Executive Summary
The 'traditional' approach to retirement is relatively straightforward: save and invest as much as you can, for as long as you can, starting as early as you can, to accumulate enough retirement savings that you no longer need to work, and instead can enjoy a life of leisure. For those who struggle to save, Social Security provides some retirement safety net, and for everyone else, the more and faster you save, the earlier you can retire and the more leisure time there may be.
The problem, however, is that a growing base of retirement research finds that fewer and fewer people actually want a retirement of all leisure and no work. Thanks in large part to our “hedonic adaptation” abilities – where we quickly adjust to our new circumstances – retirement is actually boring for many! Barely half of today’s retirees state that they never intend to work again, and barely 1/3 of pre-retirees have an intention to make retirement a period of not working indefinitely. Instead, whether it’s part-time work, entrepreneurialism, an encore career, or some other path, “retirement” is less and less about not working at all, and more and more about finding a different kind of engagement (which may still involve a non-trivial amount of employment income).
The significance of these changes is that if an intense period of work followed by an extended period of leisure turns out not to be the ideal approach retirement – and that instead, better alternatives might be an extended period of “semi-retirement” (with part-time work) or a series of “temporary retirements” (interspersed with sabbaticals and then new careers) – that the traditional retirement savings approach might not make sense either.
Because the reality is that if retirement is really more about doing different and perhaps more fulfilling (but not necessarily zero-income) work, then it really might not take nearly as much to “retire” as commonly assumed. And “retirement” portfolios themselves might look very different, if their primary purpose is to be a buffer for retirement transitions and perhaps scaled-back work, rather than a period of earning nothing at all. Some actually necessitate more savings, but have a smaller average balance (as it's built up and spent), while other types of retirement would actually allow for less ongoing savings and smaller retirement account balances (supplemented by partial work in "semi-retirement" that could last for years or decades).
In turn, a future with different types of retirement could also increase demand for disability insurance (as a greater reliance on the ability to work and earn income puts us at even greater risk if that goes away), and increase the need for emergency savings (for more extended mid-career transitions). Though from the financial advisor’s perspective, perhaps the greatest potential disruption of different types of retirement is that for most of the alternatives to the “traditional” approach, retirees will never accumulate as large of a retirement portfolio in the first place, which could substantially impair the feasibility of the AUM-based retirement planning approach!
Traditional Retirement – From Unworkable Time To Leisure Time
For most of human history, “work” was something we did for survival, as long as we were physically capable. In the “modern” era, we at least instituted a process of schooling when we were young – if only to train for more sophisticated work to do, for the rest of our lives. Of course, the caveat is that the longer we live (thanks in part to improving health and medicine), the more likely it is we’ll reach a phase in our lives where we physically (or mentally) can’t work anymore. Thus, in 1889, Germany instituted the first “old age social insurance program” – a predecessor for our Social Security program in the US – to provide a means of taking care of those who no longer could work to provide for themselves. Of course, back then, few were expected to actually rely on the program; the initial retirement pension began at age 70, when the life expectancy of a Prussian was only 45!
Yet continued medical advances over the past century have fundamentally shifted retirement, from a period of “worker’s obsolescence” (where forced retirement was a way to get older, less productive workers out of the way for younger, newer ones) into a world where retirement itself lasts so long that it’s actually a “phase of life” – a post-work period of planned leisure, the culmination of a lifetime of working and saving.
As retirement shifted from a period of obsolescence to one of leisure, it is not surprising that many wanted to maximize the leisure time – which to some extent elongated naturally with continued health improvements, but also has driven a focus on trying to retire “early” in order to have more leisure years to enjoy. Of course, the caveat is that retiring earlier means it’s necessary to save more in order to retire (since there are more retirement years to pay for), which in turn may entail trade-offs of spending less today (for current workers). Accordingly, the reigning paradigm became “save as much as you can, for as long as you can, and you’ll be able to retire as early as possible (and enjoy as long of a retirement as you can!)!”
The Hedonic Treadmill Of Leisure Time
For those who are working – particularly in a job they don’t enjoy – the idea of an extended retirement of leisure sounds like a highly appealing goal to reach. The problem, however, is that not everyone seems to enjoy it once they arrive.
