The MaxiFi Puzzler -- 5/16/25

Take your best shot at matching the power of economics-based financial planning.

Economics Matters -- Blog/Podcast/Financial Riddler/MaxiFi Puzzler

Please sign up for a free subscription at larrykotlikoff.substack.com, which I’ll immediately extend forever. Or help me provide Economics Matters by subscribing on a paid basis. You’ll receive a one-hour, free, economics-based conversation about your finances. Just email me at kotlikoff@gmail.com to find a time. You can cancel your paid subscription anytime and resubscribe forever for free. Also, please sign up your kids, friends, colleagues, and students. They can instantly unsubscribe as desired. Finally, anxious about your finances? Sign up for my Concierge Service. I’ll help you run my company’s MaxiFi financial planning software, which clients adore. It just received Bankrate’s “Best Financial Planing Software” ranking.

Sarah Just Got the Heave Ho

Hypothetical Sarah McCloughlin turned 47 today. As she heads to her friend’s house to celebrate, Sarah receives two emails from her boss — Uncle Sam. The first wishes her a happy birthday. The second tells her she’s fired.

Sarah is distraught and incensed. She’s spent the last two decades working as a key administrator for the Food and Drug Administration (FDA). Now she’s been kicked to the street along with 150,000 other federal employees. The FDA is mission critical when it comes to protecting our nation’s health. It oversees our food supply and assesses the efficacy and safety of new medications and biomedical devices.

Whether its a avian flu vaccine, gene therapy for a rare cancer, a biologic for Lupus, or an brain implant to help with Parkinson’s, the buck starts and stops with FDA oversight and approval. Yet, one in five FDA employees were summarily dismissed by DOGE with only a smattering of rehires. Taking a blow torch to the FDA is something that only our country’s worst enemies could have fantasized.

Sarah’s Particulars — Familial, Social, and Financial

Sarah’s single and has no children. Hence, she’s relatively free to relocate to a part of the country that’s not teeming with displaced workers. Free is a funny word in this context. Sarah has a strong community of friends, is a long-standing and active member of her church, and loves her home and garden (as do her three cats).

Selling her D.C. house along with so many others in what is already an awful national housing market represents a double whammy. Sarah is hoping to net $400K on her home. She’ll also walk away with $270K in her Federal Thrift Savings Plan (TSP), a $20,000 inflation-indexed Federal Employee Retirement System (FERS) pension , which she’ll start at age 67, and the $350K she has in a CD.

The Tulsa, Oklahoma Job Offer

Fast forward six months. Sarah’s has sold her house for $350K and run down her checking account to $200K. She’d be in the red had it not been for unemployment insurance. The good news is that Sarah’s finally received a job offer, albeit in Tulsa, Oklahoma. The only thing Sarah, who grew up in Maine, knows about Oklahoma is that it had a dust bowl and has an extraordinary basketball team. She’s miserable at the prospect of moving, but has no choice.

The job? It pays $75K a year — a quarter less than she was earning at the FDA. Yet, she’ll be able to get into an even larger house with her $350K home sale proceeds. Annual property taxes, maintenance, and insurance will run $10K. The job, though, comes with no retirement plan and second-rate health insurance. Sarah will contribute $7K (in today’s dollars) each year she works to an IRA. But she’ll be stuck with $10K a year in out-of-pocket costs until she’s eligible for Medicare at 65. Once on Medicare, she’ll need to pay the Medicare Part B IRMAA premium and shell out, let’s assume, $2,500K in today’s dollars for a Medigap policy.

How Much Can Sarah Spend on a Sustainable Basis?

Sarah invests conservatively, primarily in a ladder of Treasury Inflation Protected Securities (TIPS), and plans accordingly. I.e., she assumes she’ll earn a 2 percent real return on her savings. This is roughly the current maturity-weighted average real yield on TIPS.

Sarah, it turns out, read my book, Money Magic, and has absorbed one of its main mantras: You can’t count on dying on time. Consequently, Sarah sets her planning horizon at her maximum, not her expected age of life. Sarah comes from good, as in long-lived, stock. Hence, in running MaxiFi Planner, she leaves her max age of life at the tool’s default value — age 100. Sarah also plans to work till age 67, at which point she’ll take Social Security. Assuming her salary keeps up with inflation, she’ll pull down $35,576 a year in real (today’s dollars) benefits. Finally, lets assume Sarah plans to live in her new house until she utters her final words — a curse on Elon Musk.

