Assumptions I am making about FIRE

[kmt1972]

Being that this is a new year I have updated my FIRE xls and have been reviewing assumptions I am making about my FIRE plans. For me my xls or the FIRECALC calculator is only as good as the assumptions I am making. I strive to be as reasonably pessimistic as possible and I am listing them so I can hear feedback on them, especially if they sound too close to the medium or optimistic expectations and not pessimistic enough for my standards.

1) Long term inflation is 3.5% versus the 2%-2.5% over the last couple of decades
2) Medicare does not kick in until we are 67 and not 65 as today.
3) Medicare premiums twice as expensive in 2014 dollars as today.
4) Social Security benefits will pay out 70% of today's projections and will be fully taxed as opposed to 85% taxed as today.
5) No LTC insurance so I expect to pay $60K a year for myself and DW beyond what Medicare will pay in LTC starting when I am 75 then rising to $110K a year when I am 85.
6) When our 3 year old DS goes to college he will attend an expensive university (I used Yale since I went there) in 2029-2033 and cost $77K a year in 2014 dollars (as opposed to $58K a year in 2014 dollars as today)
7) Tax structure will not change other than the various brackets being indexed to inflation. (This might be too optimistic but it is hard to guess what the tax brackets/laws will be decades from now)
8) All investments including IRAs return 1% beyond inflation every year. Likely allocation being 50/45/5.
9) While our DS is attending elementary and middle school, budget $17K in 2014 dollars, for various classes/activities outside of school, especially summer camp.
10) $12k in 2014 dollars spending a year on various house and car maintenance costs.
11) Once DS is in college and we no longer need to stay in a good school district, move to Florida where state income taxes are zero.
12) Vacation budget of $20K in 2014 dollars per year up to when we need LTC which is when I am around 75.
13) The $250K Obamacare tax floor which is NOT adjusted to inflation will be linked to inflation in the future when it reaches $175K in 2014 dollars just like what happen to the AMT. This might be too optimistic but with my high inflation assumptions it will seem absurd that in the future people pay this 3.8% tax even if their income are not considered high.
14) Our medical costs before Medicare are just the cost of a Platinum Plan plus Max Out of Pocket Costs of said Platinum Plan in NY and then FL.

 

[RockyMtn]

And what sayeth Firecalc? (Versus your previous assumptions)

 

[kmt1972]

Firecalc would have me being at $1.3 million in 2014 dollars after 50 years in retirement. That is based on 3.5% inflation and 4.5% annual return. A variation of anything beyond 3% SD and then there are cases where FIRE fails. Of course if I used 50/45/5 in portfolio scenarios I am well in the clear and there are no scenario where my NW even goes down let alone fail. Even a 25/70/5 portfolio scenario analysis has similar results from a worst case scenario point of view.

 

[pb4uski]

What I use.

• Inflation 3%
• Health insurance, deductibles, and co-pays are in the living expenses and include current cost of bronze HDHI premiums and $3k a year for deductibles and co-pays and are not expected to change when we go on Medicare at 65 (probably too conservative)
• 10% haircut to SS from what SSA says for us (FRA for DD, age 70 for me)
• No LTC or LTC insurance
• $100k today's $ of college costs for DS (unclear if he will go or not - currently living independently and working full time)
• 7% federal and state taxes
• 5.5% annual return for 60/40 AA (vs 8.7% historical return from 1927-2012)
• Living expenses include house and car maintenance and car/boat/jet ski/snowmobile depreciation as a provision for replacements
• Vacation budget is only $3k/year but there is leeway within assumed annual living expenses for more
• $25k for DD wedding (+ inflation)
• Mortgage payments on top of living expenses

None of your assumptions seemed outrageous to me.

 

[jebmke]

I don't try to guess what the tax structure will be or inflation. I do everything in real dollars. I do assume health care will increase in real dollars.

 

[Live And Learn]

Your assumptions look very conservative and should give you a great deal of comfort (ability to sleep at night).

here's what I use:

• 67% of SSI estimate
• Assume Medicare doesn't kick in until FRA (67)
• Exclude $108k from portfolio for LTC (assumes 7 months per person at $250 per day) - this worries me a little as I think I should 14 months each but I have enough other "fluff"
• Assume we hit family OOP max of 12.6 for Healthcare every year budgeting 30k per year to age 67 and then 15k per year thereafter (for 2 people)
• $5k annual for vacation, even tho we never travel
• 2.5% of home value for annual maintenance / replacement of major components (roof etc) plus an additional reserve of 25k to cover "the things I didn't think about"
• $75k set aside for "bucket list" travel - this we will probably actually spend
• $4k annual "accrual" for other "one time" expenses (car replacement, etc)

You look to be golden ! congrats

 

[kmt1972]

I don't try to guess what the tax structure will be or inflation. I do everything in real dollars. I do assume health care will increase in real dollars.

