How to decide when to retire

http://www.thehindubusinessline.com/features/investment-world/money-wise/how-to-decide-when-to-retire/article4516179.ece
B. VENKATESH

Retirement planning is complex. You have to decide on two important factors — when to retire and how much wealth you want to accumulate at retirement. The problem is that both factors are dependent on each other. One way to overcome this problem is to set your retirement date and then plan to accumulate the desired retirement wealth. In this article, we discuss the issues you need to consider before deciding your retirement date.

TRADITIONAL RETIREMENT

Till not so long ago, employers assumed the risk on their employees’ retirement portfolio. In such a world, the employer paid a fixed pension to the employee during her lifetime. At worst, the employee faced inflation risk (the risk that the pension income was not enough to sustain her living expenses because of increase in price levels).

In this world, employees typically retired at 60 because their employment contracted terminated at that age. Besides, pension income was paid to the employees after they turned 60. When to retire was, therefore, never a choice that employees had, unless they wanted to retire early.

But things are different now with even the Government now passing on the retirement investment risk to its employees. Today, your employer makes an annual contribution to your retirement portfolio. This contribution along with your monthly deposits accumulates in your retirement portfolio. At retirement, you are expected to take that wealth and use it to buy assets that will fetch you monthly income in your retired life. In other words, the responsibility lies with you to convert the wealth in your retirement portfolio into a retirement income portfolio.

The passing of the investment risk from the employer to the employee has led to a paradigm shift in retirement planning, for retiring at 60 is no longer relevant. So, how should you decide your retirement date?

MODERN RISKS

Given that the amount of wealth you want at retirement and when to retire are dependent on each other, you should start with a desired retirement age to plan your retirement wealth. As it turns out, the primary factor that you should consider for your retirement date is your health.

For one, if you have moderate-to-high health risk because of illness such as diabetes, you may want to work as long as possible. The reason is simple. The healthcare plan that your employer offers you as part of your employment benefits will prove useful in managing your health risks. Of course, this presupposes that your health condition does not affect your professional work.

For another, if you are healthy and have a family history of living long, you should be concerned with longevity risk (whether the money you have at retirement will be enough to sustain your living expenses through your long retired life). You may want to work as long as possible if you are concerned with longevity risk.

From the above, it may seem that you should work as long as possible, whether you are healthy or otherwise. But you may also have the urge to take an early retirement and pursue your lifestyle desires. Your retirement portfolio should be created with a view to balancing your desire to retire early and the need to manage your longevity risk.

The need to balance early retirement and longevity risk is not easy. One way to overcome this issue is to start with a retirement date, say, 55. This assumption helps in two ways. One, this gives you a handle to calculate how much you need to contribute each month to your retirement account to accumulate wealth you require for early retirement. And two, you can postpone your retirement till, say, 60 if you are unable to accumulate the desired wealth by 55.