When Should You Retire?

MARK RIEPE: The Food Network’s Alton Brown has had several recipes go viral, but the recipe that resonates most with me is his method for cooking a steak.1 Skip the grill and use a pan and an oven. Here’s how it works.

Steak has to have a nice crust on it. To get that he suggests searing the steak in a super-heated cast-iron skillet and finishing it in a 500-degree oven.

He likes the oven because you can control time and temperature better than you can on a grill.

The time in the oven is vital because it will determine whether the steak turns out rare, medium or well done, and that means you need to decide when to pull the steak out.

It’s an important decision. Pull it out too soon and you get something that’s way too raw for most palates. Leave it in too long and you’ve got burned meat, and that’s not a winner either.

Even with timing that steak in the oven perfectly, you can still get it wrong if you don’t let the steak rest before you cut into it.

The point of this story is that there’s a range of possibilities and personal preferences that come into play when deciding when to take action.

The decision of “when to retire” shares a lot of similarities. There’s no scientific process that says this is the right date for everyone. People are unique, and there are multiple right answers depending on your situation.

Of course, making timing decisions in cooking is inherently easier because you can experiment. It’s harder to do that with retirement decisions, and so it’s more important to think through issues ahead of time.

Like cooking, the best approach is to make use of some sensible techniques that get you pointed in the right direction and then help you think about the most important decisions you’ll face. This will allow you to customize the framework to get to the right answer for you.

I’m Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab.

It’s a show where we study the cognitive and emotional biases that can influence your financial decisions, both large and small. And we offer strategies designed to help you mitigate those biases and improve your financial life.

When you picture yourself in retirement, do you imagine yourself on the deck of a cruise ship, sipping on a frozen drink? Or how about tending to seedlings in your greenhouse and volunteering at your grandchildren’s school? Which would make you happier?

The minute you answer that question, you’ve engaged in something called affective forecasting. That’s affective with an A.

It’s a fancy name for the process of predicting the emotional consequences of future events that might happen to us.

There’s a lot of evidence that we’re not particularly good at making these forecasts. This matters because many of the decisions we face are based on how we expect the result of that decision will make us feel.

One classic example involves playing the lottery.

We imagine that winning the lottery will lead to an extreme improvement in our emotional state. That’s not a sure thing. Research shows2 that lottery winners tend to revert to the same level of happiness they experienced before their win.

That same reversion to the mean works in the opposite direction. When a bad thing happens, people are remarkably resilient and are able to adapt to their new circumstances.

Affective forecasting is relevant for deciding when to retire. Let’s imagine you’re having a bad month at work because you’re mired in a project that isn’t going anywhere and frankly, it doesn’t seem particularly important.

Let’s also imagine that you’re getting to the point where retirement isn’t something that’s merely a theoretical possibility, but something you’re starting to think about seriously.

The idea of being free and not having to work sounds more attractive than ever, and you set that retirement date as soon as is financially feasible because you imagine all of that free time will boost your spirits.

You’ve just made an affective forecast based, in part, on how you think you’ll react to getting away from the daily grind and having lots of free time.

Maybe all of that free time will boost your spirits, but maybe it won’t.

One of the problems when we forecast our future emotions is that we think about just the positive and negative aspects of it in isolation, and we tend to ignore the context in which that event would take place.

Let’s go back to our example. We focus on our current project that’s going nowhere, but we forget about the social aspects of work, which matter a lot to some people, and we forget about the fact that while the current project is a pain, the next one probably won’t be.

We think about the free leisure time, but we don’t consider that if we have unlimited leisure time, it might get old and it wouldn’t be as intellectually challenging as work. 

Another relevant bias is the optimism bias. When making predictions of the future, people have a tendency to take an overly positive view of how things will play out. In the episode titled “How You Can Reach Your Financial Goals,” we talked about how this affects financial planning in general.

These two biases interact with one another in some interesting ways that make for a bad news/good news situation. Excessive optimism leads many of us to not plan as thoroughly as we might about future stumbling blocks that we might encounter during our retirement years. That’s the bad news.

