Advising Clients about When to Retire

"When can I retire?"

When clients ask this, they are usually expecting to hear a specific date. But the most useful answers look at multiple possible dates and show clients how the choice will affect retirement income.

Clients are often surprised to learn that delaying retirement can increase retirement income by a lot. There are multiple forces at work. Retiring later provides more time for existing retirement savings to accumulate and allows workers to make additional contributions. And Social Security benefits increase substantially for each year of delay up to age 70. Delaying retirement shortens the expected retirement period, so the combined result is more money spread over fewer years. Although each case will be different, I'll present an example to provide some general insights.

An example

Developing a full retirement plan for each of a client’s possible retirement dates requires a lot of input and number crunching. I'll do a shortcut version for this example.

This example will be based on a 62-year old individual assumed to live to age 90. This is a longer lifespan than we might think of for the general population, but it reflects typical advisory clients, who are more upscale and have better longevity prospects than average. This analysis will use a fixed lifespan — incorporating variable longevity will be a future project.

This person has a number of choices:

  1. Retiring immediately and receiving Social Security

  2. Retiring immediately and delaying Social Security

  3. Continuing to work to age 66 and making retirement plan contributions

  4. Continuing to work to age 66 and no longer making contributions

  5. Continuing to work to age 70 and making retirement plan contributions

  6. Continuing to work to age 70 and no longer making contributions

I assume this individual is currently earning $75,000 and has accumulated $500,000 in a tax-deferred retirement plan that he or she will use to generate retirement income. (Funds set aside for emergencies are separate.) Monies in the plan are split 50/50 stocks/bonds and will be rebalanced to maintain this allocation. The annual average nominal return assumed for this portfolio is 6.15% after expenses, with a standard deviation of 10.35%. These returns assume an underlying inflation rate of 2.5%. Withdrawals from retirement savings will be taxed at a 25% marginal federal rate and a state income tax rate of 5.2% (based on Massachusetts).

This individual's primary goal is to generate income for retirement, with a secondary goal of leaving a legacy. This person also has the flexibility to adjust retirement consumption depending on investment experience. Given these considerations, the planning will aim for retirement withdrawals that will give a two-thirds probability of not having to reduce consumption over the course of retirement. This is a lower probability of success than is often used in retirement research (where 95% probabilities of success are common), but such plans push spending toward the end of life or into legacies, which is not consistent with my assumptions in this case. This client might be considered a good candidate for an annuity to mitigate longevity risk, but for this analysis, I'll just use regular investments and leave the annuity analysis for future research.