A Two-Question Quiz on The Timing For Your Retirement

The Wall Street Journal ran an article last month about a study that focused on people’s decision-making regarding whether to retire.  Before Retiring, Take This Simple Test reports on study by “Philipp Schreiber and Martin Weber at the University of Mannheim in Germany, [where]  a simple two-question quiz [was developed] that can help predict whether you’ll regret the timing of your own retirement.”  Two questions-that’s pretty easy, right. Here we go, it won’t take you long to answer them:

Question 1: You just learned that you are due a tax refund. If you’d like, you can get the $1,000 refund right away. Alternatively, you can get a $1,100 refund in 10 months. Which do you prefer?

Question 2: You just learned that you are due a tax refund. If you’d like, you can get a $1,000 refund in 18 months. Alternatively, you can get a $1,100 refund in 28 months? Which do you prefer?

How did you answer them? According to the article, “[t]he point of the exercise is to measure the consistency of a person’s time preferences. Someone with consistent time preferences should answer both questions the same way—choosing the early option both times, or the delayed option both times. Such consistency is a requirement for making financial plans that you stick with.”  There are folks who don’t answer consistently, and that’s a red flag, the article explains. Those folks  “exhibit a tendency known as present bias, or hyperbolic discounting. They strongly prefer rewards that arrive right away.” As for timing of retirement, the article notes that study shows that those who provided inconsistent answers ultimately regret the timing (too early) of their retirement.

The article suggests some positive applications of the study results. For those of us who participate in savings via payroll deductions, such programs could be improved “if they were personalized according to the results of the two-question quiz. Consider a person who exhibits a strong bias for receiving rewards in the present. Given the likelihood that she’ll be tempted by an early retirement, she might want to be defaulted to a higher savings rate during her working years. This will help her avoid future regret over the timing of her retirement decision, since she will have sufficient savings.”  The article goes further, suggesting changes to enrollment in Social Security to minimize buyer’s remorse for early retirement (evidently a lot of folks start drawing Social Security at age 62, which we all know results in a permanent reduction in benefits).

The study referenced in the WSJ article is reported in The Influence of Time Preferences on Retirement Timing. The abstract explains

This study analyzes the empirical relation between the decision when to retire and individuals time preferences. Theoretical models predict that hyperbolic discounting leads to dynamic inconsistent retirement timing. Conducting an online survey with more than 3,000 participants, we confirm this prediction. The analysis shows, that time inconsistent participants decrease their planned retirement age with increasing age. The temptation of early retirement seems to become stronger the closer retirement comes. We show that the negative effect of age is between 1.5 and 3 times stronger for participants who can be classified as hyperbolic discounters. In addition, we find that time inconsistent participants actually retire earlier. On average, the most time inconsistent participants retire about 2.2 years earlier. The time inconsistent behavior has severe consequences: Time inconsistent participants are ex post more likely to regret their retirement timing decision. Also, the unplanned early retirement leads to a constant decrease of retirement benefits of about 13%.

The full paper can be downloaded from the SSRN link here.