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The Irrational Retirement Choices We Make

New research reveals the misguided logic we use to decide when to claim Social Security, whether to retire and how to take a pension

By Richard Eisenberg

Funny thing about the way we make key decisions on when and how to retire: Often, we’re not very rational. And a few new, fascinating studies just presented at the annual Retirement Research Consortium meeting in Washington, D.C., prove it.
By “not very rational,” I don’t mean that our choices are nutty. We’re just not doing what economists say we should be doing. Janet Novack of Forbes recently wrote a smart piece about annuities along these lines, noting that economists typically say retirees should convert their savings into these monthly-income-for-life products — but most people don’t.
(MORE: How to Take Your Pension: Lump Sum or Annuity?)

There’s actually a good reason why economists characterize retirees and pre-retirees as irrational about such things as when to claim Social Security and stop working full-time: These choices are as much psychological as they are financial.
“Is a good decision one that gives you the best economic outcome or what makes you the happiest or most comfortable? That’s hard to say,” said Suzanne Shu, an assistant professor at UCLA Anderson Graduate School of Management, and a co-author of one of the new studies. “
Here’s how four of the studies say Americans in their 50s, 60s and 70s make retirement choices today – irrationally in the first three cases, but rationally in the last one:   
Why So Many Claim Social Security So Early
Economists, financial planners and, yes, Next Avenue writers typically recommend delaying Social Security benefits until age 70, rather than grabbing them as soon as allowed, at 62. That’s because, as Kerry Hannon just wrote in “5 Cures for Women’s Retirement-Spending Paralysis,” the size of your checks will be larger.
Social Security benefits grow by 8 percent annually for every year you delay claiming between your "full retirement age" (66 to 67 for people born after 1943) and age 70; your benefits are cut if you start taking Social Security between age 62 and your full retirement age.
(MORE: 4 Costly Social Security Mistakes to Avoid)

James Mahaney, a vice president at Prudential, says you could potentially double your initial Social Security payments by waiting until age 70 to start collecting.

And yet, a paper by Shu and John Payne of Duke University’s Fuqua School of Business reports that 50 percent of Americans start collecting Social Security at 62 or within two months of leaving the labor force; 80 percent or more claim benefits before their full retirement age.
How come?
To find out, Shu and Payne surveyed 3,000 adults 35 to 65 and found that many people said they intend to claim early due to what you might call the “It’s my money!” rationale.
“There’s a feeling of ‘I contributed to Social Security all these years and I want to be sure I get some of my money out before I die, so if I’m hit by a bus tomorrow, I’ll know I got something,’” Shu told me.
But Shu is concerned that some who file before 70 will later regret that choice due to the reduced Social Security checks. “I worry that a lot of people who claim early will look back in five or 10 years and think, ‘Boy, that was a bad decision,’” she said. “We sometimes make decisions based on how we feel at the moment, but there’s a tremendous potential for those not to be best in the long run.”
To address the “it’s my money” concern while persuading more retirees to delay claiming their benefits, Shu has a novel policy proposal: “If I were to change the Social Security system, I’d introduce an option letting people claim a lump sum at 62 to get some of their benefits, but delay claiming the majority of their benefits until later.”
The Surprising Decision Older Unemployed People Make
In his study about when people retire, Matthew S. Rutledge, a research economist at the Center for Retirement Research at Boston College, just discovered something unexpected about unemployed Americans between age 55 and 70: They weren’t more likely to look for work when the job market was good than when it was lousy, even though their chances of getting hired were greater.
(MORE: The Key to Making Smart Money Decisions)
“Older individuals have little tolerance for job searches and those who can afford to make a quick exit – falling back on a substantial financial portfolio and annuities from Social Security and previous employers – will do so,” he wrote. “The lack of evidence of an association between labor market conditions and the retirement decision indicates that one’s impatience has little to do with the difficulty of the job search.”
So if the job market didn’t matter much in deciding whether to retire or look for work, what did?

