FIRE-worthy? Seeking pearls of wisdom from the FIREd

[coltsfan53]

Like many of us here, my wife and I are extremely interested in early retirement. I have gone through the excellent FireCalc exercise and have a few stats and questions so some of the Pros here can shed some light on the exciting, yet somewhat scary, possibility of early retirement. 4% draw down seems dangerous to me and I would like to know what others think with our scenario.

Me: 40
Wife: 31
Assets: $1.25MM invested in 85/15 portfolio (60% taxable; 40% tax deferred accounts)
Attempting to sell McMansion to recoup $215k in equity and buy smaller home outright (we live in very affordable city)
No children at this point, yet planning for one (soon)
Cost of Living: $50,000/year with McMansion; $18,000/year without (hence the lust to sell home)
FireCalc, even with Megahome in tow, is pretty favorable now for 50k per year for 50 years (85% with constant spend; 99% with Bernicke's rules)

My specific questions regarding ER are as follows:

1. How are you drawing down your assets? (Taxable account, then IRA down the road, I imagine)
2. Taxes: Are there any tips regarding minimization of taxes when drawing down? This is an elementary question, but when drawing down the taxable account, do you only pay tax on capital gains? I understand IRA/401k is tax deferred and will be paid much later.
3. Portfolio: did you change your mix of equities to fixed drastically?
4. Inflation: how do you guys account for inflation in your annual withdrawal? Does the amount you take out reflect inflation, which I assume it does, or do you stick with the original set amount, which seems absurd but I need to ask?
5. Health Insurance: how do you currently handle health insurance in early retirement? How much is it costing for couples?
Note: I do not claim to be a proponent of the new healthcare law. In fact, it is in part driving my decision for early retirement. It does seem, ironically, that low cost health plans will be available to those with "lower incomes." $50K between my wife and I ought to qualify as low (until they begin culling our portfolios).

Thanks a million for anyone who has slogged through my post and can offer any pearls of wisdom. If you have been in ER for a while and managed to slip out of the corporate world early, then let me know how this has gone for you. How did your peers react?

 

[aaronc879]

First of all, let me say congratulations. Being 40 years old and having a 31 year old wife is quite an accomplishment Oh yeah, the $1.25MM ain't bad either.

Being so young, i'd go with less than 4% SWR. Maybe take 3% for the first few years and see how it goes. Seems like your expenses will be low enough for that after downsizing the house. Good luck!

 

[David1961]

Since you are so young, I'd also recommend an SWR of no more than 3%. Your retirement may have to last 50 or 60 years (especially for your wife). For some specifics on drawing down, I recommend this book. I personally like the strategy of withdrawing a certain amount of your remaining portfolio each year. The downside is you have to be able to reduce your spending if your portfolio had a down year.

Work Less, Live More: The Way to Semi-Retirement: Robert Clyatt: 9781413307054: Amazon.com: Books

The biggest issues I can see for you are the costs of health insurance and the number of children you will have.

 

[Independent]

4. Inflation: how do you guys account for inflation in your annual withdrawal? Does the amount you take out reflect inflation, which I assume it does, or do you stick with the original set amount, which seems absurd but I need to ask?

When people here talk about "Safe Withdrawal Rate" what they really mean is a fixed real dollar withdrawal.

In your case, a 3% SWR means that you withdraw $37,500 the first year. In the second year, you withdraw $37,500 x (1+increase in CPI). etc.

Note that according to the BLS, only 30% of the US families of three spend less than $39k per year (very approximately). So even at $37,500, you're more thrifty than most people.

ftp://ftp.bls.gov/pub/special.requests/ce/CrossTabs/y1011/SIZbyINC/xthree.TXT

 

[daylatedollarshort]

Welcome. Good plan on ditching the McMansion to buying a house outright and being able to live on 18K.

Are you sure you are accounting for everything in your budget? That is pretty close to federal poverty level for two people.

 

[yakers]

At a low income level you will want to convert the tax deferred funds (IRA 401k) into Roths.

 

[rodi]

Welcome Coltsfan.

The spending you put into firecalc - did that include taxes? It's gross spending as an input.
But - if you downsize and eliminate debt there's no reason you can't live on a frugal budget.

