Employees who plan to retire when their savings accounts are flush from an economic windfall should rethink their strategy, new research shows.
A study by University of Missouri assistant professor Rui Yao found that retiring when economic conditions are at their best often causes major problems for a retiree's long-term financial stability.
Yao said potential retirees often meet their targeted retirement savings goals during an up market and will be tempted to retire at that point, but never account for how cyclical the economy is and that it will eventually take a downturn.
"People who have retired shortly before an economic downturn run a serious risk of losing a significant portion of their retirement savings, which will shorten the longevity of their retirement income," Yao said. "This could result in many retirees outliving their retirement savings and facing financial hardships toward the end of their lives."
As part of her research, Yao examined data from the Health and Retirement Study, a national biannual survey conducted by the University of Michigan. She reviewed the financial and retirement statuses of more than 4,000 households with retirement-age Americans from 1992 to 2008 and found that the probability that retirement-eligible Americans chose to retire increased as the number of consecutive up- market years increased. The research shows that every 1 percent increase in market returns increased the probability of retirement by more than 2 percent.
Yao recommends that if their savings will allow for it, potential retirees end their working careers during an economic downturn. Then once the market recovers, retirees' savings will increase above their initial target goals, creating an adequate financial cushion for future economic downturns, Yao said.
The research also shows that married couples who choose to retire at the same time could be setting themselves up for financial problems late in life.
"It makes sense that many married couples would want to retire around the same time," Yao said. "However, if both spouses decide to retire close to the end of an up market, the household would have little to no cushion should their retirement portfolios be affected by an economic downturn."
Yao believes the research shows the need for retirement planners, employers and financial educators and practitioners to help pre-retirees better understand the challenges they face in order to reduce the likelihood of financial difficulties during retirement.
The study was published in the Journal of Personal Finance and funded by a grant from Prudential Insurance Co. of America.