Ask Big Ern: A Safe Withdrawal Rate Case Study for “John Smith”

Welcome! Today is a premiere! Our first case study for a fellow FIRE planner “John Smith” (not his real name) who asked me if I can look into his early retirement plan, run some numbers and check whether he can retire already. John and his wife have done a phenomenal job and reached the “millionaire club” in their thirties! Congrats!

I should also state that I don’t consider this any competition to the great crowdsourcing FIRE advice project that Brad and Jonathan run on over at ChooseFI podcast. Their first case study for Paul went on for multiple weeks with lots of different experts weighing in (including Big ERN in Part 3!) so our analysis here is probably not as thorough as on the podcast.

In any case, without further ado, let’s just jump right into the case study:

John’s situation

I’m 37 years old. I make about $114k per year (plus bonuses which have varied from 5-12% of base pay in the past few years).  I can’t wait to hit FI to ‘retire’ from a 9-5 job, but I don’t have confidence in my current net worth holding up for the duration. Wife is almost 36 and (since 1 year ago) stays at home with the kids (who are 1 and 3).

We don’t feel a large needs to save for the kids educations, since they can learn a trade, pay for their own schooling, get scholarships, or maybe (as I’m hoping) some sort of ‘youtube university’ or ‘itunes university’ will really grow and take over as the legitimate higher education option  in the next 15 years.  🙂

Our total expenses, not including my income tax, in 2016 were $60,370.  We have tracked expenses going back longer, but those 12 months (with the few adjustments below) are a good indication of things to come (or as close as I can guess at this point).

I made the following adjustments to plan for a more ‘typical’ year:

  • removed $7k (of $11k) worth of house repair expenses in 2016 since we had a higher than normal year for repairs due to selling our old house, but I kept in 4k per year for other repairs/updates each year.
  • removed $14,500 per year for mortgage – I’m assuming we’d pay off the ~160k mortgage (2.875% fixed rate for 14 more years) just to keep the FI calculation simple
  • added $12,000 per year for health coverage for a family of 4 – I am guessing here on the costs, it may be high, it may be low, ACA could be changed… this is a giant question mark.
  • added $5,000 per year for vacation expenses (since we didn’t take a vacation in the last 12 months and 5K is a pretty decent vacation budget I figure).
  • added $700 per year for gym memberships since we’d like to focus a lot more on health post-FI.

So our expected yearly costs going forward should be around $56,570.  Kids can get expensive, but we’ll be trying to control that.  This makes our FI number, using a rough calc of x25, $1,414,250.

We currently have a net worth of $1.1M – after subtracting the ~145k in cash we currently have for the purpose of (almost entirely) paying off the balance of our mortgage if we chose. Here’s the rough breakdown of the 1.1M:

  • $300k in Taxable Investments.
  • And $812k in qualified investment accounts
    • $162k in 401k
    • $219k in Roth IRA
    • $431k in Traditional IRAs.

I realize our net worth is $300k+ short of my theoretical FI number of $1,414,250… but if I assume the $1.1M we currently have, IF SHIFTED/MOVED INTO THE RIGHT TYPES OF FINANCIAL PRODUCTS, could generate $46,800/yr in income, then I feel confident I could make the additional $10k per year we need with small side hustle earnings.  I realize the assumption that 1.1M could create an income of ~$46,800 is way over simplified since I didn’t account for taxes etc, but it’s the best I can do for now.

What I DON’T know however, is how to turn $1.1M into $46,800 in yearly income when 66% of that is in various types of qualified accounts.  I’m aware of the limited options I have (Roth conversion, 72T, real estate inside of a qualified account, etc), but the real mechanics of creating an income plan (that also accounts for taxes) is what escapes me.

Several more follow-up emails clarified this:

  • Annual Social Security benefits expected at age 70 would be about $20,900 for John and $16,100 for his wife, which already takes into account a 20% haircut to future benefits.
  • The Traditional IRA is actually mostly a Rollover IRA from previous 401(k) plans, so upon withdrawal, we can assume that 100% will be taxable as ordinary income.