But it seems to me that one has to make some sort of assumption on inflation mainly to figure out taxes ones owes. Even if one measures consumption in real terms the fact is we are taxed in nominal terms. If we had an asset that is 100 and had a real gain of 2% with inflation at zero, then we are taxed on the gain of 2. But if inflation is instead 8% then we are taxed on the gain of 10 (2%+8%) and we might end up with after tax losses if inflation is high enough and we are in a tax bracket that is high enough.

The way I plan for taxes is to assume we are taxed in nominal gains (real returns plus inflation) any given year. That is the best I can do even though which year we take the gain will make a difference on the AGI of any given year.

 

[pb4uski]

But tax brackets are now indexed for inflation.

 

[kmt1972]

But tax brackets are now indexed for inflation.

Yes. But that only helps for earned income and not as much for asset based income.

Lets go with an example and assume you have an asset worth 1000 which made 2% real increase. Lets assume that taxes are so that any income below 10 are not taxed and any income above 10 are taxed at 50%.

Say inflation is 0%. You made an income of 20 (2% of 1000) so your tax bill is 5 (50% of 10 which is 10 greater than income tax bracket of 10). So now your asset is worth 1000+20-5=1015 which is 1.5% real increase after taxes.

Say inflation is 10%. You made an income of 120 (10%+2% of 1000). Now because the tax brackets are indexed to inflation, the cutoff for tax of 50% versus 0% is 11 and not 10. So your tax is (120-11)*.5=54.5. So now your asset is worth 1000+120-54.5=1065.5. But since inflation is 10% your asset is actually worth after taxes 96.86% (1065.5/1100) of the value before in real terms for a loss of 3.13%.

So inflation makes a big difference, despite the help of tax brackets are now indexed for inflation. Of course for earned income, assuming your salary increases each year keeps up with inflation or more it make no difference. The key difference for asset based income is that we get taxed on nominal increase in asset price not real increase in asset price.

 

[kmt1972]

I do like the feedback on wedding costs. Never thought of that. I guess I have a DS and not a DD so I will really not budget for it. I say, if he is mature enough to get married he should be pay for his share of the wedding costs without his parents (us) having to pay for it.

 

[W2R]

Good list, IMO, that shows considerable thought.

Something to consider is that Medicare costs may possibly be even more than twice what they are today, because it is presently so underfunded. On the other hand, health care realities are changing so fast lately that it is hard to know what to suggest here.

Also possibly LTC costs could be a considerably more than anyone expects by the time you need it, due to increased demand for good LTC when baby boomers become old enough to need these services. Because of this I like the way you have your LTC expenses increasing from $60K to $110K in just 10 years.

 

[bUU]

1) Long term inflation is 3.5% versus the 2%-2.5% over the last couple of decades
2) Medicare does not kick in until we are 67 and not 65 as today.
3) Medicare premiums twice as expensive in 2014 dollars as today.
4) Social Security benefits ... will be fully taxed as opposed to 85% taxed as today.
8) All investments including IRAs return 1% beyond inflation every year. Likely allocation being 50/45/5.

This demonstrates a really big problem with this discussion space. I couldn't imagine making such assumptions because of how they would dictate such a severe reduction in our standard of living. I wonder if we could establish a correlation between someone's absolute level of wealth and their receptiveness to adopting increasingly smaller-probability pessimistic assumptions.

 

[REWahoo]

This demonstrates a really big problem with this discussion space. I couldn't imagine making such assumptions because of how they would dictate such a severe reduction in our standard of living.

For some the OMY syndrome isn't a disease, it's a cure.

 

[Live And Learn]

For some the OMY syndrome isn't a disease, it's a cure.

Wow - that is a quote worth remembering and repeating !

 

[REWahoo]

Wow - that is a quote worth remembering and repeating !

The challenge is to know which applies to you.

 

[kmt1972]

This demonstrates a really big problem with this discussion space. I couldn't imagine making such assumptions because of how they would dictate such a severe reduction in our standard of living. I wonder if we could establish a correlation between someone's absolute level of wealth and their receptiveness to adopting increasingly smaller-probability pessimistic assumptions.

Thanks for your feedback. If you feel that my assumptions are overly pessimistic, I love to hear what you feel are reasonably pessimistic assumptions. It can only help me in my planning to hear many different point of view.