The good news is that the studies of affective forecasting tell us that people adapt to negative circumstances. Even if we hit some large speed bumps along the way and retirement doesn’t turn out exactly as we planned, people tend to move on and don’t let themselves get derailed.

What we’d like to do in this episode is to help you plan for one of the biggest decisions in your life: when to retire.

Mark: Joining me now is Robert Aruldoss, who is a senior research analyst for financial planning at the Schwab Center for Financial Research. He is a CFP® professional, and he is responsible for financial planning and retirement income issues. 

He’s here to talk about some of the factors that you need to think about while deciding when to retire. Welcome, Robert.

Robert: Happy to be here.

Mark: Deciding when to retire is a big decision and it’s complicated. What are the three most important factors that need to be thought through before settling on a retirement date?

Robert: Savings, health insurance/Medicare enrollment and Social Security.

Mark: That’s a good list. So let’s take those in order, starting with savings. How much money do you need to retire?

Robert: It’s a tough question, perhaps the toughest question to attempt to answer as a financial planner. But that’s what we help clients figure out. You can retire at any time. Whether that’s going to be enough for a comfortable retirement for you is a different story.

Mark: What do you need to ask yourself to get at what a comfortable retirement looks like?

Robert: Part of the answer is based on when you plan on retiring, how you define retirement, how long you might be in retirement, and what goals are most important to you in retirement. No two individuals are the same. 

Mark: Deciding what goals are the most important is going to make a big difference in how you choose to spend your savings. What’s a good way to go about making that determination?

Robert: One of the ways we help clients determine how much they need is to help them frame their retirement expenses into three big categories: needs, wants and wishes. Understanding their goals in these three categories can help me as a planner together with the client to determine if they’re on the right track based on where they are at.

Mark: Are there any rules of thumb people can use to determine how much money is enough?

Robert: Rules of thumb like having enough to replace 60 to 80 percent of your income or having X times your salary when you retire can be OK starting points when you’re a good ways away from retirement, but the closer you are to retirement, the more you want to focus on your specific situation.

Mark: Robert, earlier you mentioned that you need to get a handle on how long your retirement savings are supposed to last. How is a listener supposed to make that determination? Or another way of thinking about it is how long should someone plan on spending in retirement?

Robert: Average life expectancy for a 65-year-old male is about 84, 86 for a female. But average means that half of people live longer than that and half live shorter. What should you plan on? Well, generally it’s less risky to plan on living longer than average than shorter than average. 

Imagine you’re planning on travelling to the airport to catch a flight. If you get to the airport an hour early, you have quite a few options on what to do with the additional time you have. If you get there one minute late and miss your flight, your options are quite different and can be quite stark. Planning for how much to save and how long you’ll be in retirement is a little bit like this. 

Mark: Let’s say you’ve used a retirement calculator or you’ve spoken with an advisor of some sort, you’ve settled on a date and have a sense as to how long you’d like your savings to last. What do you do if you planned on retiring at age X and because of factors beyond your control you have to retire, let’s say, two years early?

Robert: This is where financial planning can really pay off. A well-designed plan can incorporate these types of “what ifs” to evaluate different scenarios and what options might be available to you. Financial planning is a dynamic process that helps you adjust and adapt when things go awry. It can’t include every worst-case scenario, but it can help you figure out what to do and what not to do next. A good retirement financial plan is both resilient and flexible.  

Mark: Everyone has a personal balance sheet with assets on one side and liabilities on the other. In the past most people tended to enter the retirement years with assets, but relatively little or no debt. In recent years, though, retirees with debt—that’s become a more common situation. So my question is, should you wait to retire until you’re debt free?

Robert: You don’t have to, but it’s a pretty good idea for people to plan on paying off debt before they retire. In some cases, it can make sense for a client with low interest, deductible debt to carry it longer. The math can make sense, but I’ve found over the years it’s important not to discount the emotional dividends that many people get from being debt-free. I would say that it’s risky if you are heading into retirement and are increasing the amount of debt you carry. 

