Determining the best age for retirement is a multifaceted process, but financial needs should be a central consideration. Retirees require sufficient cash flow to cover basic needs along with desired lifestyle, but they also have to manage the biggest risks, including longevity risk, inflation risk, and healthcare. If all the elements of a financial plan aren't in place to provide enough cash flow without incurring too much risk, investors might have to consider a different retirement age. 

To determine the ideal retirement age, people need to weigh their anticipated cash needs against guaranteed income and cash flows produced by their accumulated assets. A successful retirement can be achieved once those cash needs are covered.

1. Anticipated cash needs

Investors need to estimate how much cash they'll need annually to meet basic needs and support their desired lifestyle. It's generally understood that income after retirement can be meaningfully lower than during working years because there's no explicit need for continued saving, houses tend to be paid off, and people usually no longer have children to support. 

Older couple sitting together on a couch, smiling at a tablet computer.

Image source: Getty Images.

However, people often require more than anticipated during the golden years due to higher medical expenses, more time spent traveling or eating out, and changing standards of living. In the 1980s, people likely hadn't expected to incur bills for internet service or cellphones that are seen by many as basic costs of living today. Long-term care has become a major element in retirement financial planning, with more and more seniors requiring nursing homes, acute care, or in-home care that can easily surpass $7,500 each month.

Moreover, inflation drives all these prices higher over time, further complicating the decision. Retirees need to conservatively tally their anticipated income to ensure that it can cover expenses. Any shortfall here might force them to delay retirement. 

2. The amount you've saved and interest rates

Savings in brokerage and retirement accounts can produce cash flow through dividends and interest, and assets can also be sold to pay for lifestyle needs. Retirement planners often quote the 4% rule, meaning that investors can safely withdraw 4% of their total portfolio value each year in retirement without running out of cash.

However, historically low interest rates and rising life expectancy are causing many to challenge this rule, which may need to be revised downward to 3% or lower. So, for every $1,000,000 in savings, retirees can reliably expect $30,000 in annual cash for living expenses. Rising interest rates would hypothetically reduce the amount of savings required to generate that income, but the Fed has indicated that rates will remain low for the foreseeable future.

Anyone relying on funds in a qualified plan such as an IRA or 401(k) should also note that withdrawals generally cannot be made prior to age 59 ½ without penalty.

3. Guaranteed income sources

Most retirees have some form of guaranteed income from Social Security benefits, annuities, and defined benefits plans, such as pensions. Monthly Social Security benefits are dependent on someone's age and the amount they've paid into the system throughout their working life, so retirees have to check with the Social Security Administration to determine their exact income.

The average monthly benefit in 2020 was $1,503. Full retirement age ranges from 66 to 67 years old, depending on year of birth, but people can elect to start collecting at any age between 62 and 70. The longer collection is delayed, the higher the benefit will be. For example, someone who turns 62 in 2021 and starts collecting retirement benefits immediately will get just over 70% of their full retirement benefit, while waiting until age 70 can increase that number to more than 125%.

Younger people should note that Social Security benefits may be unavailable or reduced in the future. By 2035, the system is expected to lose more money than it collects, meaning it may be underfunded several decades from now.

Pensions used to be very popular. They've become more rare, but more than 20% of American workers still participate in pensions. These provide guaranteed monthly payments for either the life of the retired person, or whichever spouse lives the longest. Length of service and retirement age can change the amount paid out each month by a pension, but it should be relatively easy to determine how much income a household will receive in retirement once those factors are determined.

Many people purchase annuities, which provide guaranteed monthly income over the lifetime of the purchaser. These can be complicated products with numerous options, but they are ultimately designed to eliminate longevity risk by transferring assets and risk from an individual to an insurance company. Insurance carriers can provide estimates, through an official forecast called an illustration, for payouts based on assumed account growth and age of retirement. Policyholders should know that these are usually not guarantees, but they can be useful for forecasting cash flows after their working years.

When doing financial planning for retirement, people need to understand whether or not their cash flows will be high enough to cover anticipated costs. Retirees should estimate their guaranteed income, along with the cash flow that their assets will produce, then compare these to monthly expenditures on housing, medical expenses, basic needs, and lifestyle. Ideal retirement age should be whatever age allows retirement cash flows to be sufficiently high.