The Problem With Essential vs. Discretionary Retirement Strategies: Pt. 2

In the first part of this post, I discussed how when planning for retiring clients, it's crucial to get an understanding of what the client's goals are in the first place, so that recommendations can be made about how to financially secure those goals. I also gave specific examples of how to go about it. In the second part of the post, I’ll explain what is “essential" for retirees versus the needs of accumulators.

In the general case of spending, where people are ultimately are constrained by income and must make spending and saving decisions with the income they have, it is valuable to distinguish between needs and wants. In the case of retirees, however, the situation is somewhat different—for the simple reason that if retirees are not satisfied with the total level of spending available, the retiree can choose to spend less and save more before retirement, and/or can choose to work longer to accumulate more before retiring (at least to the extent health allows).

Thus, in the case of the retiree, there is an interaction between "essential" needs in retirement and the decision to retire at all: if your accumulated savings can afford only the bare essentials and not the full amount of the "discretionary" desired lifestyle, the prospective retiree keeps working until the entire lifestyle they feel is "essential" is affordable!

As a result, in all but the situations where retirement is forced due to external circumstances, the distinction between essential and discretionary spending appears to be less relevant. If there are only sufficient assets to afford essentials but not the desired discretionary spending, the prospective retiree keeps working until they can afford their entire lifestyle, including the essentials and a desired amount of lifestyle discretionary spending.

From there, if returns are even better than anticipated, lifestyle can always be upgraded further. But from the perspective of someone considering the retirement decision—who has a choice about whether to retire or not—the goal rarely is to secure essential spending and take the risk that the rest won't be affordable because it's just "discretionary." Instead, the typical goal is to afford the entire retirement lifestyle.

In fact, retirees are often willing to work longer specifically to ensure that their later retirement years aren't stripped of enjoyment (no more eating out, no more visiting the grandchildren) because there wasn't enough money to afford the desired "discretionary" spending.

Or stated more simply, the psychological impact of losing one's discretionary expenses—those not required for food, shelter, and clothing, but still deeply tied to life enjoyment, personal satisfaction, social and family ties, etc.—can be so severe, that it's not really clear whether we can fairly call them "discretionary" at all, until/unless there are absolutely no other choices available and we have to.

In practice, I believe this is why an essentials versus discretionary discussion is often difficult to have with a retiree, especially a prospective retiree. If the answer is "you can afford the essentials in retirement, but not the discretionary expenses that also constitute lifestyle you are accustomed to" the typical answer is not "let's guarantee the essentials and hope returns carry us to the rest" but instead is "I'll keep working until I have reasonable certainly my entire lifestyle goal can be accomplished"—and if there's upside from there, all the better.  

In turn, this is why approaches like tying total spending to an amount sustainable under a safe withdrawal rate approach seems to be far more popular with planners and their clients than buying an annuity to secure "essentials" and investing for the discretionary expenses that remain.

So what do you think? Is the essentials versus discretionary distinction really meaningful for a retiree who can just work longer to ensure their entire lifestyle is affordable? Does the psychological impact of being unable to afford the discretionary expenses that constitute a lifestyle still make them somewhat essential? If the essential versus discretionary approach only meaningful for people who can't afford their lifestyles in the first place?

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