 

[kmt1972]

Bear in mind one of the reasons why I use these fairly pessimistic assumptions is that my DW is a serial pessimist who is obsessed with being in the poorhouse if she loses her job. Part of my FIRE planning is to also convince her that we got it covered in terms of money. I want to show her fairly pessimistic assumptions and then the math to prove to her that we will still have a boat load of money at the end of our lifetime even if most coin flips in the rest of our life comes up against us.

 

[Live And Learn]

Bear in mind one of the reasons why I use these fairly pessimistic assumptions is that my DW is a serial pessimist who is obsessed with being in the poorhouse if she loses her job. Part of my FIRE planning is to also convince her that we got it covered in terms of money. I want to show her fairly pessimistic assumptions and then the math to prove to her that we will still have a boat load of money at the end of our lifetime even if most coin flips in the rest of our life comes up against us.

Agree. To Midpacks comment, I think we add these pessimistic views into our plans because we don't know if the future will be like the past, and these "gotchas" help us to feel that we've mitigated at least some of the risks that we can quantify. Heck, I even have a budget line that's called "the unknown". Its only $2,500 a year, but it helps me when I get hit with a bill I never even thought about (who knew that HVAC ductwork needed to be replaced ).

 

[bUU]

Thanks for your feedback. If you feel that my assumptions are overly pessimistic, I love to hear what you feel are reasonably pessimistic assumptions. It can only help me in my planning to hear many different point of view.

You're talking about something that is playing double-edged risks and probabilities off each other, i.e., deciding between buying a proposition for which the down-side is low probabilities of terrible things happening [with the up-side being low probabilities of great things happening], on the one hand, and buying a proposition for which the down-side is high probabilities of marginally bad things happening [with the up-side being high probabilities of marginally good things happening]. With so many moving parts (probabilities and the dual-edged nature of the consequences) the determination of what's optimal is going to be very much a personal decision. It's a matter of risk tolerance in two dimensions. Your assumptions may be the perfect assumptions given your own situation, and (more importantly) your own priorities, while being completely inappropriate for other people.

In the context of the situation my spouse and I find ourselves in, I highlighted the specific assumptions that would categorically destroy any chance we would have of achieving our dreams. YMMV. So the question boils down to, taking that as a given, which do you wish to choose: taking exceedingly little risk and resigning and consigning yourself to disappointment, or taking some more risk and thereby incurring a small possibility that you could end up in trouble later on.

 

[robnplunder]

The challenge is to know which applies to you.

Both.

To OP, pessimistic is one thing. Looking at the worst (or near worst) case scenario is another. For me, I'd like to be realistically pessimistic (or pessimistically realistic) when planning for RE. I will have enough to cover for surprises but don't try to build a large pond for paper boat.

 

[kmt1972]

You're talking about something that is playing double-edged risks and probabilities off each other, i.e., deciding between buying a proposition for which the down-side is low probabilities of terrible things happening [with the up-side being low probabilities of great things happening], on the one hand, and buying a proposition for which the down-side is high probabilities of marginally bad things happening [with the up-side being high probabilities of marginally good things happening]. With so many moving parts (probabilities and the dual-edged nature of the consequences) the determination of what's optimal is going to be very much a personal decision. It's a matter of risk tolerance in two dimensions. Your assumptions may be the perfect assumptions given your own situation, and (more importantly) your own priorities, while being completely inappropriate for other people.

In the context of the situation my spouse and I find ourselves in, I highlighted the specific assumptions that would categorically destroy any chance we would have of achieving our dreams. YMMV. So the question boils down to, taking that as a given, which do you wish to choose: taking exceedingly little risk and resigning and consigning yourself to disappointment, or taking some more risk and thereby incurring a small possibility that you could end up in trouble later on.

You make good points. Thanks for your thoughts. I would love to hear your alternative assumptions for

1) Long term inflation is 3.5% versus the 2%-2.5% over the last couple of decades
2) Medicare does not kick in until we are 67 and not 65 as today.
3) Medicare premiums twice as expensive in 2014 dollars as today.
4) Social Security benefits ... will be fully taxed as opposed to 85% taxed as today.
8) All investments including IRAs return 1% beyond inflation every year. Likely allocation being 50/45/5.

I want to be pessimistic but not unreasonably pessimistic as I could then miss out on doing something fun or great for fear of lack of funds. Hear your assumptions could help me calibrate my assumptions.

 

[bUU]

You make good points. Thanks for your thoughts. I would love to hear your alternative assumptions for

I use three different retirement planning tools. As a rule, unless I have a specific personal reason to change something I use the defaults because smarter people than I set the defaults. I do, of course, enter personal info as applicable (i.e., my portfolio size, my age, my expected SS amounts, etc.), and I will make conflicting defaults between different tools consistent so their results ostensibly support each other better. There's enough divergence in their methodologies - no sense in making it worse by starting off with inconsistent default assumptions about returns, inflation, etc.