A Retirement Withdrawal Strategy

This situation calls for the Roth Conversion Ladder, (see some great summaries/examples at Mad Fientist, Retire by 40, Root of Good), which I would implement as follows:

  1. If your side hustle earns $11,000 p.a. contribute all of that to your Roth IRAs ($5,500 each). You mentioned you wanted to make 10K, but I just upped that by another $1,000 to max out that Roth IRA. Might come in handy later! I also assume, conservatively, that you do the side hustle for “only” 10 years, not your entire retirement. Who wants to drive for Uber or Lyft for the next 50-60 years, right?
  2. Use the taxable account for living expenses, always making sure you withdraw only long-term capital gains.
  3. I assume that you use the $12,700 p.a. standard deduction and 4 exemptions until year 15, then 3 exemptions in years 16-17 and 2 exemptions after that, when the kids are likely no longer considered dependents.
  4. You can generate roughly $29,000 of income tax-free (federal) by using the $12,700 standard deduction and four exemptions ($4,050), then adjusted for inflation (2%) per year. Remember, the $11,000 in side hustle income are taxable, too! So, initiate roughly $18,000 p.a. (29,000 minus 11,000) in Roth Conversions from your tax-deferred accounts to fill up this zero marginal “tax bracket” while working.
  5. I ignore state income taxes in the simulations. They would be a flat 3.07% rate in Pennsylvania. But you also get a child tax credit and potentially even earned income tax credits and I would feel confident that it will be more than enough to offset the modest state tax burden.

Challenge #1: This SWR strategy will not avoid Federal income taxes, i.e., the Roth Conversion Ladder works only partially!

A lot of John’s portfolio is concentrated in retirement accounts. Only $300k, or less than 30% is in easily accessible taxable accounts. Let’s “simulate” forward the account balances, assuming a 6% (nominal) asset return and 2% inflation, see table below:

  • The taxable account lasts for only about 6 years.
  • Starting in year 7, you will now start withdrawing from the Roth (while still rolling over the maximum every year from the Traditional IRA) to max out the 0% tax bracket.
  • Unfortunately, the Roth will run out of money in year 29. At that time, you’ll be able to make penalty-free withdrawals from the Traditional IRA, but they will be taxed at 10-15% marginal.
Case Study John Smith Table01
Roth Conversion Ladder until Social Security kicks in (Year 33). Starting with so little money in taxable accounts will risk exhausting the Roth before Social Security kicks in.

But the situation is even worse. In the table below, I zoomed into the Roth IRA numbers over the first 22 years (while still below age 59.5). Not the entire Roth IRA is eligible for a penalty-free withdrawal. Only the contributions plus rollovers that are five years or older can be withdrawn tax-free. Let’s keep track of how big the Roth IRA pile of eligible tax-free withdrawals actually is. I assume here that out the current $219,000 are approximately half-half contributions and gains. The new annual Roth IRA contributions add immediately to the pile that’s eligible for withdrawals, but the Rollovers only after 5 years. So we keep track of gains vs. contributions, and subtract the last 4 years of rollovers to get the column “Contributions eligible for tax-free withdraw.” Notice how that column never reaches more than about $173,000.

Case Study John Smith Table02
The Roth ladder will likely fail even earlier: In year 11 all the tax-free contributions might be exhausted. At that time one would incur federal income taxes from 401k distributions!

Once you run out of taxable accounts and you need to live off the Roth you exhaust that pile pretty quickly: In year 11 you need $68,959 in consumption but you have only $2,477 in funds eligible for tax-free withdrawals in the Roth. The shortfall of over $66,000 would have to come out of the Traditional IRA. You’re only in your late 40s and you already have to tap your Traditional IRA/401(k). You can do that penalty-free through a 72(t) (Substantially Equal Periodic Payments) plan, but you do owe taxes on that. See a nice link here and the extensive material on the IRS site. The $66k shortfall, of course, is taxed at a 10-15% marginal tax rate, for a tax bill of probably close to $9,000, considering that you exhaust the entire zero % tax bracket for continued Roth rollovers. Bummer!