The usual advise around here (good advise) is to make sure your spending includes budgeting for big ticket items that come along less than once a year - like cars, new roofs on your house, etc. If your spending doesn't include that - you may hit a point where you need to draw more from your portfolio.

As far as how to determine what accounts to draw from - there's a very good calculator that determines your optimum strategy of which account to pull from to reduce taxes - Retirement Calculator - Parameter Form. It uses a strategy of converting 401k/IRA money to Roth as you go - so that later you have even lower taxes. Just another tool for planning.

 

[coltsfan53]

Welcome Coltsfan.

The spending you put into firecalc - did that include taxes? It's gross spending as an input.
But - if you downsize and eliminate debt there's no reason you can't live on a frugal budget.

The usual advise around here (good advise) is to make sure your spending includes budgeting for big ticket items that come along less than once a year - like cars, new roofs on your house, etc. If your spending doesn't include that - you may hit a point where you need to draw more from your portfolio.

As far as how to determine what accounts to draw from - there's a very good calculator that determines your optimum strategy of which account to pull from to reduce taxes - Retirement Calculator - Parameter Form. It uses a strategy of converting 401k/IRA money to Roth as you go - so that later you have even lower taxes. Just another tool for planning.

Thanks for all of the helpful replies. Yes, if we unload the home, then our cost of living could be very low. We would have zero debt and our largest expense would be our property taxes. A $30k emergency fund is set aside in addition to what I had listed to take care of the unforeseen (roof, computer, car, et al). I appreciate your passing along the retirement calculator. I haven't seen this one prior.

 

[daylatedollarshort]

We do our annual budget with reserves for major home repairs, new cars, extra medical bills, etc. Thirty thousand can go pretty quick if you need a new car, a new roof and max out your health insurance out of pocket maximum all in one year. And I think everybody who lives long enough is going to have some high cost years where everything hits at once.

I see on some of the early retirement blogs how low the bloggers say their annual expenses are and then when you look at the expenses lists they don't account for items like car replacements, car repairs, new roofs, increasing health insurance premiums as they get older and dentist visits.

It is probably better to have your annual budget be more than you need instead of less for planning purposes to lessen your chance of running out of money at some future point.

 

[walkinwood]

My specific questions regarding ER are as follows:

1. How are you drawing down your assets? (Taxable account, then IRA down the road, I imagine)

Taxable first. Like you, I am younger than 59 1/2. There are papers out there that talk about this. Typically, it is taxable, then T-IRA and then ROTH. However, it makes sense to look at this more granularly - with your returns assumptions, what will your RMD be at 70? If that puts you in a higher tax bracket than you're in now, it may make sense to tap the IRA when you qualify or do T-IRA to ROTH transfers. Very complex topic, so the time you spend researching it will pay big dividends.

2. Taxes: Are there any tips regarding minimization of taxes when drawing down? This is an elementary question, but when drawing down the taxable account, do you only pay tax on capital gains? I understand IRA/401k is tax deferred and will be paid much later.

Yes. You'll mainly pay Cap gains & taxes on dividends/interest. If you do T-IRA to ROTH transfers, it counts as income & is taxed as such.

3. Portfolio: did you change your mix of equities to fixed drastically?

I went from 80/20 to 60/40 around ER time.

4. Inflation: how do you guys account for inflation in your annual withdrawal? Does the amount you take out reflect inflation, which I assume it does, or do you stick with the original set amount, which seems absurd but I need to ask?

I use a fixed percentage of existing assets so our budget swings with the portfolio value and not inflation.

5. Health Insurance: how do you currently handle health insurance in early retirement? How much is it costing for couples?

It depends on the state & it is in such flux right now, that I would wait till your state/fed exchange is up to make an estimate.

Note: I do not claim to be a proponent of the new healthcare law. In fact, it is in part driving my decision for early retirement. It does seem, ironically, that low cost health plans will be available to those with "lower incomes." $50K between my wife and I ought to qualify as low (until they begin culling our portfolios).

You'll have to include this in your calculations to take cap-gains or do T-IRA to ROTH transfers.

Thanks a million for anyone who has slogged through my post and can offer any pearls of wisdom. If you have been in ER for a while and managed to slip out of the corporate world early, then let me know how this has gone for you. How did your peers react?

I've had very positive responses.

 

[almost there]

Correctly guess the inflation % over the next 50 yrs and you will have it made.

