As we plan for retirement, many of us start with the age at which we'd like to retire and then work backward. What will I need to save? What standard of living will I have, now and in retirement? How should I invest?
If we don't like the answers, we make adjustments accordingly.
For those of us who don't intend to work indefinitely, when we'll retire is the foundation upon which our retirement plan rests. Unfortunately, that foundation isn't nearly as solid as we think. We often systematically misjudge when we'll actually retire, and that can wreak havoc our finances.
In a new paper, David Blanchett, Morningstar's head of retirement research, analyzes the gap between when people think they will retire and when they actually do. He finds that despite our intentions, roughly half of Americans retire earlier than planned. On average, the best formula for this gap--between our intended retirement age and actual--is this: Subtract 61 from the planned retirement age, then divide by 2.
For example, people who expect to retire at 65 will most likely actually retire two years early, at 63. People who plan to retire at 67 will likely actually retire three years early, at 64. Those who plan to retire before 61 often misjudge in the other direction (retiring later than expected), but they are a smaller portion of the population.
For many of us, we think we'll work longer than we actually do. This happens for a variety of reasons--including health issues and job changes--and the impact can be severe: fewer years of saving combined with more years of retirement that we need to fund from our savings.
Blanchett analyzes the impact of retirement age uncertainty on the probability of having what one needs for retirement. Run the numbers for your own plan or have your advisor do it. Consider:
What would happen to your standard of living in retirement if you suddenly retired two, three, or four years early--without saving more and without making any other changes?
For those already in retirement, did you end up retiring earlier than you'd initially planned? What effect did that have on your finances in retirement?
There is another challenge for pre-retirees as well. Delaying retirement has become standard advice to help fix an unsatisfactory retirement plan: if you don't have enough money, just retire later. Blanchett's analysis shows that planning to delay retirement isn't the life raft it seems to be, and it doesn't always translate into reality.
At an individual level, determining one's actual retirement age (given health, job, and other factors) isn't a straightforward calculation. The formula above gives a good estimate, on average, of the gap between people's planned and actual retirement date, but there is quite a bit of variability. It's not just that people are likely to retire early, but that the date is uncertain and idiosyncratic.
Blanchett's findings suggest that given this uncertainty regarding retirement age, some investors may need double their current savings to achieve their retirement targets. A person's retirement age is simply too unpredictable, and we must plan accordingly to help avoid negative surprises. We should focus on saving and investing, and less on the timing of retirement.
For more information on the research and its surprising findings, see The Retirement Mirage by Blanchett.
This paper and Morningstar.com article are part of the Investor Success Project. Learn more about the Morningstar Investor Success Project and read our latest insights.