A growing base of research shows that even though money itself is fungible, the way we think about our various money assets is not; instead, we tend to “mentally account” for money into various buckets of current income, current assets, and (assets for) future income. The fact that we tend to categorize our income and assets into various buckets helps to explain the popularity of so-called “bucketing strategies” for retirement income, whether segmented by time (short, intermediate, and long-term needs) or type of spending (essential vs discretionary needs).
However, the research also suggests that the way we mentally account for income and assets also has an intrinsic hierarchy of priorities – first, we need to cover our current income needs, then our current assets, and finally our savings towards future income needs (ideally, with some potential for further upside and the possibility that our future income could continue to improve over time).
The significance of this “hierarchy of retirement needs” is that it helps to explain why some types of retirement income strategies like annuitization are very unpopular (despite the fact that retirees routinely state their biggest fear is outliving their retirement assets and annuitization can guarantee that will never happen), while others are used far more often even if their current guarantees are inferior to available alternatives (e.g., most guaranteed living benefit riders on today’s variable annuities).
However, perhaps the biggest caveat to the hierarchy of retirement needs is that if retirees must satisfy a desire for current income, and future income, and have liquid current assets available, they may actually feel compelled to save more for retirement than they actually need (even if there is no desire to leave a legacy behind). After all, it “should” be sufficient to just save for future and current income, without a separately holding of liquid assets; nonetheless, recent research finds that the amount of “cash on hand” (or at least, liquid bank holdings) a person has is directly (and positively) related to their self-reported well-being and life satisfaction, even if they didn’t have a financial need for it. Nonetheless, if the need for future income cannot be achieved until the need for current assets has been mentally satisfied first, retirees may continue to feel constrained by not having enough – even if they do – and/or to choose retirement income solutions that are mechanically inferior but psychologically more satisfying to our hierarchy of retirement needs!