 

[robbridg]

Cost of Living: $50,000/year with McMansion; $18,000/year without

What are you not including in your "Cost of Living" numbers? $18K seems very low. Are you including income taxes, health insurance, property taxes, food? Those are the biggies for us.

 

[Fred123]

I'll join the chorus here and say that $18k seems way too low. If you're planning on having a child, there's no way that this will work -- you might want to read this report which indicates that it costs $12 - $14K/year for a middle class family to raise a child. ACA subsidized health insurance will probably be at least $4K/year. This will increase (as will uncovered medical costs) as you age. Throw in insurance, utilities, food, property taxes, auto expenses, home repair etc. and I'd guess that $30K/year is a bit more realistic. And that's still pretty bare bones.

 

[nash031]

Go Colts! I'm originally from Indy. Bailed to find better climes, but get back there several times every year.

 

[pb4uski]

I'm drawing down taxable first, then tax-deferred, then tax-free.

For the taxable account I have income from dividends and capital gains, most of which are tax free if I keep my income in the 15% tax bracket (which I do).

I didn't change my AA at all - the same 60/40 as when i retired. What is different is that I keep ~6% of the 40 in cash/short-term investments rather than bonds.

I just take out what I need to live and this year is the same as last year.

I formed an LLC and have a small group of one policy that is a HDHP and coasts me $629/month. My premium will increase to ~$750 in 2014 before subsidy, but I plan to manage my income so I am below 400% FPL and claim a subsidy.

 

[siamond]

Don't rush to switch to a bond-heavy stock/bond split. You have a LOT of time in front of you, (early) retired or not, you are a long-term investor (e.g. you're speaking of 50 years...). It might be quite a waste to not benefit from the better returns of stocks with such time ahead of you. Model a 75/25 split or something like that, and see what goes...

Also, you're young, it is quite likely that as you go through early retirement, by serendipity, just doing what you like, some of your activities will translate into something revenue-generating. So you might want to account for a bit of it, and... not hesitate to live a slightly less frugal life than what you seem to have in mind. There is no harm spending money you can undoubtedly afford!

 

[kramer]

I think you need to save more, although that will be easy now since your net worth will grow rapidly. The joint life expectancy for you and your wife, the age until at least one of you will still be alive just less than 50% of the time, is well above even 50 years. Your wife is only 31. There is possibly college for your first (and second, etc.) children. I personally would not even withdraw 3% in this scenario.

You have big risks not only in investment returns but in future spending levels.

The fact that you are throwing out $18K for annual expenses makes me think you really have not thought this through (and I say that respectfully -- who does not want to retire and make the numbers work).

I retired at age 41, so it is not like I am afraid of risk, but I think you need to wait awhile. Also, keep in mind the stock market is at an all time high.

You have basically won the game. I wouldn't have 85% in stocks.

Taxes: Under current law, and assuming you structure your portfolio correctly, your federal income tax bill will be $0. Your only decision will be whether to convert tradition IRA to Roth IRA -- I find this harder to justify for very early retirees like yourself than many other board members.

 

[tuixiu]

I formed an LLC and have a small group of one policy that is a HDHP and coasts me $629/month. My premium will increase to ~$750 in 2014 before subsidy, but I plan to manage my income so I am below 400% FPL and claim a subsidy.

So what will your net be for health insurance premiums with subsidy? My wife and I have also been planning for this (being within the 400%) and it will still likely fall in the $400-$450 range for just two of us in our 40s. If it is $500 with the kid (just throwing out a number) there goes 1/3 of your 18k budget on healthcare premiums alone. That isn't all of healthcare costs, it is just the premiums you'd pay the insurer.

Can you really feed a family, maintain a house, pay utilities, out-of-pocket healthcare, home insurance/taxes, unexpected large expenses etc. on the remaining $1k per month? I know there are families that do it but I suspect very few are by choice, you can choose to keep working to have more.

 

[pb4uski]

To clarify, the premium amounts that I mentioned are for me and DW, not one.

But I agree with others that $18k a year of spending without the McMansion is very spartan and probably unrealistic.

 

[ducky911]

your spending will go up (a good thing) with children....

 

[Al in Ohio]

your spending will go up (a good thing) with children....

