Thanks to layoffs, health problems and caregiving for a spouse or loved one, many Canadians don’t end up working for as long as they anticipate or hope. Such sudden retirees find themselves having to make many life decisions before they are ready.
As a result, according to a report from Chicago-based Morningstar Inc. – “The Impact of Retirement Age Uncertainty on Retirement Outcomes” published last year in the Journal of Financial Planning – financial advisors need to do more to help clients prepare for the possibility of retiring earlier than anticipated.
While many studies use investment returns, withdrawal rates and longevity models as random variables, few treat retirement age in the same manner. Typically, the anticipated retirement age comes directly from a client who, in theory, should have a reasonable idea of the time at which he or she will retire. In reality, however, a growing body of research demonstrates that clients do not leave the workforce when anticipated and primarily retire earlier than planned.
This uncertainty can derail a client’s retirement income plan in several ways, warns David Blanchett, head of retirement research, investment management, at Morningstar and author of the report. Uncertainty can reduce the time horizon for saving and investing, accelerate the point at which portfolio withdrawals begin and, potentially, reduce government pension benefits.
Using the University of Michigan Health and Retirement Study (HRS) – a data set that allows comparisons of the time at which people estimated they would retire against when they actually did – Blanchett determined that planned and actual retirement ages align at approximately 61. That is, people who plan to retire earlier than at that age tend to retire later and those who plan to retire after 61 actually do so earlier than expected. Those targeting a retirement age after 61 generally retire about a half-year early for each additional year of work planned past that age. In other words, someone who plans to retire at age 69 is likely to do at 65.
Blanchett also looked at the probability of retirement plan success for clients who make it to their planned retirement age vs those who do not. This was done using Monte Carlo analysis, which provides a wide range of possible outcomes using multiple scenarios.
The individual’s age for the analysis was assumed to be 55 and was conducted for retirement ages of 60 to 70, in one-year increments, and for initial annual withdrawal rates at the target retirement age of 3%, 4% and 5%. Retirement was assumed to last until age 95, regardless of when it commenced.
Incorporating retirement age uncertainty can increase required savings levels significantly, especially for clients targeting later retirement ages and with a higher target probability of success. For example, if the “average client” is assumed to be seeking a 4% initial withdrawal rate and wants to retire at age 65, such uncertainty would require approximately 28% more savings to achieve the same income level with the same probability of success.
Blanchett’s advice: advisors should consider showing clients the implications of an early retirement to get them to save more than they would using a more traditional approach in which retirement age is treated as certain.
To read the study, visit onefpa.org/journal/Pages/SEP18- The-Impact-of-Retirement-Age-Uncertainty-on-Retirement-Outcomes.aspx.