Challenge #2: Sequence of Return Risk – Base Case SWR simulations

Notice that the calculations above were mostly about the tax-hacking. True, the Roth Conversion Ladder is not as useful as one would have hoped for and there are some tax bills, but at least John doesn’t run out of money, right? Not so fast! There was no Sequence of Return Risk built into the calculations. Let’s look at how the John Smith withdrawal strategy would hold up with historical asset returns. I inputted your parameters into my Google Sheet:

  • Link to the John Smith Base Case Google Sheet
  • In our SWR series, part 7 we provide additional details on how to use this and how the SWR are computed.
  • Also notice that the sheet cannot be edited by anyone but me, for obvious reasons. If you like to play around and make any changes, please save your own copy, see instructions in the screenshot above!
How Save Your Own Google Sheet
Please save your own copy. Only Big ERN can edit the master sheet!

I assumed an 80/20 Stock/Bond allocation, and also added the extra income from the side hustle for 10 years as well as Social Security, starting in year 33 (John) and 34 (wife). The results are in the table below:

  • A reasonably safe withdrawal rate would have been 4.25%. This generates a roughly 10% failure probability in historical simulations, conditional on an elevated CAPE (20-30). Side note: the most recent CAPE I saw was actually slightly above 30, but Prof Shiller hasn’t updated his equity earnings numbers for a while and I’m pretty sure the revised number will drop to below 30 again.
  • The proposed annual consumption of $56,570 (a whopping 5.14% withdrawal rate) would have failed in more than 40% of the simulations with a starting CAPE of 20-30. That is unacceptably high!
Case Study John Smith Chart01
Base Case SWR historical simulation results.

Cut expenses?

If $56K in annual expenses don’t seem like a sustainable spending level given today’s equity valuation, why not try to hack expenses some more? Are you sure you maxed out all the tricks of frugal living? Have you checked out the Root of Good blog? One of my personal all-time favorite blog post on that blog (or maybe among all blogs) is this one:

Living a $100,000 lifestyle on $40,000 per year

This couple has three kids and they live on $40,000 a year. If you could look at your budget and theirs, meet everywhere half-way you’d be at around $48K a year: a pretty decent consumption budget and almost low enough for the 4.25% safe withdrawal rate!

Work for four more years?

Let’s assume that John works for four more years, bringing in $120,000+ annually. I also assume that he does the side hustle for only six more years after retiring. Working longer, of course, brightens the early retirement outlook in (at least) five ways:

  1. shorten the retirement horizon, especially the number of years you have to bridge before Social Security kicks in
  2. Increase the expected Social Security benefits
  3. additional contributions into the FIRE stash
  4. additional capital market returns for the existing stash
  5. make the Roth Conversion Ladder work longer!

Let’s assume the following annual savings:

  • Contribute $24,950 p.a. to the 401k. (John’s estimate)
  • Contribute $11,000 into the two Roth accounts. (John’s estimate)
  • Contribute an additional $10,000 into taxable savings every year. You said that you have enough cash to pay off your mortgage. When you do so, direct the savings from not having to pay the mortgage every month into a taxable account!

With a conservative asset return of 6% nominal (not as conservative as Jack Bogle, though), my estimate is that the financial net worth will increase to about $1,470,000 in today’s dollars. Plug in those updated numbers and see the second Google Sheet here:

Google sheet with SWR simulations

The picture looks much brighter now. At a 4.1% SWR (around 90% success rate, conditional on an elevated CAPE), we’re now looking at a much more generous initial consumption rate. See the results below. The safe consumption amount is now significantly higher: above $60k p.a. (in today’s dollars, not future dollars!), even though the percentage withdrawal rate is now only 4.1% (that’s because the side hustle is now lasting only 6 more years and both the side hustle and Social Security benefits are a smaller % of the increased asset value, hence the SWR is a bit lower here).

