Is Early Retirement a Mistake?

Laurence Kotlikoff, an economist and writer I admire, recently published an article on CNBC titled A Harvard-trained economist says ‘early retirement is one of the worst money mistakes’—here’s why you’ll ‘regret’ it. While the title is intended to be provocative (aka click bait), the article is well-written and sensible–as Dr. Kotlikoff can be counted on to be–and the article raises important questions for people who are considering leaving full-time work to retire early, take an extended sabbatical, etc. There are, however, a number of points that deserve scrutiny and further discussion.

Dr. Kotlikoff’s article starts with the assertion people should not consider early retirement because Americans tend to have low savings rates so that most cannot afford to leave the workforce. Well, yes. Hopefully this is kind of obvious, but it raises the question of how people can determine whether they have enough wealth to stop working. What Dr. Kotlikoff means, I believe, is that people should not consider retiring unless they have a solid handle on whether they have enough money to sustain themselves. This also seems kind obvious, although most Americans report that they don’t know how much they will need to be able to retire or how to tackle this process.

The answer to the question of whether / when people can afford to step away from full time employment can be addressed with reasonable confidence. If you don’t do the work of financial planning, simply staying employed as long as possible is the safest route, but this does not generalize to suggesting that early retirement is a bad idea.

Dr. Kotlikoff cites a range of statistics indicating that many Americans accumulate little wealth and thus may never be able to retire. There are a range of problems with current data on American wealth accumulation and I don’t believe that discussions of the average American make much sense anyway. Given the enormously skewed distribution of wealth in America, the averages apply to very few people. Rather than discuss the statistics, let’s agree that financial decisions depend on the details of each household’s situation.

The real question that we need to answer is how people can plausibly estimate whether they can afford to leave traditional full-time employment. Simply put, people can work to generate income, draw income from investments, or receive government support (Social Security, Medicare, Medicaid, disability, etc.). The starting point to consider the implications of a substantial reduction in income from work is (1) whether you have enough income from other sources to cover your needs, and (2) how your financial needs are likely to change.

For most people, ceasing to work full-time results in lower income. This is not necessarily a problem, however. For many households, a substantial amount of consumption is entirely discretionary. Having lower income, more time, and adjusting consumption to match may be a great choice. Indeed, this is the key theme in Your Money or Your Life, one of the early books in the Financial Independence / Retire Early (FIRE) movement. The critical starting point is to have a solid handle on how much you will spend each year once you leave the traditional workforce.

Many retirement planning tools start by assuming that people will need 80% of their pre-retirement income after they stop working. While I am a fan of decision heuristics (aka rules of thumb), this one is simply not very helpful. Another rule of thumb is that people should plan to be able to draw a constant inflation-adjusted retirement income. This is simple, but also not very useful. Some households will see their consumption track upwards with inflation while others will not. In summary, rules of thumb are appealing in their simplicity but must be used with caution because there is so much variability in the real world of household finances. By tracking recurring expenses, most people can come up with a solid estimate of their baseline budgets.

Dr. Kotlikoff writes that one of the great sources of uncertainty in financial planning is how long you will live. This is certainly true and the issue becomes even more challenging when you are trying to plan for joint longevity for a couple. Lifespan is one of the issues for which using statistics for the average American is a bad choice. I suggest starting with a decent estimator–and I like this calculator.

So, you have to start with a personalized estimate of how much income your household needs to cover consumption and how long you need to plan for in retirement. These are the big issues to start with. The next question is how much wealth you have accumulated to provide retirement income in addition to any passive income that you receive in the form of rent, royalties, etc. Once you have these numbers in hand, you can make a solid first cut at calculating whether you can afford to take early retirement using Google Sheets or Microsoft EXCEL. The actual calculation can be done in just a few minutes. The linked post provides the details.

Dr. Kotlikoff is certainly correct that leaving the workforce voluntarily is economically costly. That said, life is about far more than financial optimization. Most people make work choices largely or entirely on the basis of how much they need in order to live the way that they want to. Considering early retirement starts with thinking through how both income and consumption will change if you reduce or eliminate your income from work. I agree with Dr. Kotlikoff that the evidence suggests that most Americans save too little and that it is foolhardy to retire without doing a detailed examination of household finances. That said, there is no reason why people should not go through the process of reconsidering work-life balance. If people have the resources to support their needs without working much or at all, this may be a shift that is worth exploring. Rather than condemning early retirement because the average American saves too little, helping people to understand the tradeoffs is a better approach.