Larger numbers of retirees are heading into retirement with increased levels of debt3 for a number of reasons, and this is a cause for some concern within the financial-planning community. Having no or little debt provides you with increased flexibility while you’re in retirement. 

Mark: Robert, we advise that retirees, especially early in their retirement years, that they hold a decent percentage of their portfolio in stocks. The rationale is that there’s a good chance that an individual will spend decades drawing from that portfolio and therefore the portfolio needs to have a growth component to it. That does create some risk, though, that the market has a big downturn just before or just after the retirement date. What do you do if you’re getting close to your retirement date and a severe market downturn hits?

Robert: First, don’t panic. It can be quite upsetting, but avoid acting rashly. You can often make things worse by making sudden moves. Instead, reassess your plan. One of the great things about having an investment plan is it keeps you focused on why you’re investing. A financial plan helps you keep things in perspective. Second, consider your options. Can you work longer? Save more? Reduce expenses?  And then lastly, ask for help. Having someone to talk to can help you see possibilities or strategies that you may not have considered on your own.   

Mark: All right, that’s enough about savings, let’s move on to the second item on your list, which is health care. How much should an individual plan on spending for health care?

Robert: There’s a number of figures out there, and it can be quite a shock. Some research from the Employee Benefit Research Institute4 indicates that it’s about a $125-130,000 for a 65-year-old. And those figures don’t include things like long-term care or dental expenses. With any figure like that, it’s important to consider what goes into that number. What are they including, for how long, with what degree of confidence, and how much do they project expenses to change over time? Quite honestly, almost any expense converted into a lump sum—your daily coffee habit, your annual property taxes over the next 30 years, can be an eye-popper. I find it more helpful to break down estimated health care expenses by month or year based on what a client is spending, from the actual composition of their expenditures, or is likely to spend and adjust these expenses based geography, rather than focusing on one giant number.

Mark: Let’s talk about that $125,000 number for a bit. Does that mean that the average person will spend, out-of-pocket, about $125,000 in today’s dollars on health care expenses?

Robert: Yes. Out-of-pocket expenses would include insurance premiums for things like Medicare, and supplementary insurance that many retirees have called Medigap, as well certain things that Medicare doesn’t cover like co-pays and deductibles.

Mark: My guess is that there’s a lot of variability around that number from person to person. Is that right?

Robert: Yes, some people pay less. Some people may pay a lot more. The difficulty with estimating health care costs is you don’t know precisely how and when these expenses can change. Everybody is a little bit different.

For example, I was trying to contact a new client who was in his late 80s. And when I initially tried to contact him, his wife told me that he wasn’t up to talking as he had been rather ill and in and out of the hospital. I told her that I was sorry to hear about this and would just leave it up to them to contact me. After not hearing from them for a couple of weeks and getting a little worried, I finally got hold of him. Well, it turned out that he had been racing around on his motorcycle and taken a turn too quickly and had gotten pretty banged up. Two lessons there: You don’t know what your health is going to be in retirement, and as good as it is, your health can change quickly. My client went back to riding; he’s just a little more careful these days.

Mark: That’s a great story and breaking that number down into a monthly number makes a lot of sense, and we know that health care expenses vary dramatically across the country. How does one go about converting that into a monthly number that makes sense given where they live?

Robert: For pre-Medicare eligibility health insurance costs, or before age 65, you can go to healthcare.gov to look at the cost of health insurance plans in your area. For post-65 costs, you can go to medicare.gov to see premiums for Medicare as well as to shop for Medigap plans. Remember, you’ll also want to pay attention to costs for health care services that Medicare or other insurance doesn’t provide.

Mark: So let’s talk about that more generally. How does medical insurance factor into the “when to retire” decision? Medicare is generally available to everyone at 65, and my guess is that that fact alone makes 65 a popular retirement age.