The problem is that human beings are remarkably adaptable to their circumstances, and our happiness tends to revert to a relatively stable level, even after major changes and life events. The phenomenon, known as “hedonic adaptation”, means that while we’re working, a life of leisure sounds great… but once we actually retire into that life of leisure, it often becomes boring and routine and no longer as enjoyable. In other words, we may continue walking towards a goal that we perceive will bring us happiness, but like being on a (hedonic) treadmill, no matter how long we walk, we never actually make much progress forward.
As a result, a growing number of retirees are seeking ways to stay active even after retirement – developing, in the words of Mitch Anthony, a “New Retirementality” about what retirement really means, that goes beyond just living an “active leisure” lifestyle. From the rise of “Encore Careers”, to growing entrepreneurialism amongst “seniors” over age 65, a recent Age Wave study found that in reality only about half of retirees actually plan to “not work” in retirement! And the trend is accelerating – the same study found that amongst pre-retirees, only 28% actually plan to “never work for pay again” in retirement (and amongst those, some will likely simply “work” as a volunteer instead)!
In other words, the transition to “retirement” might at least mean retiring away from a current job or career – particularly if it’s not a very enjoyable one – but doesn’t necessarily mean retiring from work altogether. Which is important, from the perspective of the modern focus on saving (early and aggressively) for retirement!
3 Different Types Of “Retirement”?
If you assume, for a moment, that reaching the moment of “retirement” doesn’t actually mean the end of work, but merely the end of a current job or career – opening the door to a new type of work instead (and, potentially, one where it matters less how much you make) – what you end up with what J.D. Roth calls several different “types” of retirement.
The “traditional” type of retirement is the one that we’re all most familiar with – save early and often, invest prudently for growth, and retire as soon as you’re financially able. If you can grow your retirement portfolio fast enough, you can retire early. If not, you’ll at least have the opportunity to retire in your 60s when Social Security becomes available. The time in retirement is filled with leisure, or perhaps engagement through volunteer “work” (but without any financial remuneration).
One alternative, though, is a form of “semi-retirement”, where work is scaled back, but not eliminated. This might entail starting a business, pursuing a new career, or engaging in consulting or part-time work in a prior career. In essence, semi-retirement in this context means retirement from the current full-time job/work, but not necessarily from any work. In fact, some level of ongoing – and paid – work would be anticipated, which helps both personal fulfillment and wellbeing, and provides substantial ongoing financial assistance (which in turn means it may be able to happen earlier than traditional retirement)!
The third type of retirement is engaging in a series of “temporary retirement(s)” – in essence, sabbatical breaks that occur, with some planned regularity/periodicity, for a limited period of time, after which the individual returns to the working world (albeit in a potentially new job or career track). In this approach to “retirement”, the act of retiring – withdrawing from the working world – is not something that comes at the end, but instead is dispersed more regularly throughout the individual’s productive years, perhaps as transitions between extended careers. Depending on the individual’s inclination (or type of work, or chosen profession), the pace of sabbaticals could be less frequent but for longer periods of time, or for shorter periods that occur more often. The phase of retirement at the end would be shortened though, as those retirement years are intentionally “redistributed” into earlier phases of life.
Saving For Different Types Of Retirement?
The reason why these different types of retirement are so important is that the “standard” saving for retirement approach is really only effective for one type: the traditional one (either at ‘normal’ retirement age, or earlier retirement). Because in most other forms of retirement, that won’t have such an extended period of “no work” (and no income), it’s simply not as necessary to generate a huge pile of retirement dollars in the first place!
For instance, if leisure periods are going to be shorter and temporary, followed by a return to work (which continues to a later age), then the reality is that for most of your life, you never need as much in retirement savings, as it only peaks at the very end to cover the last decade when some sort of work is no longer feasible!
As shown above, with a series of ongoing temporary retirements (or sabbaticals), the retirement savings account never quite accumulates as high, and doesn't need to be accumulated nearly as rapidly, because the retirement phases just aren’t that long! On the other hand, it’s notable that with shorter ramp-ups and faster spend-downs, the portfolio never has as much time to grow and compound, nor will it be invested as aggressively (given the shorter time horizons), which means the prospective (ongoing-temporary) retiree will need to spend less and save more to make the balance work. In this case, the retiree had to increase savings for $350/month to about $600/month to maintain the same standard of living. Yet ultimately, that’s simply a trade-off decision to consider when choosing the ideal type of retirement.