 

[Katsmeow]

I do have a different take with a lot of the assumptions being made including those by the OP and Live and Learn and pb4uski.

First - let me be clear - If making those assumptions helps you to be more confident about retirement and is what is necessary so you can sleep at night then it works for you and it doesn't matter what I or anyone else thinks.

Second - there may be some people who would think that those kinds of assumptions are necessary for everyone and who might not retire because of using those assumptions. I know that I personally tend to be risk averse and there is benefit in it. On the other hand, you can't get time back and if I retire later due to unreasonably pessimistic assumptions then I've lost that time forever.

Third - Using such pessimistic assumptions is nice for people who have lots and lots of money and you can use them and still retire really early. I mean that in all sincerity. But, for many people (most probably) using those kinds of assumptions might been retiring at advanced age or even never retiring at all. There's that time thing again.

Fourth - The biggest problem I have with the long list of assumptions for all the one's I've mentioned is with the conglomeration of them all and not the individual assumptions.

That is, while bad stuff happens and more than one bad thing happens is far less likely that every bad thing will happen.

So, planning for every bad thing to happen is probably overkill even though each individual thing could happen.

An example from my life. I used the each year budget for various "bad things" that could happen. I had once had $6000 in auto repair in a year. Or, once I had $13,000 in household repair one year (mostly tree clean up after a hurricane). And, I had a year with lots of unreimbursed medical expenses ($15,000 or so).

Now all of that didn't happen every year. It could happen in one year but it was vanishingly unlikely that it would.

So to budget $34,000 each and every year just because those things could happen would be overkill. The likelihood was that maybe one of them would happen in a year. In fact, most might never happen again in my lifetime. I realized that instead what would work better was to budget a typical amount for those types of things - an average for auto repair, etc. based upon typical years. Then, put $X into an irregular expense food that would cover one of those things happening in a year. If it didn't happen, then carry it over until I got to some predetermined maximum.

So - the problem with the OP's list is that while I think some of those thing could happen it seems extremely unlikely that all of them will happen. Same thing with Live and Learn's list.

If it was me, I would do one of two things to deal with those kinds of things. One option is set aside some amount outside the regular portfolio to collectively handle the possibility that some those kinds of things will happen. However, I wouldn't personally feel that I had to guard against every one of them happening. It would be enough to come to some reasonable reserve for a reasonable number of them happening. This is sort of like my irregular expense fund.

The other option (and the one I've used) was to go through my projected budget and think about how I would cut expenses if various things occurred. If I can cut enough expenses without negatively affecting my quality of life than I feel OK.

 

[ksr]

So to budget $34,000 each and every year just because those things could happen would be overkill. The likelihood was that one of them would happen in a year. In fact, most might never happen again in my lifetime. I realized that instead what would work better was to budget a typical amount for those types of things - an average for auto repair, etc. based upon typical years. Then, put $X into an irregular expense food that would cover one of those things happening in a year. If it didn't happen, then carry it over until I got to some predetermined maximum.

This is exactly what I do. For my first few years in retirement, I just let the unused "irregular expense" money stay in my portfolio. However, I realized that I was still irrationally worrying about something big and expensive going wrong and breaking my budget. So a year or two ago I decided to start actually moving that unused money into a separate account, and I don't include that account when calculating year-end portfolio value for WR purposes. I know it's all just funny math, but it seems to work better for me to have a physical "emergency" account that is separate from everything else.

 

[bradaz2488]

Here are the assumptions I have been using:

45 year plan (live till 95)
Inflation = 2.5% and 7.5% for medical costs
Average annual return on investments = 6% with a AA of 65/20/15
Annual expenses: Essential = 65% and Discretionary = 35%
Decrease annual expenses by 12% at age 75.
Assume no SS or Medicare benefits.
Medical costs (% of expenses) = 18% at age 65, 25% at age 75 and 35% at 85.
Tax rate on taxable accounts is ~12% and slowly decreases to ~3% at age 70.
Tax rate on tax-deferred accounts (RMD) starting at 70 is ~13%.
Purchase car every 7 years (only if it cost more to maintain vs. buying).

I think my overall plan is conservative. The 2.5% inflation rate is probably on the low side, but if you add in the 7.5% inflation rate for medical cost it ends up being around 3.5% inflation rate.... Big unknowns are "real" medical costs and how taxes will changes over time. I know assuming "no" SS or Medicare is very conservative. If I do account for in in my planning I only use 75% of what I would get in benefits. I'm not counting on the clowns in Washington to fix this any time soon....