Robert: There are some exceptions if you’re disabled, but yes, if you’re a U.S. citizen or a legal resident for five continuous years, collecting or are eligible to collect Social Security, you’re eligible to enroll in Medicare at 65. Since most people have health insurance through work, 65 is a popular retirement age because of the availability of Medicare. If you retire before age 65 you can’t enroll in Medicare until age 65. A person would need to find health insurance coverage on their own, through the private market or possibly through expanded Medicaid eligibility or possibly by paying an extra amount to stay on their employer plan through what’s called COBRA until they reach age 65.  

Mark: Medicare, that’s a good transition to start talking about Social Security, which was your third big decision point. Should you retire when you start taking Social Security?

Robert: I encourage people to decouple the decision about when they retire and when they should claim Social Security to some extent. You’re not required to claim Social Security as soon as you retire, but many people do. But by claiming early, you permanently reduce your benefit. We believe that if you have a choice and are in good health, it’s generally best to wait as long as you can to take Social Security, but no later than age 70.

Mark: We did a whole episode on when to take Social Security last season, so I’d encourage people to go listen to that. But one thing we didn’t cover was the situation of the person who feels great and wants to keep working as long as they can. How does that impact their Social Security benefits?

Robert: This is an increasingly common planning issue that I come across as many people are living longer as well as living healthier lives. There’s several things to think about. One, if you’re still working, you’re still paying into Social Security. That increases your benefits because your Social Security benefits are based on your highest 35 years of Average Indexed Monthly Earnings, or AIME. If you don’t have 35 years of work history, those years are filled with zeros. Indexed means your earnings history is adjusted to reflect wage levels during that time period. So the income earned in your later years may fill in some of those zero or low earnings years from your work history. What’s more is, income earned after age 60 is no longer indexed, so are more likely to replace low earnings from early in your career—let’s say when you were working at a grocery store after school. If you are still working and don’t need the income from Social Security, you can delay claiming Social Security up to age 70. Delaying claiming Social Security substantially increases your benefit. Whether you are working or not, you shouldn’t delay claiming Social Security beyond age 70. There is no additional benefit.

And I said “if you are working,” since studies have shown that fewer people work as long as they plan to. About 40% of people5 retire earlier than planned due to health issues that come up or a change at their company.  

Mark: As a general rule, we’ve been proponents of holding off on taking Social Security as long as possible. Why is that?

Robert: For retirees that don’t have a traditional pension plan or annuity income, Social Security provides the only source of guaranteed income that the individual receives. By delaying Social Security, you are increasing the amount of inflation-adjusted, guaranteed income. Having a stable form or forms of income in retirement to replace your paycheck you received while you were working can improve your ability to cover essential expenses deep into retirement to hedge against longevity risk and provide increased peace of mind in the case of market volatility, increases in inflation, as well as cognitive decline. Once you set up Social Security, there’s not too much you need to do to manage it. But the main decisions when claiming are largely irreversible. 

Mark: Let’s talk taxes for a second. From a tax standpoint, what are the most important considerations that influence the retirement date?

Robert: There are a couple key ages that are important to keep in mind when it comes to taxes. To encourage people to save, the IRS can hit you with a 10% early withdrawal penalty when withdrawing from retirement accounts like IRAs or 401(k)s if you’re under age 59½.  If you leave your job on or after the year you turn 55, that 10% early withdrawal penalty doesn’t apply to withdrawals from employer-sponsored accounts like 401(k)s and 403(b)s, though. At 70½, you are subject to mandatory withdrawals called required minimum distributions, or RMDs. So if you’re still working, you can continue to make contributions and defer these RMDs to a traditional 401(k) until you leave.6 But that’s not the case with Roth 401(k)s, however, or traditional IRAs.

Mark: Let’s talk about some special situations. Partners with big ages differences and someone who’s single. Let’s start with the age gap. How does one deal with the financial aspects of that when it comes to the retirement decision?