Some helpful reminders: Oklahoma is one of the 42 states that has an income tax. Its six brackets are shown below for 2024. Sarah assumes the brackets will be CPI indexed. Also, unlike Uncle Sam, Oklahoma doesn’t tax Social Security.

1. How much can Sarah spend, in today’s dollars, year in and year out through age 100 on a discretionary basis. (Note, the assumptions I’ve made ensure Sarah is never cash-flow constrained, which would require her spending spend less before she retires. I’ve also assume that the Tax Cut and Jobs Act is retained.) Discretionary spending is spending above and beyond fixed spending —- outlays on FICA and federal income taxes, state income taxes, housing costs, Medicare B premiums, and out-of-pocket healthcare costs, including Sarah’s future Medigap policy.

   a. $73,558

   b. $51,027

   c. $44,821

   d. $37,711

   e. $29,034

And the answer is …

The answer is $51,027 or $4,252 per month. That’s just enough for Sarah to live on, make annual trips to D.C. to see her friends, and cover her first-ever depression medication.

If you got this wrong, you’re in good company. Before I ran MaxiFi, I guessed Sarah’s sustainable spending would equal roughly $45K. How could I be almost 15 percent off — year after year for the next 44? After all, I developed MaxiFi’s patent-winning, not to mention top-ranked, computation engine.

Simple. Our brains aren’t wired to jointly (simultaneously) solve large numbers of complicated non-linear equations let alone, as in MaxiFi’s case, do so precisely within a second. Neither, by the way, are modern AI programs. They are guessing machines, not computation machines. Using them to handle Sarah’s questions is like, well, using a blowtorch to improve the FDA’s operations.

But how can Sarah check that $51,027 is the right sustainable discretionary spending given her assumptions? The answer is by looking at Sarah’s MaxiFi reports, particularly the two below. The first confirms that Sarah’s real discretionary spending is the same value through time. The second shows that the Sarah’s lifetime budget balances to the dollar. Stated differently, the present value of Sarah’s fixed plus discretionary spending, through age 100, equals the present of her resources. This means Sarah’s annual and, thus, lifetime discretionary spending is affordable. Annual discretionary spending above $51,027 would break her lifetime budget. And annual discretionary spending below $51,027 would leave money on the table.

2. How much is Sarah’s real (today’s dollars) income in the year before she retires?

   a. $118,354

   b. $110,472

   c. $103,916

   d. $97,703

   e. $75,523

And the answer is …

The answer is $75,523. This reflects Sarah’s $75K salary plus her some minor asset income. Sarah doesn’t save much prior to retirement — for good reason. Her income after retirement — the combo of Social Security benefits, the FERS pension, and withdrawals from Sarah’s TSP and IRA accounts — will actually be higher than before she retires.

3. How much do conventional planning tools advise Sarah spend, on everything, annually in retirement?

   a. $92,412

   b. $88,569

   c. $76,714

   d. $69,932

   e. $60,418

And the answer is …

The answer is $60,418, which is 80 percent of Sarah’s pre-retirement income of $75,523. The 80 percent multiplier is the industry’s standard retirement-income replacement rate. In my experience, the 80 percent rule recommends total retirement spending that’s miles too high. But in Sarah’s case, it’s far too low.

Check out the next chart. It shows total annual spending — fixed plus discretionary. Note first that Sarah’s total real retirement spending isn’t constant. Nor is it remotely close to the replacement rate rule of dumb. In fact, Sarah’s total real annual spending ranges from $76,512 to to $83,713. These values exceed conventional planning’s recommended $60,418 by between 27 percent and 38 percent.

Consider a financial advisor who does conventional, not economics-based planning. Conventional planning, by the way, isn’t taught in a single top finance or economics department anywhere on the planet. It’s that bad. Of the 342,000 FINRA (Wall Street’s Financial Industry Regulatory Authority) recognized financial professionals, virtually all do conventional planning and virtually all would run Monte Carlo simulations for Sarah based on an aggressive investment strategy.

