The Economy's Lasting Impact on Your Retirement

Economic declines shortly before retirement can permanently decrease retirement income.

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The economic downturn has changed the way Americans think about retirement. Instead of chasing the highest possible investment returns, many people are seeking a measure of safety. This will certainly help middle-aged and younger retirement savers to better weather future stock market declines. But for the oldest baby boomers already on the verge of retirement, it may be too late.

"Just as it matters what the economy is doing when you first enter the job market, it also matters what the economy is doing when you retire," says Olivia Mitchell, director of the Boettner Center for Pensions and Retirement Research at the University of Pennsylvania. "Some who expected being able to rely on their own private saving and investments in old age have now awakened to the unpleasant new reality that their future is likely to be far riskier than they had anticipated." Here is how the state of the economy in the year you retire can impact your retirement income for the rest of your life.

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Lower investment returns. A stock market slump in the years leading up to retirement could affect your investment income decades into your retirement. Declines in stock prices when workers are in their 50s and 60s results in lower investment income for retirees ages 70 to 79, according to new research by Wellesley College economists Courtney Coile and Phillip Levine. Conversely, retirement income increases when there is a run-up in stock prices in the years before retirement. If S&P 500 returns are 100 percentage points higher during the five-year period when a worker is between ages 55 and 60, retirement income is estimated to be about 22 percent or $1,750 higher annually between ages 70 and 79, the researchers found. A similar boost in the stock prices between ages 60 and 65 results in a 13 percent or $1,100 boost in income in the retiree's 70s. Workers who reach retirement age when the stock market is declining will need to cut their retirement standard of living or delay retirement. "If they work long enough they can in some sense completely fix the problem," says Levine.

Unplanned early retirement. Delaying retirement isn't an option for everyone. Many older workers find themselves pushed into an early retirement after a layoff or buyout. Those who can't find a new job may begin to reluctantly call themselves retired. Workers who are at least age 62 when they are laid off can claim Social Security benefits, but annual payments are reduced for early claimers. A baby boomer born in 1946 who would have received $1,000 monthly if he signed up at age 66 will receive just $750 each month if he claims at age 62.

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"In some sense, it's just the luck of the draw. You are born and 62 or 65 years later you hit a labor market that is either strong or weak," says Levine. "If it's strong, you can work as long as you'd like and choose the retirement date and level of Social Security benefits that is right for you, and if the labor market is weak that might not be possible. People born at the wrong time are getting lower benefits." The reduced Social Security payments last for life unless the beneficiary suspends payments or pays back the money already received.

401(k) mistrust. Fewer investors now believe that simply contributing to a 401(k) or similar type of retirement account will propel them to a secure retirement. Retirement savers are becoming more sensitive to the risk associated with retirement investments (73 percent) and increasingly interested in products that provide a guaranteed return (70 percent), according to a recent Financial Planning Association survey of 1,068 financial advisors with baby boomer clients underwritten by MetLife. The majority of the financial advisers say that retirement planning is largely about protecting your portfolio against market losses (83 percent) rather than participating in market gains (17 percent). "Most clients and advisers are more protection oriented than they were before," says Julia Lennox, vice president for retirement products at MetLife. "Unless we see a prolonged positive steady market I think we are going to see this protectionist mentality stick."