Yeah and if the OP is targeting only 18k annual expenses I'd say spending after having say 2 kids will increase that by 50-80% more!

 

[In-control]

My observations while being FIRE'd. I went back to work after 3 months, not because of $.

> I assumed that my finacial budget would not change and added $10k per year as a safty net for HC insurance. So my $60k budget was $70k one. It is better to have more $ then not enough!

> I had three kids in High school and my wife and I wanted to spend time with them so we could not really travel w/o them.

> We needed a house big enough for the 5 of us plus all their stuff and the large sleepovers/gatherings.

> Once you have kids you get dogs and other pets so your even more tied down to the location. They are also expensive to keep.

> I relaized that I needed to challenge my brain and interact with people. You have to build schedual that will satisfy your desires and fill the day with interesting things to do. We went to the YMCA each morning and then did local stuff until the kids came home.

> Kids are expensive!!! Each of my kids needed over $5k worth of braces. Sports/dance class, car insurance, college. Another car for all of them to use to get to work etc..

> You want to retire in style - if you are worried about surprise expenses breaking your budget then you could be introducing alot of stress into your life that is not fun!

> We have 5 yrs of budget in a high yielding savings account and a 50/50 split for our investments. It depends on alot of things esp. age. We are in our 50's so our portfolio is very conservative. Much of it is in Vangard Wellesely Income, which is a 30/70 split. I make up the difference with Index funds. This has worked very well for us as we weathered Great Recession without having to alter our allocations or worry about dipping into our income generating portfolio.

> I was keen on retiring early but my wife was not - she just was not ready for it and was nervous. Even though we had the $. Now - 6yrs later and in our 50's we are both ready. The kids are graduating next year from college. Even with that we will have to hold onto the house for a year to give them some breathing room to find work.

> Kids and retiring early. My kids heard me talking about it and looking forward to it and I think they felt that I could not wait for them to leave. So I am very carful about talking about it infront of them. Esp. selling the house - which is their home and not just an asset to them. All their childhood memories are their, it's a part of them.

Now we are telling them. You can stay and take care of the dogs and house while your mother and I travel. Leaving our options open.

These are just my observations and personal experiences - everyone is different.

 

[coltsfan53]

Kramer - I really appreciate your feedback on my ER query. Since I fired my financial planner and went to a simple indexing investment approach, I guess I need to ask how one knows if the portfolio is "structured correctly" so that our tax bill can be $0. I honestly had no idea that this is even a possibility. My impression is that 15% is the lowest a person can pay, given any reasonable income.

 

[urn2bfree]

Kramer - I really appreciate your feedback on my ER query. Since I fired my financial planner and went to a simple indexing investment approach, I guess I need to ask how one knows if the portfolio is "structured correctly" so that our tax bill can be $0. I honestly had no idea that this is even a possibility. My impression is that 15% is the lowest a person can pay, given any reasonable income.

It depends on where your income is coming from.
If you take most out of tax deferred accounts, that all gets taxed like ordinary income...the taxes were deferred not avoided.

If you take dividends and cap gains up to about $90,000 a year they can be taxed at 0% (federally, married file jointly) so if say $50000 is dividends and $40,000 is capital gains you subtract your standard deductions and your federal income tax bracket is under $70,000 so you owe ZERO to the federal government. Your ACTUAL money to spend will be over $90,000 because if you have $40,000 in capital gains, it means you made money above the principle investment. If your gain was conservatively 3% per year for 20 years then you got a $40,000 cap gain by selling out $66,667 of assets. So you would have an "income" of $116,667 which while not extraordinary has to be considered reasonable. Some of it will have to be used to pay state income taxes, but in most states that still leaves a reasonable income on a yearly amount on which you paid far lower than 15%.

 

[kramer]

Coltsfan, yes urn2bfree got it exactly right. Additionally, about 20,000 or so (the standard of a married couple) of that 90,000 or so can be interest income and unqualified dividends. So you can keep some fixed income in your taxable account for security purposes (even though most of that should be in IRA) and you probably even have headroom to do some annual IRA to ROTH IRA conversions, without paying federal income taxes.

Other considerations are state income taxes and keeping your income low for ObamaCare subsidies.

I live overseas so I pay no state income taxes and I don't have USA health insurance, so those last two items don't affect me personally.

You made the right decision by going to index funds!