Thursday, February 2, 2017

Avoiding Financial Regret about Retiring Too Early

In their recent Wall Street Journal article, “Before Retiring, Take This Simple Test,” Dr. Shlomo Benartzi and Dr. Martin Weber encourage individuals considering retirement to take a “two-question quiz that can help predict whether [they will] regret the timing of [their] retirement.”  Dr. Benartzi is a behavioral economist professor at UCLA, and Dr. Weber is a professor at the University of Mannheim in Germany, with special interests in behavioral finance and its psychological foundation.  It is an interesting article that advocates the use of behavioral economics tools like the two-question quiz to “help us find ways to stop people from retiring too early" and regretting their decision.

The two questions in the quiz are almost the same, but the slight difference in timing of the two questions allows for measuring the consistency of time preference.  That is, answering the two questions inconsistently exhibits preference for immediate rewards, as opposed to postponement of rewards.

The recommendation comes from a study of over 3,000 Germans who answered the quiz.  Per the authors, the respondents with inconsistent answers to the quiz:

  • “exhibit a tendency known as present bias, or hyperbolic discounting”, 
  • “tend to retire…earlier (about 2.2 years on average) than those with consistent preferences”, and 
  • “over time, these people are also far more likely to say they regretted the timing of their retirement.”
The authors also concluded that retiring about 2.2 years on average earlier than those with consistent preferences resulted in “roughly a 13% reduction in their monthly benefits.”  Perhaps the German retirement system is different from that in the U.S., but as we will show in the example below, each year of continued employment and deferral of retirement from age 62 to age 70 results in closer to a 10% increase in an individual’s real dollar spending budget, rather than the 6% figure (13% divided by 2.2) cited by the authors.

As retired actuaries and not behavioral economists, we at How Much Can I Afford to Spend in Retirement believe that substituting facts for appearances and demonstrations for impressions are still good ways to influence individual behavior.  And while we share the goals of behavior economists to help people make better decisions, we believe that any “framing” of the retirement age decision should be based on reasonable calculations.


Let’s assume we have a single female, Beth, currently age 62, making $100,000 per year.  She has $500,000 in accumulated savings, in addition to her home equity.  She is currently eligible to receive an immediate annual Social Security benefit of $20,124, but she has no other sources of retirement income.  Her employer sponsors a 401(k) plan that matches contributions up to 6% of pay with a 50% match.  Beth contributes enough each year to receive the maximum employer match and her annual savings (including her 401(k) contributions) are 15% of pay. 

Beth wants to know about how much her real annual spending income would be if she retired today at age 62 or if she kept working and retired at age 65, 68 or age 70.  For immediate retirement, she uses our Actuarial Budget Calculator (ABC) for retirees workbook.  For the other ages at retirement, she uses our ABC for pre-retirees.  She makes the following assumptions and other data entries:

  • Our recommended assumptions for discount rate (4%), inflation (2%) and lifetime planning period (death at age 95) 
  • Her pay will increase in the future with inflation (2%) 
  • No amounts desired to be left to heirs 
  • Present value of unexpected expenses: $50,000 
  • Desired increases in future spending budgets equal to inflation (2%) 
  • Continued pre-retirement savings rate: 15% 
  • The present value of her long-term care costs will be covered by her home equity
She uses the Social Security Quick Calculator to estimate what her Social Security benefit in today’s dollars will be (shown in the table below) if she continues her employment.  She enters the following amounts into the ABC pre-retirement workbook for future dollar amounts (today’s dollars increased by 2% per year inflation):

The Table below shows the results of Beth’s calculations:

The table shows that, given Beth’s information and assumptions, her spending income will increase about 10% for each year she continues to work and save 15% of her pay.  She can either choose to look at how much her income will increase each year by working or, as suggested by the behavioral economists, she can look at her relative loss by not working.  However she looks at it, she will benefit from using our workbooks to help her make her decision about when to retire. It is important to note that results will vary for different individuals and you should always model your own situation.