Stock Options in San Diego

[Doubledoc]

Hi,

Thanks to some lucky job choices (stock options in high tech for both of us) and conservative spending/aggressive saving, my wife and I are in our early 40's and on the brink of FIRE (we think). Here's our situation:

$3.5M in taxable investment accounts (65% ETFs with overweight in LC Value and foreign and 35% bonds overweighed in CA muni's for tax advantage). We also have small positions in TIPs and high yield bond funds and a few specialty sectors (energy) to round out the core holdings.
$1.5M in unexercised stock options (after-tax value) - we've been selling quarterly for 2 years to spread out the tax burden and expect to sell the rest of my wife's ($600K) this year and mine ($1M) next year. If the stock price stays stable I will vest in another $500K (after taxes) by next year this time.
$400K in our 401K's
$40K in a term life annuity
Currently have annual expenses of $130K (based on actuals in Quicken) including $40K/year mortgage and $10K/year property taxes.
House is worth $1M with $440K left on a 6% 30y mortgage that we've paid down with extra payments.
We have locked in long-term care insurance through my wife's employer that is portable.

Post-retirement assumptions
Mortgage paid off at retirement with lump sum to end up with $5M and no debt leaving us with annual expenses of about $90K (this includes $12K for vacations/travel)
Additional health insurance premiums will cost $12-15K per year for the two of us.
Portfolio will include about 50% bonds (overweighted in CA munis) to yield $2.5Mx4.2%=$105,000 and 50% core ETFs with slightly aggressive international positions to yield average dividends of 1% = $25,000.
We will live off of the yield and let the portfolio grow at or above inflation to keep up with inflation.

Questions:
Are we really in financial shape to retire? I know it sounds like a lot of money, but all of our peers (who, by the way, can't retire) make us feel like we're cutting it close.
Am I crazy not to just sell/exercise all of my options now that we've hit our target number ($5M plus mortage)? Should I just suck up the taxes and do it or should I let it ride and take the chance?
Any input on the investment/withdrawl strategy?
Am I in the right ballpark for medical?
Have I forgotten any other expenses?

I really like this forum and would love to hear your feedback. We're really looking forward to walking on the beach every day, getting to know each other again, traveling without having to work, and enjoying beautiful SoCal while we're still young and healthy!

 

[clifp]

Financial? hell yes. Best of all you are well ahead of many us in your understanding of expense and sources of income.

Psychologically, I don't know but it sounds like it.

Non-savers really don't like to hear about people who have accumulated enough to FIRE, so don't let your uneducated peers throw cold water on your ideas.

I am surprised that your health insurance will be so high. Take a look at catastrophic insurance with an HSA account I think you should be able to find them in 300-500/month range.

 

[Tracy42]

There are others on this board who know more about taxes than I, but I just looked up the 2007 tax table and it looks to me like you are not saving any money by spreading your stock option exercises over multiple years, you are paying the same amount of tax (35%), just mentally easing the pain a little by not paying it all at once. What you are risking, though is a sharp drop in the price and a delay to your FIRE.

I exercised all of my remaining options this year when they hit the price I realized would allow me to semi-RE this year rather than hold off until next year. Within a month after I exercised the last block of them, the share price dropped $5.00. Yep, it's going to be painful come April 15, 2008.

Will you have to remain employed with the company in order to vest your remaining shares? That's the way ours worked, and while I am going to be walking away from some future unvested options, I planned it so my last highly appreciated block had vested before I leave. Tracy

 

[Doubledoc]

HI Tracy42,

Yes - I would have to stay employed to vest in the remainder, which is fine for now (unless the value drops!). I guess your perspective on the taxes is a really good one I hadn't considered. There is a little-known CA state metal health tax (I'm not kidding) that adds a punative 1% overall tax to your entire adjusted growth income for every $ over $1M. I guess in the long run paying an extra few thousand ($40 thousand!) in taxes is peanuts compared to securing my nest egg and dropping my risk.

Thanks for the suggestions.

 

[Coach]

Doubledoc, it sure sounds like you've got it made to me -- a couple of times over. You are competent investors and have managed expenses well.

