When Should JG Mullaney Retire?
Informing his choice.
At the corner of Maple and Motor in Dallas sits its namesake restaurant that has the best hamburger in the Metroplex. On a spring day you may find cardiology faculty from the nearby UT-Southwestern medical school wiping their chins of all the greasy goodness of the perfectly “red” cooked beef, drinking a Shiner, and having cheesy-tots smothered with bacon and jalapenos. Patients can wait on their gurneys. Another 10 minutes will not matter. A meal doesn’t get much better. Doubt anybody would give up regular Maple & Motor visits to extend their heart health a few more years. Might even convert a Vegan or two.
If you go into Maple & Motor for a meal, grab a booth, and listen to the conversation you may hear a story like JG Mullaney’s story. JG is a younger doc, about 35, with a wife who works for AT&T corporate. JG starred on his college campus. He was a D1 golfer, member of the advisory group to the dean of student life, part-time hasher at a sorority house, and a major in math. JG learned to fly before the summer of his senior year and is fluent in Mandarin. All that talent and varied interests. An amazing guy. JG’s first job was with a tech startup in Boulder, CO, but he soon decided that medicine should be in his future. Matriculated into UCLA Geffen, took a residency in Boston, the city where he met Beth his wife, and landed his first professional job in a cardiology practice group that works mostly at Dallas’s public hospital, Parkland. Yes, the Parkland that received JFK.
JG and Beth rarely go out. Beth loves adventure, but is mostly limited to her CrossFit membership on St. Paul Street. JG is very frugal; he has made a habit of saving money. How might someone on the periphery of JG’s life explain his interest in saving? Life-cycle theory gives us some ideas: JG may want to have the flexibility to retire, or wishes to establish an emergency fund, or would like to fund a child’s education, or expects some other future financial need. A “just in case” pot of money for whatever might arise. Observing that people save is the essence of Modigliani and Brumberg’s sophisticated explanation of why people save. In JG’s case, the details are important. JG’s primary goal is early retirement.
There is No Standard Saving’s Behavior
For individuals and households, active saving’s behavior is normally driven by a goal and that objective is key to the financial plan. Whatever early retirement means to JG will be his financial planning outcome that will define the length of a savings time period, may dictate the types of investments that should be undertaken, and whether the tax law offers costs and benefits that should be considered. Many individuals may have the same goal of leisure, “a comfortable retirement,” but the actual steps necessary to achieve a comfortable retirement differ dramatically across individuals and households. There are too many unique attributes of households to render a standard template for all. No general financial planning “rule of thumb” could be applied to all households.
There is good news. When the objective is well defined by the household and the characteristics of the household are known, life-cycle theory offers the foundation for the best solution. In other words, the optimal standard of living is the objective, and the magnitude of savings is dictated by household inputs to that goal.
JG’s goal is to work hard until he is 60-years old and then cease working to pursue his dream of traveling with Beth, piloting his own plane from country to country all over the world. JG (and Beth’s) retirement plan requires saving during their working years (i.e., when young), to fund a substantial number of years of consumption after their earned income flow stops. Both are healthy and bio-family members have a history of living to old age. Understanding the Mullaney’s personal scenario signals the general solution to their their retirement planning question. The Mullaney’s household income will be substantial, but work life vis-à-vis natural life is limited. Any 401(k) or IRA assets cannot be pulled until age 59 ½ and social security retirement benefits don’t come into play until the Mullaney’s turn 62.
Three Retirement Dates
How should the advisory approach the early retirement question? To illustrate the solution, three different financial plans are developed for the Mullaney household, each defined by a different retirement age. The base solution for JG and Beth is defined by their highest, sustainable living standard when working until age 60, given their prospects of living to a max age of 90. Two additional scenarios they’d like to consider are retirements at age 62 and age 65. With those time periods set, here is a subset of the household characteristics necessary to generate their financial plans.
JG and Beth, both age 35, have salaries of $350k and $90k, respectively and forecast 1% real salary raises up to retirement
JG and Beth both have 401(k) plans with 3% contributions and employer match
The Mullaney’s have $75k in a brokerage account
The Mullaney’s own a home valued at $1.5 million, a $1 million mortgage with a monthly payment of $4,774, and have a $31,000 annual property tax bill
The Mullaney’s will begin withdrawing from their 401(k)s at their retirement date; social security retirement benefits will begin at their respective ages 62, except they will wait to age 65 under that retirement option
Employer-sponsored retirement account assets earn a 4% annual real return, and brokerage account assets earn a 1% annual real return
Results are presented two ways. The table below lists today’s value of the Mullaney’s lifetime sources of income and expenses as of today based on their current financial condition, current tax law, social security benefit structure, and other assumptions.1 The last row of the table, shaded in blue, lists lifetime “discretionary spending,” which is the total amount of spending available for all other household consumption after housing, taxes, retirement contributions, Medicare Part B premiums, and life insurance premiums. As a reminder, the discretionary spending amount is the optimal amount determined by a life-cycle theory-based dynamic programming algorithm underpinning the financial advisory software, MaxiFi. Spending that achieves the highest level of economic happiness.
The Mullaney’s lifestyle v. work trade-off is now better informed. If they work beyond age 60 until age 65, they increase their net amount of money for consumption by about $1.69 million. More earnings, retirement contributions, social security retirement benefits, and taxes. But, 5 fewer years of flying around the world and a more leisurely life. Which to do? They have to decide.
The chart below may help the decision. JG and Beth are the same age which labels the horizontal axis. Today’s value of their annual living standard is mapped by retirement age choice. Note how today’s choice of when to retire yields a behavior chance in the near-term. JG and Beth’s current year living standard can increase if they decide their goal is to work to age 65 then retire. The percentage change is 22.77% year-over-year for the balance of their lives. If they value that increase, fostered by a longer working lifetime, then they can enjoy it today. Their decision today is based on uncertainty, but after all that is the point of planning. Financial lives change and the plan should be updated as it does change.
How does the optimal living standard per adult get translated to a prescribed budget? The economics of shared living imply a higher living standard per adult when two adults live within the same household rather than separately. The Mullaney’s optimal amount of discretionary spending in the current year is a bit less than simply taking the living standard per adult and multiplying it by 2. For their financial circumstances, the optimal amount of after-tax, after-housing, after-retirement contributions discretionary spending amounts for the current year by prospective retirement ages are,
$158,000 if they wish to retire at age 60
$173,000 if they wish to retire at age 62
$195,000 if they wish to retire at age 65
The financial trade-off from a more leisurely life is now clear. Plenty of money in any of the budgets for a great hamburger, and a well-defined sustainable living standard to weigh against different retirement lengths.
Where is Investment Risk?
Advisory subscribers will rightly wonder about investment risk. Up to this point, I have kept to deterministic models to illustrate how Personal Finance Economics can be used as a decision tool. Modeling future returns is one of the intellectual condiments added by advisory in their role as private wealth managers. Good planning should consider how risky the living standard is to changes in investment prospects. Next week I’ll introduce investment risk to non-investment financial planning decisions and explain the Mullaney’s “decision when to retire” choice with this added layer of texture. Spoiler alert: their taste for risk may matter.