Robert: A big one is making sure there is no gap in health insurance. This is critical if the person who is retiring has group coverage that also covers a younger spouse or partner. Another important consideration is accounting for two different life expectancies and retirement durations. This can impact how you invest and how much you need to save. A big difference in ages can also affect how you approach claiming your Social Security benefits. So for example, in some cases it might be beneficial for a younger spouse with a smaller Social Security benefit to claim early and an older spouse with a larger Social Security benefit to claim later. This is sometimes called a “split” strategy.  Such a strategy could improve cash flow early in retirement but still provide a higher Social Security survivor benefit to the younger and more likely surviving spouse. These are some of the things planners can help clients evaluate.

Mark: How about single people? Is there anything special they need to be thinking about?

Robert: A single person doesn’t have the advantage of some of the resource pooling that a couple has. For example, housing costs for a couple aren’t typically two times the amount of a single person. But then again, a single person only has to save for one person versus two for retirement.

A single person may need more of an emergency fund than a household with two people able to work and save.

Interestingly, long-term care insurers often provide a premium discount if there is more than one person in the household since they know that another person at home can help reduce or delay the likelihood of a long-term care claim for the insured if they have difficulty with activities of daily living—so things like eating, bathing, and dressing. 

So resources, which could include long-term care insurance, to help address physical or cognitive decline is particularly important for single individuals.

Mark: Robert, we know that lists are popular when it comes to this type of material. So give me a list of key ages for people in their 50s where something important is going to happen that affects their retirement planning decisions.

Robert: Fifty-five. So if you’ve left your job during or after the year you’ve turned 55, you can withdraw from an employer-sponsored 401(k) or 403(b) without being subject to that 10% early withdrawal penalty.

Fifty-nine and a half. That’s is the key age where you can withdraw from an IRA or other retirement accounts and deferred annuities without that 10% early withdrawal penalty.

Mark: What are the key dates for people in their 60s?

Robert: Sixty-two is the earliest you can claim Social Security retirement benefits. And 65 is the earliest you can enroll in Medicare, but it’s not that simple. Specifically, the Initial Enrollment Period for Medicare is 3 months before your 65th birth month, your birth month, and 3 months after your 65th birth month. So you’ve got a seven-month window to enroll.

For example if your birthday is June 15, your window starts March 1 and ends September 30.

The Special Enrollment Period is for people who enroll in Medicare later, so typically because they are working past age 65 and still have employer coverage and it’s within an eight-month period of losing employer coverage.

After age 65, non-qualified Health Savings Account withdrawals, or HSA withdrawals, are only subject to ordinary income taxes. So they act like an additional retirement account.

And then between 66 and 67, which is the full retirement age for Social Security based on your birth date, you’re no longer subject to the Social Security Earnings Limit test, where working can reduce Social Security benefits you are receiving.

Mark: So Robert I wanted to go back to this initial enrollment period for Medicare. So if I retire June 15, that’s my birth month, and my three-month window prior to that would be March, April, May, and then my three months after would be July, August, September?

Robert: Correct.

Mark: So my whole seven-month window is March first through September 3oth. Is that right?

Robert: Correct

Mark: What about key dates for someone in their 70s?

Robert: So 70 is the maximum age to contribute to a traditional IRA. And it’s also the maximum age to claim Social Security. Seventy and a half is when you’re subject to required minimum distributions.

Mark: And those required minimum distributions are from those tax-deferred accounts like 401(k)s, IRAs, that sort of thing, right?

Robert: Correct

Mark: I meet people of retirement age all the time, and for many of them retirement in the traditional sense just isn’t on their radar. They like what they do, they want to keep doing it. But even if that’s the case, are there some things they need to be paying attention to anyway?

Robert: Working longer can be a powerful strategy7 in helping you reach your financial goals and make up for savings shortfalls. But you may not be able to work as long as you’d like. You really want to focus on—keep saving. It may not seem like much, but every little bit helps. And then focusing on things you can control. Expenses, savings, your asset allocation. And as always ignore the noise.