Similarly, someone who chooses to engage in semi-retirement – and continues to partially work while being financially independent – also drastically reduces the required savings to “retire” for most of their lifetime. Because human capital – the present value of future earnings from continued work – is actually worth a lot as a “retirement” asset!
After all, at a 4% safe withdrawal rate, generating $40,000/year of income for several decades of leisure requires $1,000,000 of retirement savings. Which means someone who’s willing to continue doing at least some work in retirement could substantially defray the required savings. Every $10,000/year of work in a state of “semi-retirement” financial independence reduces retirement savings needed by $250,000! “Just” earning $20,000/year to supplement a $40,000/year withdrawal goal cuts the required retirement savings by half a million dollars.
Notably, in the semi-retirement scenario above (where it is assumed that the retiree works part-time to cover household expenses from age 55 to 80), there may still ultimately be a final period without any work at all, but again, it tends to be much shorter in duration and occurs later; in this context, retirement savings is less about a period of "leisure" and more about just covering the final decade when work fully stops! But the fact that the portfolio itself has longer to grow also drastically reduces the required retirement savings; in the semi-retirement scenario, "success" requires only about $120/month of savings, or nearly 2/3rds less than the traditional retirement!
And notably, the key point here is not merely that these alternative paths to retirement may entail different retirement savings strategies, but specifically that alternative forms of retirement may require far more in ongoing monthly retirement savings, or far less, depending on the type of retirement – and either way, most will have a much smaller retirement account balance for most of their lifetimes. In the context of today's prospective retirees in particular, for those who may be able to engage in "semi-retirement" and still partially work, the results suggest that many may be unnecessarily stressing about their ability to save for a “retirement” that won’t actually necessitate nearly as much in retirement savings!
Disability Insurance And The Risks To Human Capital
One of the key risks to consider in these alternative types of retirement is that when retirement savings never accumulates as high (or at least, not until much later), and are more reliant on earned income and “human capital”, the individual doesn’t have as much of a buffer against truly unexpected retirement – e.g., due to disability. Social Security provides at least some safety net, but may be far below the standard of living he/she is accustomed to.
Arguably, this makes disability insurance even more important than it already is, in the future of retirement. An important consideration, given that in practice today, disability insurance still isn’t actually utilized very much (with only a 33% participation rate for group long-term disability insurance in today’s work environment, and relatively little private disability insurance adoption). And even then, it typically only goes until age 65 and provides a bridge to relying on Social Security in “traditional” retirement.
The good news, at least, is that as medical advances proceed, and we continue to “square the curve” on longevity, we may be less likely to be disabled in the first place. Nonetheless, though, this implies at a minimum that having an even larger emergency savings to help navigate the transitions becomes more important.
The bottom line, though, is simply to recognize that alternative types of retirement have the potential to substantially change traditional retirement advice. With planned semi-retirement or sequential temporary retirements, retirement savings will not be invested nearly as long term (which demands a different portfolio composition), and will never accumulate as high (since there isn’t nearly as long of a non-work period). In turn, emergency savings and disability insurance become even more important, as do other key human-capital-related elements of financial advice, from guidance on career advice to job retraining to help navigate each ‘re-entry’ after a transition phase, or to find an appropriate semi-retirement role.
As noted earlier, though, with the latest Age Wave study already showing that the majority of today’s pre-retirees don’t actually intend to engage in the “traditional” retirement approach, it’s time to consider whether retirement advice itself needs to shift from being less retirement-portfolio-centric. Which could actually be a substantial transition – and substantial challenge – to today’s financial advisors, as our business models are increasingly focused on an assets-under-management approach that has a natural bias towards just one of the three types of retirement (and our financial planning software is not well built to model alternative types of retirement strategies). Which in turn raises the question of whether as financial advisors, we ourselves are fully prepared – from our advice and value proposition, to our business models and software tools – for the alternative types of retirement that the future may hold!?
So what do you think? Will most people find traditional retirement fulfilling? Do you see more clients engaging in alternative forms of retirement? Do we need new strategies to address saving and risk management for different types of retirement? Please share your thoughts in the comments below!