Rutledge said that being eligible for Social Security was a powerful influence – even though the unemployed who collect sooner rather than later will wind up getting smaller benefits.
“A lot of the jobless go to the Social Security office at 62 and claim benefits even if they hadn’t planned to,” Rutledge told me. “They’ll cost themselves some money this way, but they think it may be better than looking for a job.”
I asked Rutledge why he thinks so many older, unemployed people won’t look for work when the job market is rosy. “It could be that job searches are really daunting for them,” he said. Many, he noted, may have worked for the same employer for decades and are unfamiliar with today’s job-hunt process.
On top of that, some may avoid looking because they believe employers' age discrimination would prevent them from getting hired.
Rutledge said some of the older jobless who decide not to search for work could face serious financial consequences in retirement. “You’re going to be using your retirement savings for more time than you’d hoped and that’ll put some strain on you,” he said. “That could mean you’ll have less money to leave your kids or you’ll have to cut back on consumption.”
His advice: “Keep an eye on reversing this decision and going back into the job market, especially when times are good and prospects for getting hired are not quite as daunting. That’ll be a whole lot better than drawing down your savings too fast or getting a smaller benefit from Social Security.”
Why Retirees Snub Annuities
Another study tried to solve “the annuity puzzle.” That's what economists call the conundrum of why employees who are about to retire tend to take their pension as a lump sum rather than an annuity (most 401(k)s don't offer an annuity option).
After all, the economists say, if you select a lump sum, you then have the responsibility of managing the money and making it last your lifetime. The annuity, by contrast, automatically invests the cash and sends you monthly checks that won’t run out.
After surveying 5,000 Americans age 50 to 75, John Beshears, an assistant professor of the Harvard Business School, and four co-authors discovered that although older Americans like the idea of a steady income stream in retirement, they hated annuities’ lack of flexibility.
Signing up for an annuity, those seniors said, meant giving up control over their retirement funds. If you’re socked with an unexpected medical bill or need to replace the roof, an annuity won’t let you temporarily bump up the amount of cash it provides to cover the expense.
This worry is especially pronounced when retirees are faced with a choice mimicking the old Frank Sinatra song "All or Nothing At All" and must take their entire retirement stash either as a lump sum or annuity rather than a little of each.
“Putting all your money in an annuity can feel scary,” Beshears said. “But if retirees are allowed to keep 50 percent of their money in an annuity, that helps them feel they’ve met their need for flexibility and control.”
Indeed, when survey respondents were given a hypothetical partial annuitization option – taking an annuity for between 25 and 75 percent of their retirement money – 60 percent chose it.
Beshears thinks more people would sign up for annuities if they were given the partial choice. He also would like to see employers offer a “bonus” option, allowing retirees to, say, get somewhat bigger annuity payouts in December to help pay for holiday gifts and somewhat smaller ones during the rest of the year.
If you’re confronted with the lump sum vs. annuity decision, Beshears has some advice:
“You need to keep multiple objectives in mind. You want to be able to respond to contingencies in the short run, but you also need to keep in mind the objective of sustaining an adequate standard of living long into retirement,” he said. “It’s increasingly common that people are living well into their 90s. Do you have the ability to sustain a reasonable standard of living that long if you take the money as a lump sum?”
How Debt Affects When People Retire
The last paper that caught my eye, about the nexus of debt and retirement, was the outlier. It showed that people can sometimes be pretty rational when making retirement decisions.

The Urban Institute’s Barbara A. Butrica and Nadia S. Karamcheva looked at the finances of people 62 to 69 – all eligible for Social Security – and discovered that “older adults with debt are significantly more likely to work” than their counterparts without debt. This was especially true for those with mortgage debt.
Their paper is especially timely because debtloads for people over 65 have shot up in recent years. According to the most recent statistics, 43 percent of households age 65 and older had some outstanding debt in 2010, up markedly from 32 percent in 2000. And the amount they owe has soared, too – from $14,000 to $21,000, adjusted for inflation, among those who had debt.
“There’s so much talk about how expensive health care costs are in later life, and yet the number one expense for older Americans is not health care, it’s housing” said Richard Johnson, director of the Urban Institute’s Program on Retirement Policy.
Curiously, the researchers also found that people in their 60s with debt were significantly less likely to receive Social Security benefits than other people.
That surprised me, since I figured that people saddled with mortgages and credit card bills would be especially eager to sign up for Social Security and use their benefits to help pay the debt.
But Johnson said the reason is precisely because the debtors were still working. Social Security’s “earnings test” discourages people with jobs in their early 60s from claiming benefits.
With the earnings test, if you start taking Social Security between 62 and your full retirement age, you give up $1 in benefits for every $2 you earn from employment income exceeding a certain amount – $15,120 in 2013.
Johnson says Americans in their 60s with debt are making a wise choice by continuing to work and postponing retirement. “It’s smart to work a little longer if you can,” he said. “That’s the best way to improve retirement security – working till you’re 70, just a few extra years. It lets you increase your income and spread your wealth over fewer years than if you retire earlier.”
That’s not bad advice if you don’t have debt, too – assuming you can keep your current job or have the tenacity to find a new one.

Photograph of Richard Eisenberg
Richard Eisenberg is the former Senior Web Editor of the Money & Security and Work & Purpose channels of Next Avenue and former Managing Editor for the site. He is the author of "How to Avoid a Mid-Life Financial Crisis" and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS MoneyWatch. Read More
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