Health insurance scares many of us. Will you have continuing coverage through your employer? You can afford most anything imaginable as far as HI is concerned, so I'd only want to make sure you can get it, without exclusions.

Congratulations! Head for the beach pronto.

Coach

 

[RunningBum]

Sounds good to me. I thought I was in good shape in 2000 with tech stock options but didn't pull the trigger hard enough and lost a lot of it when the bubble burst. Part of why I held off selling was that I was going to move to a state with lower taxes, but trying to wait for that 2% savings didn't help when stock more than halved. And too much of what I had sold was reinvested in similar high fliers. Now I'm back to about where I was but I'm much more diversified. So my message there is don't worry about the extra 1% even though the $ amount seems high, it's a pittance if you company stock gets ill. Not knowing which one it is, I have no idea how possible that is.

For your case, it sounds like you can cash out at any time, and might at least consider liquidating more options even if you decide to stay. 50/50 mix sounds a bit conservative to me at your age but you have a nice cushion and if playing it safer helps you sleep better, do it. You're looking at spending just 2% of your net so that not at all cutting it close.

The one question about expenses is whether you are also funding for car replacement and any other large non-annual expenses. I'm budgeting about 10K for capital expenses.

 

[donheff]

You sound like you are in great shape and have thought things through. I suspect the reason your friends are skeptical is that they are spending at a far higher level than you and/or don't really understand what it takes to be FIREd.

 

[SecondCor521]

The only question I have is if exercising such a large volume of options in a single year would make you affected by AMT. But if Tracy42 is correct and you are in the 35% bracket, and since I think AMT is 26%/28% flat rate, then maybe it's a non-issue. I dunno.

Check with a CPA. If the tax situation says there is no benefit to waiting, I would exercise my options today, wait for the check to clear, then retire.

A couple of other comments:

1. Most people on this board think that you can safely spend 4% of your initial portfolio value and then increase it by the CPI every year after that and never run out of money. If you buy into that -- do your research first -- then you'll want to spend more money, more like $200k or so.
2. I'd take a look at whether paying off your mortgage makes sense or not. This topic is a near religious war on this board, but you should at least make your own educated decision. $440K is a big portion of your assets. If you search on these forums you should be able to find old threads debating this.
3. Since you two have a net worth of $5M, you should probably consider some estate planning to avoid the estate tax.

2Cor521

 

[Doubledoc]

Hi Secondcor,

Thanks - great suggestions. I have agonized about the mortgage decision myself. After a lot of thinking and research, my conservative nature told me that having a less demanding cash flow situation better protected me from portfolio volatility and once we have very little taxable income I felt the deduction wasn't worth the added cash flow risks.

It is only in the past 2 years I decided we wanted to save enough to pay it off completely because it actually became possible. Another advantage of no mortgage is if we accumulate more than we spend over time we could buy a small cabin or vacation house and easily support the extra monthly payments. This would be impossible/tough if we had to float both payments on a fixed income. I would love to hear other poster's opinions about this because financially I could go either way and it is a pretty big decision.

Regarding AMT, we seem to only get hit with that when our deductions are high enough as a percentage of our income. Since we've been selling stock options our salary is so high we don't even come close to the line.

Thanks again to everyone for your insights. As usual they are very helpful.

 

[Tracy42]

HI Tracy42,

I guess in the long run paying an extra few thousand ($40 thousand!) in taxes is peanuts compared to securing my nest egg and dropping my risk.

Sell now, deposit the after tax 1 million proceeds you were expecting to get next year into a money market account (vanguard yield is currently around 5.10) and make around $34,000 interest on the money before your tax bill comes due. True, you will pay taxes on the $34,000 you make, but you still ought to cut your overall additional tax bill by about half. Tracy

 

[Tracy42]

correction--you don't actually "cut" your tax bill. You just fund about half of the additional tax amount incurred through your CA 1% mental health add on tax. Tracy

 

[Doubledoc]

Pay off Mortgage or invest the $$$?

