerned about having enough money to spend later in retirement, retirees revert to reducing spending in the present day.

Annuities Can Solve the Retirement Spending Dilemma

Annuities can solve the retirement spending dilemma by providing a guaranteed, lifetime income stream. While people with self-managed accounts have to worry about the trade-off between spending a dollar today vs. saving that dollar for future consumption, annuitants can spend money today with the confidence that they can count on future income to meet expenses tomorrow. Earlier posts have highlighted how the consumption framework can solve the annuity puzzle by encouraging people to purchase annuity income. Here, the consumption framework is also a valuable tool in getting retirees to spend money in retirement, as the guarantee of a lifetime income stream no longer makes consumption in retirement a trade-off within a fixed amount of assets.

Let’s use Matthew as our example to see how annuities can improve people’s ability to spend in retirement. A big portion of his IRA is invested in an investment grade bond fund which is only earning 2% (he’s decided to invest it very conservatively). Taking a look at his sources of retirement income (such as Social Security and a rental income property), Matthew has a spending gap of $1,000 per month, i.e. his projected monthly expenses are $1,000 higher than his income. Matthew decides to fill that spending gap with an immediate annuity. Matthew will take $174,000 of his IRA that’s currently earning only 2% and use it to purchase an immediate annuity. Starting in one month, the immediate annuity will provide him with a $1,000 paycheck that will continue for as long as he’s alive. In comparison, simply leaving the money invested in his IRA bond fund and withdrawing $1,000 per month would deplete his IRA by age 82.  

An Annuity Simplifies Spending & Preserves Wealth

pros and cons of an immediate annuity
Immediate annuity rates based on a $174,132 Integrity single and joint life-only policies for a male aged-65 and a female aged-62 with income starting immediately. Rates as of 10/4/2017.

By opting for an annuity, Matthew has solidified his ability to spend what he wants every year in retirement, no matter how long he lives. If he had simply kept the IRA, he’d be nervous to spend that money knowing that it would come at a cost later on should he live past 82.


In summary, an annuity is a valuable retirement tool that helps reduce the risk that you or a loved one run out of money in retirement. The income annuity can also give people confidence to start spending their hard earned money in retirement, as they can count on future annuity income to help them meet future expenses. This confidence can solve the retirement spending dilemma, allowing retirees to enjoy the fruits of their hard-earned labor throughout their golden years.

With Blueprint Income, you have the option of buying a one-time annuity (get a quote) if you’ve already saved enough, or funding your annuity slowly over time (build a Personal Pension). With either, you get guaranteed retirement income you can count on for life. Use the tool below to help you estimate how much guaranteed, lifetime income you can afford.


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Lauren Minches

Lauren Minches

Financial Planning Professional

Lauren is an actuary by training with expertise in retirement, finance, and risk. She writes about annuities to make them easier to understand and evaluate. Her goal is to help people create retirements with more time for living and less time thinking about money.