Retirement

Retirement is the period of life in which an individual reduces or ceases regular employment or other primary income-generating activity, generally after reaching a specified age or accumulating sufficient financial resources to support continued living expenses.

Retirement may be voluntary or involuntary and may occur at different ages depending on an individual's financial circumstances, employment conditions, health, personal preferences, and applicable pension or social-security rules.

Retirement income

Retirement income may come from multiple sources, including:

pensions;
pension plans;
social-security programs;
personal savings;
investment income;
annuities;
rental income;
other assets or financial arrangements.

The combination of income sources varies among individuals and retirement systems.

Retirement planning

Retirement planning is the process of estimating future financial requirements and developing a strategy to accumulate and manage resources for retirement.

Planning may consider:

expected retirement age;
current savings;
future contributions;
investment returns;
expected expenses;
inflation;
taxes;
healthcare and other costs;
expected longevity;
desired retirement income.

A simplified future-value calculation for a single investment can be expressed as:

$F V = P V (1 + r)^{n}$

where:

FV = future value;
PV = present value;
r = rate of return per period;
n = number of periods.

Actual retirement planning generally involves multiple contributions, withdrawals, changing returns, inflation, and other variables.

Pension systems

Pension systems provide structured mechanisms for financing retirement.

Major pension arrangements include:

defined benefit pension plans;
defined contribution pension plans;
government pension programs;
individual retirement arrangements.

The design of pension systems determines how contributions, investment risks, longevity risks, and retirement benefits are allocated.

Defined benefit pensions

A Defined benefit pension plan provides retirement benefits according to a predetermined formula.

The benefit may depend on factors such as:

salary;
years of service;
retirement age;
an accrual rate.

The plan sponsor generally assumes significant responsibility for funding and investment risks associated with the promised benefits.

Defined contribution pensions

A Defined contribution pension plan specifies contributions rather than a predetermined retirement benefit.

The retirement value generally depends on:

contributions;
investment performance;
fees;
withdrawals;
length of participation.

Investment risk is generally borne primarily by the participant.

Retirement savings

Retirement savings are financial resources accumulated during an individual's working years for use during retirement.

Savings may be held through:

pension plans;
retirement accounts;
bank deposits;
mutual funds;
securities;
other investments.

The appropriate allocation depends on factors such as investment horizon, risk tolerance, liquidity requirements, and retirement objectives.

Investment management

Portfolio management plays an important role in retirement planning because accumulated retirement assets may need to support expenses over a potentially long period.

Investment strategies may involve:

Diversification;
Asset allocation;
Portfolio rebalancing;
active management;
passive management;
income-oriented investments.

The appropriate strategy may change as an individual approaches and enters retirement.

Retirement income risk

Retirement income can be affected by several risks, including:

investment risk;
inflation risk;
longevity risk;
interest-rate risk;
sequence-of-returns risk;
liquidity risk.

Managing these risks is an important component of retirement planning.

Longevity risk

Longevity risk is the risk that an individual lives longer than anticipated and therefore requires financial resources for a longer period.

An individual who retires at a relatively young age may need to finance several decades of expenses.

Annuities and other lifetime-income arrangements can be used in some retirement systems to transfer or manage longevity risk.

Inflation risk

Inflation risk occurs when increases in prices reduce the purchasing power of retirement income and accumulated savings.

For example, if retirement income remains fixed while prices increase, the real purchasing power of that income declines.

A simplified relationship between nominal and real returns is:

$1 + r_{real} = \frac{1 + r_{nominal}}{1 + π}$

where:

r_real = real rate of return;
r_nominal = nominal rate of return;
π = inflation rate.

Retirement age

Retirement age refers to the age at which an individual retires or becomes eligible for specified retirement benefits.

Different systems may distinguish between:

normal retirement age;
early retirement age;
deferred retirement age.

Eligibility requirements and financial consequences vary according to the pension system and applicable rules.

Early retirement

Early retirement occurs when an individual stops regular employment before the standard or normal retirement age.

Early retirement may require greater accumulated savings because retirement resources must support a potentially longer period.

Some pension systems may also reduce benefits for early commencement of pension payments.

Deferred retirement

Deferred retirement occurs when an individual continues working beyond the normal retirement age.

Depending on the pension system, continued employment may increase retirement savings, pension benefits, or other retirement resources.

Retirement and taxation

Retirement income and withdrawals may be subject to taxation depending on the jurisdiction and source of income.

Tax considerations may include:

taxation of pension payments;
taxation of investment income;
taxation of capital gains;
taxation of retirement-account withdrawals;
tax treatment of contributions.

The applicable rules vary substantially among jurisdictions.

Retirement and healthcare

Healthcare and long-term-care costs can be significant components of retirement expenditure.

Retirement planning may therefore consider expected medical expenses, insurance coverage, government healthcare programs, and potential long-term-care requirements.

Importance

Retirement represents a major transition from employment-based income to a combination of pensions, savings, investments, and other sources of financial support. Effective retirement planning requires consideration of income requirements, accumulated assets, investment returns, inflation, longevity, taxation, and financial risks over the retirement period.