Should I retire at 55?

By Brad Thomason, CPA

 

I get variations on this question all the time.  People want to know when it’s OK to retire.  It’s a good question.  Most seem to think that the sooner, the better.

In our practice we generally use a functional definition for retirement:  the point at which your assets can pay for your life, so your efforts don’t have to.  We favor this definition because being able to afford it doesn’t necessarily mean you have to stop working; it’s actually two variables.  But the practical question remains:  “When can I stop working?”

As you already know (I suspect) the answer is:  it depends.  Lots of factors go into the determination and the calculations can get pretty involved.  But even amidst all of this complexity, there is a simple, universal constant that cuts across all of it: the longer you can work, the better.

A couple of qualifiers, here.  First, that’s mathematically speaking.  For purposes of this discussion I’m going to ignore the qualitative implications of working longer (which we don’t ignore in real life cases; but I’m trying to make a point here, and I have limited space…).  No matter how you do the math, working longer leads to a better result.

Second, by better, I mean one with a greater probability of working out as planned (because remember: none of this stuff is certain).  Perhaps we should say:  One that has a greater margin for error, in the form of extra cash or extra productivity, above and beyond what you should need, in the strictest sense.

Let’s get out of the conceptual and look at an example.  Using a simplified version of a retirement income planning model that we use for client work, we created a fictional case of a 55 year old who wants to retire.  We gave her $1M, compounded her returns at 7%, drew out $60K annually for expenses (increasing annually by 3% for inflation), and started an additional inflow of $15K at age 67 for Social Security.  Under this scenario her money will hold out until she’s 87.  Note that these are not all of the variables that have to be accounted for in an actual case, but it creates a close enough version of reality to be able to isolate the impact of the decision we’re really interested in: the one about retiring at 55.

So to begin analyzing the decision we simply need to look at the projections associated with having her wait until she’s 56 to retire, instead.  Leaving all other variables the same, her money doesn’t run out until age 91.

Working one more year gives her an extra four years of projected income.

How?  Well, there are a couple of things going on.  First of all, the wages earned during that additional year are true extra dollars coming into the system, ones that were not there before.  Revenue went up and expenses stayed the same, so clearly there has to be a net benefit that’s realized.  But the other thing which is going on is that the asset base gets to accrue its winnings for one more year before the draw-down starts.  Over time, this is the factor which will do the heavy lifting.  It increases the earnings capacity (because last year’s returns become this year’s investment capital, so to speak), and puts more distance between the balance when draw-down starts and the end of the income stream (i.e. $0).

So should you retire at 55?  Dunno (though we’ll be happy to help you figure it out…).  But I certainly wouldn’t do it before assessing the long term impact it is likely to have on your retirement income potential.  And even if it looks like it will be OK, you might want to put in a couple of extra years anyway.  It will dial down your risk profile and increase the chances that you can absorb any future unexpecteds that might otherwise derail your plan.

Whether an extra year of work will lead to four years of extra income in your specific case will be a function of all of the actual factors which make up your financial life.  But the longer you can leave your savings alone, the better your chances of getting a win.

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