Mark: Robert, this has been terrific. I appreciate you coming by today.

Robert: Thank you for having me.

A variety of factors contribute to happiness in retirement. Health and having an adequate income are among the items on the list. And that’s why it’s important to sit down and think about what an adequate income means to you and determine what combination of savings, Social Security and other resources will supply that income.

But don’t forget about three other items on that list: sufficient social contact, a sense of purpose and quality leisure time.

For many people, employment provides both social contact and a sense of purpose. When you’re thinking about when to retire, by all means pay attention to the financial side of things, which is what Robert spoke about.

But don’t neglect planning for how you’ll replace the social relationships that you get at work and how you’ll create a new purpose for your life. If you’ve already figured that out, then that’s terrific.

As for leisure time, those who have retired have a lot more of it. Spending that time in a way that provides meaning and enjoyment appears to be a powerful predictor of happiness in retirement. Before you leave your job, make sure you’ve got that one figured out.

But don’t forget about affective forecasting. It’s entirely possible that the thing you think you’re going to enjoy a lot may not turn out to be so enjoyable. Have a back-up plan, or at least plan on spreading your leisure time across several activities, knowing that some may not pan out exactly as planned.

The other bias we talked about in the opening was the optimism bias.

We highlighted that because it also comes into play when planning for your retirement date. Studies show that people tend to retire three years before they planned. The leading causes are involuntarily termination from their jobs or poor health.

Part of the reason people need to plan for a retirement date is to get an estimate as to how long they’ll spend in retirement. Circumvent the optimism bias by taking whatever time period you estimate and add on three years to take into account the possibility of exiting the workforce earlier than you anticipate.

One of Robert’s key factors for deciding when to retire is to make sure you have adequate resources to support your desired standard of living. In order to make that determination, one approach is to think about how you’ll be spending your time and make a detailed budget to go along with that.

That approach makes a lot of sense, but there are two problems with it.

First, practically no one actually does it. Only one-third of Americans prepare a budget, and that percentage is remarkably stable across all sorts of sub-groups of the population.

Second, people who do it don’t count correctly. This is called the budget fallacy. When budgeting, it is relatively easy to track recurring expenses, but if you focus on those your estimate will ignore all of the one-time, big-ticket expenses that occur from time to time, and that’s exactly what happens.

Here’s the really pernicious part of the budget fallacy. In one study, people who felt that savings was an important thing to do actually did the worst when it came to estimating future expenses.

The hypothesized reason is that people make predictions about their future behavior to match up with their self-conception. If one thinks savings is important, then they tend to predict a lower level of expenses to match up with their frugal image of themselves, but they actually end up spending more than they forecast.

A better approach for most people is to not build a bottom-up budget, but instead do a top-down budget. By that I mean look at what you’re spending today and take that as a starting point. And then add to it those items that will cost money and that you don’t spend money on today and subtract those expenses that will disappear or be reduced.

You can also find more information about timing your own retirement decision at schwab.com/retire.

Thanks for listening. If you’ve enjoyed this episode, consider leaving us a review on Apple Podcasts or your favorite listening app. It helps others discover the show.

For important disclosures and a transcript, see the show notes and schwab.com/financialdecoder.

¹ https://www.foodnetwork.com/recipes/alton-brown/pan-seared-rib-eye-recipe-2131274

² https://link.springer.com/article/10.1007/BF01367438

³ https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3018721

⁴ https://www.ebri.org/docs/default-source/ebri-issue-brief/ebri_ib_460_medicare-8oct18.pdf?sfvrsn=5c1b3e2f_2

⁵ https://www.ebri.org/docs/default-source/rcs/2019-rcs/2019-rcs-short-report.pdf?sfvrsn=85543f2f_4

⁶ Note: You can only defer an RMD from the 401(k) with your current employer. If you have a 401(k) with a previous employer, you have to take RMDs. 

⁷ https://siepr.stanford.edu/system/files/John%20Shoven%20-%20The%20Power%20of%20Working%20Longer.pdf