Say a retired husband and wife determine that they need $50,000, in addition to Social Security and any pension, in order to have a comfortable retirement.

The Wall Street retirement income approach would typically have them invest $1,250,000, assuming a 4% withdrawal rate adjusted for inflation. However, this approach does not guarantee the retirees will not run out of money early.

Another approach would be to find an immediate annuity that provides the same $50,000 income that would increase with inflation. When last priced, such an annuity was available for a single premium of $1,050,000.

The immediate annuity solution costs less, increases with inflation, and solves the problem of running out of money. However, it will seldom be selected. The reason: Although immediate annuities are often the most rational solution, retirees have consistently voted with their pocketbooks for non-immediate annuity solutions.

Another strategy may do a better job of solving the retirement puzzle than the planning approaches currently used. This is to use an income-based approach to retirement that takes into account the way people really make decisions. This behavioral retirement approach recognizes that a consumer does not have an overall “low” or “high” risk tolerance, but that the perceived risk of each retirement income decision is defined by what the consumer will do with that income.

So, retirees will choose safe, less risky assets to fund an income that will always be there to cover food, housing, medical and other essentials. However, they will choose riskier assets to fund expenses they view as non-essential or luxury, such as travel costs, because they know that if the riskier assets perform poorly, the retiree can always cut back on those expenses, but if those assets do well, the retiree can fly first class instead of coach.

In short, consumers mentally create sub-accounts that link together the income producing asset and the expense.

Realizing this enables providers to better position products to solve retiree needs by showing retirees how the asset matches the expense from a risk perspective.

Let’s say the retirement budget for the above couple treats housing, groceries, utilities and medical needs as essential expenses. After deducting Social Security and pension income, there remains a balance of $20,000 needed for these essential expenses. So, the couple wants $50,000 income from their assets to provide a comfortable retirement, but they absolutely need $20,000 to cover essentials.

To get $20,000 guaranteed for life, this couple would need to put $400,000 in an inflation-adjusting immediate annuity, or a variable or fixed annuity with a guaranteed lifetime withdrawal benefit (GLWB) paying 5% as a joint payout. The annuity GLWBs are not inflation-adjusted, but offer the potential for increasing income if their net account growth exceeds the payout and annuity expenses.

For $400,000, then, the couple knows that their essential needs are provided for and they will still have an income even if the stock market crashes, interest rates drop back to 1%, and they live to be 110.

How will they fund the remaining $30,000 in income to produce the desired $50,000 retirement budget? It depends on their aversion to risk and how essential they feel other retirement expenses are.

If this couple views all other expenses as nonessential–for instance, they feel they could postpone travel and eating out for a year or two–then the remaining funds could be invested in higher potential/higher risk assets and the payout from the assets could be increased to 5% or 6% a year. Under almost any long-term scenario, $500,000 to $600,000 invested mainly in equities and not bonds would support a 5% or 6% payout for the life of this couple; this is so because, in periods of market decline, the withdrawal would be curtailed or severely cut.

After adding the immediate annuity to the equity portfolio, the retired couple knows that, for a total of $900,000 to $1 million, the essentials are covered for life; the income will increase with inflation; and they still have at least $500,000 in cash available for bequests.

Or, after adding the fixed or variable annuity with GLWB to the equity portfolio, the couple knows that they will keep access to the full $900,000 to $1 million, and that their retirement essentials will be covered.

In sum, the behavioral approach to retirement uses considerably less cash than the $1.25 million required by the Wall Street plan and offers greater certainty of income. It also requires less cash than simply purchasing an inflation-adjusting joint immediate annuity–and the couple still has access to most or all of their cash when entering retirement.