Are Thoughts of Early Retirement Today’s ‘Irrational Exuberance’?

While more Americans expect to retire before age 60, few have actually done the financial calculation

by E. Thomas Foster Jr

As the stock market continued to rise in value during the 1990s, investors continued their stock-buying binge despite warnings that the market was due for a correction.  A high-ranking Federal Reserve official described investors’ optimism about the prospects for stock valuations as “irrational exuberance,” prompting an immediate market selloff. Today, the term “irrational exuberance” may be applied to another optimistic expectation: Americans’ plans for early retirement.

Four in 10 Americans (40 percent) say they intend to retire before age 60, up from 32 percent five years ago, according to MassMutual’s 2018 State of the American Family (SOAF) Study¹. Only 22 percent of respondents now expect to retire after age 65, down from 30 percent in 2013. Americans on average now say they plan to retire at age 62, two years sooner than they did in the last SOAF study.

Yet, fewer people indicate they have calculated how much income they need to retire. In 2018, 56 percent of respondents had done the math compared to 61 percent in 2013, the SOAF study found¹. The greater optimism about the ability to retire at earlier ages potentially reflects a spike in 401(k) balances, according to the research. If you drill deeper into the data, though, it appears that many Americans may have a false sense of security when it comes to retirement.

For instance, the average 401(k) balance was $75,385 in 2016 compared to $72,383 in 2013, according to the latest data available from the Employee Benefit Research Institute, Consistent 401(k) Participation Leads to Higher Account report².  EBRI reports that “consistent savers,” those who continued to save throughout the period as measured, had average balances of $167,330 in 2016 compared to $121,152 in 2013.

So, When Is The Best Time To Retire?

To be fair, older Americans typically have more money put aside for retirement. The Economic Policy Institute reported that families aged 56 to 61 had an average of $163,577 saved, which would generate an average monthly income of $1,3293. Not much to be exuberant about, even with Social Security included in the mix. Perhaps a little less optimism about when it’s best to retire might help.

While Americans’ confidence about their ability to retire at a given age has risen slightly, to 47 percent in 2018 from 45 percent in 2013, some doubt remains, according to MassMutual’s SOAF study. Confidence in having enough money to last throughout retirement has slipped, with 35 percent of respondents in 2018 worrying about outliving their retirement savings compared to 33 percent in 2013, the study found.

Before retirement savers err on the side of optimism and leave their jobs sooner than they are financially prepared to do, financial advisors can help them avoid making a big mistake by conducting a gap analysis.

A gap analysis involves estimating both expenses and income in retirement, comparing the two and determining if there is likely to be an income shortfall.  Advisors can get retirement savers started down this path by asking a few pointed questions about whether they have calculated how much retirement income they will have and if they have determined what their monthly expenses are likely to be in retirement.

In general, savers need to project how much income their retirement savings will generate and how they will turn on the income spigot. Will they annuitize their savings, skim off their earnings or draw down some portion of both principal and earnings? How much do they expect to earn on their investments? Do they have any sources of guaranteed income such as a pension, immediate annuity or cash balance plan? And how much do they expect to receive from Social Security and when do they anticipate starting those payments?

Once you answer the income questions, it’s time to review expenses. Of course, how much savers anticipate spending in retirement may be highly variable. For instance, do they expect to have a mortgage, rent or other household expenses? What are they budgeting for food, transportation, clothing and other fundamentals? There are taxes and insurance to consider. Of course, there needs to be money set aside for recreation, travel, hobbies, dining and entertainment. But the biggest and most difficult expense to determine is often healthcare, especially for people with serious health problems.  If the analysis concludes there is a gap or shortfall between retirement income and expenses, then one factor to consider is that the saver’s planned retirement date may need some recalibrating. Learning that their retirement glass is half empty rather than half full is likely to be unwelcome news to some people.

Retirement Readiness: Patience & Pessimism

Fortunately, not all is lost if savers can exercise some patience and perhaps a little pessimism about their readiness to retire at earlier ages. Advisors may help clients and retirement plan participants overcome these challenges by encouraging them to pull as many levers available to help catch up on savings and better prepare themselves to retire more comfortably as possible:

• Maximize deferral
  Workers who have access to a 401(k) or other defined contribution plan can contribute up to $19,000 annually. Even over a short time, those savings can quickly add up, especially with positive investment returns. Advisors can help clients review their budgets to find extra dollars to save.
• Use the catch-up provision
  Those who are age 50 or older – this applies to all baby boomers whether they want to admit it or not — can contribute an additional $6,000 annually in a defined contribution plan for a total of $24,000. Putting away the maximum amount allowed from ages 50-65 can add up to another $360,000 – and that’s before any investment gains.
• Take advantage of any employer match
  While not all employers match employee contributions, many do. If a retirement plan participant cannot afford to contribute the maximum or close to it, then he or she should consider saving enough to secure the available maximum in matching contributions. A 50 percent match on the first 6 percent of salary deferred to a 401(k) for someone earning $50,000 a year may yield an extra $1,500 in annual retirement contributions.
• Save pre-tax
  Contributing pre-tax dollars to a 401(k) or similar plan can reduce the saver’s taxable income. Doing so can help free up additional dollars for savings in another vehicle such as an IRA, mutual fund, annuity or other financial vehicle.
• Work longer
  Many boomers have already come to the conclusion that they will need to work longer. The good news is that the skills, experience and knowledge of many older employees may be in demand, especially those with hard-to-replace capabilities.
• Put off taking Social Security
  Postponing Social Security at age 65 or later can boost future payments by 8 percent for every year the income is deferred until age 70, the Social Security Administration reports4. Few investment strategies net such a return, never mind one with a guarantee.
• Work in retirement
  Three in four (74 percent) working Americans say they plan to continue working after retirement, according to Gallup’s Economy and Personal Finance Survey⁵. That includes both full-time and part-time work.

Taking these steps – particularly working longer and putting off Social Security – demand patience and taking a longer-term view. But those who do can potentially improve their ability to live more comfortably and enjoy a more fruitful retirement.

All of these retirement preparation tactics should be part of a saver’s overall retirement plan, a living document that should be reviewed annually or if life or market conditions warrant. As the plan comes together and savers check off individual tactics, their retirement readiness may improve.

It’s understandable that the prospect of retiring – especially doing so early – can evoke feelings of exuberance.  Just make sure their feelings remain rational. ◊

Endnotes
1. MassMutual 2018 State of the American Family Study Fact Sheet on Retirement,  https://www.massmutual.com/~/media/files/State-of-the-American-Family-Retirement-Fact-Sheet.pdf
2. Consistent 401(k) Participation Leads to Higher Account
Balances, Employee Benefit Research Institute, Nov. 6, 2018, https://www.ebri.org/docs/default-source/ebri-press-release/pr-1225-long-k-6nov18.pdf?sfvrsn=37773e2f_2
3. Economic Policy Institute, the State of American Retirement, 2016, https://www.epi.org/publication/retirement-in-america/#chart1
4. Social Security, Delayed Retirement, https://www.ssa.gov/planners/retire/1943-delay.html
5. Gallup Economy and Personal Finance Survey, 2017, https://news.gallup.com/poll/210044/employed-adults-plan-work-past-retirement-age.aspx?g_source=link_NEWSV9&g_medium=TOPIC&g_campaign=item_&g_content=Most%2520U.S.%2520Employed%2520Adults%2520Plan%2520to%2520Work%2520Past%2520Retirement%2520Age