Thanks for all of the input so far,

I'm still not clear on what the advantages of NOT paying of the mortgage are in my situation. It cuts my cash flow (draw down rate) in half and frees up cash to buy a vacation home or RV. I will be living off of CD interest and Muni bond yield, so don't expect to have much of a tax burden so I don't see the tax advantage.

My choices are to take $440K of my nest egg (still leaving me with $5M to live off) as soon as I retire and stop having taxable income, or to let the $440K ride in my investments. If my mortage interest rate is 6% and now I don't have any taxable income from which to deduce this interest, I might make a percent or two more by investing it but risk a higher draw-down rate for years to come. It seems that any volatility in the market or my expenses would put me at higher risk if I keep the mortgage.

What do you guys think?

 

[Darryl]

Sell as many of the options as you can (to reduce your market risk).

Payoff the house (to reduce your market risk).

Decide if you want to stay long enough to pick up the other 500k.

I think you've made it. Congratulations!!!!!!!!!!!!!!!

 

[ats5g]

Doubledoc,

If you can't deduct any of the mortgage interest, you'll need to make greater than a 6% after tax return on any investment, and that investment has to be relatively risk free. That's virtually impossible today, so I'd agree to pay off the mortgage.

To put it another way, and to get rid of any anchoring biases, say you didn't have a mortgage, but were going to purchase a house. In your situation, if you had the cash to buy a house, would you:

1) buy the house and have no mortgage, or
2) take a mortgage whose interest is not tax deductible and invest it.

If #1, pay off the mortgage.

- Alec

 

[Doubledoc]

Ats5G,

Great perspective. I got my wife to start selling her stock options more aggressively using a similar approach. I asked her if I gave her $1M today how much of it would she use to buy her stock at today's prices. Her answer was $50K, so we were off to the races and selling. Of course it got easier and easier as we approached our target number and realized most of the options represented risk to KEEPING that number rather than risk of not reaching it!

Thanks again

 

[Doubledoc]

My wife just took the plunge today!

My wife just gave her notice today so we're firmly on the path. We're both excited and nervous, and I keep working the numbers to make sure it's real. I need another year to pay off the mortgage and let my shares vest. We're dumping all of her shares as soon as her window opens to lower our exposure. If mine stay where they are all should be good.

We are already getting along better and are both happier - just because we took action and feel more in control of our lives. It'll be great to have someone able to take care of our lives at home for a while and to practice living on our target income (my take-home income is about what our investment income should be when I quit).

Thanks again for all of the encouragment and support. I'll keep you posted as to how it's going and see if I can pull off my own FIRE in a year...

 

[Darryl]

Congratulations to you and your wife. Good to hear about the immediate relationship improvement. Good plan to practice on your target income and knock out the mortgage before you join her. Keep us posted.

 

[HobbyDave]

Congratulations That's great, hope your wife enjoys the retirement. Tell her she needs to cook for you now, that should fix those relationship happy thoughts

By the way, I don't think you replied to the health insurance post. With the funds you have available, you really should look at a high deductible plan, which will save you a lot on your monthly bills. You can easily cover the 4-5k deductible if something happens.

 

[Rambler]

I'm in a similar boat and keep hoping the stock will rise. But thinking about pulling the plug on the options soon because current incentive scheme is also tied to the share price. I don't want all my eggs in the company basket...

I also think that 12-15k for insurance is on the high side. DW and I have shopped around and think we can do pretty well with 600-700 per month, BUT you do live in San Diego (read pretty high cost of living).

Also, I think you may be a little conservative with the 50/50 split. I'm heading for somewhere between 65/35 and 75/25. I'm also in a similar age bracket, got a lot of years to go, so maybe shouldn't be so conservative. I'm with you about living off the yield though...that's what we are planning.

 

[kramer]

I also think that 12-15k for insurance is on the high side. DW and I have shopped around and think we can do pretty well with 600-700 per month, BUT you do live in San Diego (read pretty high cost of living).

As someone who recently FIRED and moved to San Diego and got high deductible health insurance here, I can state that health insurance is not particularly high in this area. It surprised me. It seemed to be about the same cost as in Arizona and Texas. Also, some insurances were a little cheaper in this part of the state than other parts of California.

Kramer