They’d easily show that Sarah can not just meet “her” retirement-spending target with almost 100 percent probability, but also have a huge bundle left over to spend, bequeath, or donate down the road. This “plan” could well lead Sarah to hand over her assets to an “expert”, pay a hefty 1 percent asset-management fee, and leave her at major financial risk. Why? Because conventional planners would use, as just indicated, a spending target, which in Sarah’s case, is miles too low!

Since Sarah wants to reclaim financial stability, playing dice with the stock market, let alone paying half of the available safe real return for the privilege, is the last thing she should do.

4. How much can Sarah raise the present value of her sustainable discretionary basis by taking Social Security at 70?

   a. $39,678

   b. $71,342

   c. $91,852

   d. $117,992

And the answer is …

MaxiFi’s robo Social Security optimizer’s instant answer is $39,678. Her monthly benefit will be 24 percent larger than her full retirement age benefit or $3,206, i.e., she’ll collect $3,975 per month thanks to receiving an 8 percent boost in her benefit for each year she waits to collect after full retirement age. But waiting till 70 to collect produces a cash-flow problem. Sarah will need to lower her real annual spending by $2,878 prior to age 70. But after age 70, her real, sustainable annual spending will be $6,202 or 12 percent larger than would otherwise have been the case.

5. Assuming Sarah take Social Security at 70, does her lifetime discretionary spending rise or fall by contributing $7000 a year to a taxable Roth IRA rather than to a tax-deferred traditional IRA$

   a. Rises

   b. Falls

And the answer is …

The answer is a slight increase — roughly $8,000 — in lower lifetime taxes. Note, though, that this substantially worsens Sarah’s pre-retirement cash-flow problem.

6. Can Sarah lower her lifetime taxes and raise her lifetime spending by starting smooth IRA and TSP withdrawals either before of after retirement?

   a. Yes

   b. No

And the answer is …

The answer is Yes. The gain is only $7K. But, interestingly, MaxiFi’s robo Retirement Account Withdrawal Date Optimizer has Sarah starting her smooth withdrawals at age 59, not age 67. This materially relaxes her pre-retirement cash-flow constraint.

7. Given that Sarah waits till 70 and starts smooth taxable retirement withdrawals at 59, does MaxiFi’s robo Roth Conversion Optimizer come up with any additional lifetime tax savings assuming that taxes will be 15 percent higher starting in 2028 and that any conversion start after Sarah retires?

   a. Yes

   b. No

And the answer is …

The answer is yes, but the gains are modest — just over $10K in present value. Since Sarah is only 47, she has plenty of time to reconsider Roth conversions as she runs MaxiFi through time.

Post Script — Bankrate’s Naming MaxiFi and Two Other Tools as “Best Financial Planning Sofware of 2025”

I deeply appreciate our ever-improving, 32-year-in-the-making software being ranked where it deserves — as among the top financial planning tools available.

Bankrate provides an excellent description of MaxiFi, but I have to take offense at its brief overview description, which includes, “Best for DIY Tinkerers.” That’s true, but it’s also best for everyone, including financial advisors who are supposedly trying to pad, not pick their clients’ pockets.

Here’s the deal. Financial planning is precision business. You either get everything precisely right or you get everything terribly wrong. By everything, I’m referring to how much to spend, save, and insure, when to retire, whether to downsize and where, how much downside risk to take in your investing predicated on the upside risk doing so will provide, which Social Security benefits to take and when, when and how much to Roth convert, whether to contribute to Roth or tax-deferred retirement accounts, whether to switch jobs or go back to school for a masters, which college is affordable given its requisite borrowing and your intended major, how much to save for potential old-age nursing care, whether to annuitize your retirement account, and …

None of these financial problems are confined to tinkerers. These are questions we all have and we all need correctly answered. Those who don’t like to run software or don’t want to do so on their own can sign up for my Concierge Service.

Finally, if you are using a different financial planning tool, see if you can derive the same answers to the questions I posed about Sarah. Or share this article with your financial advisor and ask them if the software they are using produces the same results given the same assumptions. You may decide it’s time to let economic science, not Wall Street, help you handle your financial future.