Case Study John Smith Chart02
SWR historical simulation results when working for 4 more years

One word of caution, though, is that even with this improved asset position, there is still the problem that the Roth Conversion Ladder does not work all the way through retirement. After about 15-16 years, you will still likely face some federal tax liability in the future. Not as bad as in the base case, of course. But with $60k in annual consumption allowance, there’s some room to budget for paying federal taxes.

Some ideas to “boost” returns

Regarding John’s question:

“IF SHIFTED/MOVED INTO THE RIGHT TYPES OF FINANCIAL PRODUCTS, could generate $46,800/yr in income, then I feel confident I could make the additional $10k per year we need with small side hustle earnings.”

Let’s first clean up one small misunderstanding: As we wrote in our SWR series: The number 1 reason your SWR fails is the sequence of return risk. Not low returns, but sequence of return risk! So boosting returns might be barking at the wrong tree here. If a higher expected return also brings higher risk with it, you might be doing more harm than good. If I had to recommend something to generate more stable returns I would look into 2 interesting options:

  1. Rental Real Estate. I’m not the expert on this so I will defer to Coach Carson. The idea I liked the most is the “house hacking” concept: Buy a multi-family (2-4 units) property, live in one unit yourself and rent out the others and essentially live for free. You mention that you have $100,000+ to pay off your mortgage. Why not use that money to buy a duplex, rent out your existing house and one duplex unit, live in the other duplex unit and get some serious house hacking underway? Again, I’m not the expert on this, but the relative stability of rental real estate income, inflation protection and diversification with your equity-heavy portfolio seem like an interesting idea.
  2. Option writing.  I have written about this topic (see a two-part series here: part 1 and part 2 and make sure you also check out Fritz’ post on the topic, it’s a classic!). The idea is that if you have already achieved FIRE or are close to it, there is no need to shoot the moon and generate outsized equity returns anymore. By selling the equity upside you can generate some nice steady additional income.

But a word of caution: Whether it’s real estate or derivatives trading, you’d be wise not to jump into anything new right after retiring. Explore this while you still have the safety of a paycheck! Run this for a few years (ideally four years!) before you pull the plug on the job only after you are comfortable with the results.

One other thought about the work->retirement transition

Financial Samurai wrote about the benefits of “engineering” your layoff. The advantage of being laid off (not fired, big difference!) is that you will likely get some sort of severance package from your employer. A few extra months of severance pay can make a big difference in your FIRE plan. Also, if you’re laid off you’ll be eligible for unemployment benefits, which is not the case if you leave yourself. Pick up every extra dollar you can!

Summary and a final word

Sorry, I didn’t have better news! Despite your very impressive savings performance, I would consider it a bit premature to retire anytime soon. But then again, I’m Big ERN and extremely conservative about the FIRE arithmetic. Others who look at your numbers will likely tell you to go for it. There are lots of precedents of folks who retired with similar asset positions but keep in mind that many of them retired several years ago when equities were much cheaper. People who retired in, say, 2012 with $1,100,000 had a very smooth ride so far. But we can’t guarantee that today’s early retirees can repeat that experience. In addition to the high CAPE ratios there are several risk factors in this retirement plan:

  • The taxable account will last for only six years and the Roth conversion ladder may only work until your late 40s. After that, you have to plan on paying several thousand dollars in federal income taxes every year.
  • Even if you are comfortable with the 72(t) plan for digging into 401k/IRA assets penalty-free before age 59.5 make you are aware of all the pitfalls. If you start this route and don’t keep up the substantially equal periodic payments you could be on the hook for the 10% penalty for early withdrawals.
  • You already plan with a side hustle in the base case scenario. Normally, I would recommend using the side hustle as an “insurance policy” in case money gets tight during retirement. Make sure you have a second one for an additional $10,000 income potential just in case. Remember, all SWR calculations still have a 10% historical failure rate built in!
  • Health expenses: You can probably get away with lower health expenses than your $12,000 estimate. But who knows? Obamacare can either collapse in a few years or could be replaced with something less generous.

Finally, I sensed a bit of frustration about work and an eagerness to call it quits. I know it’s a bit of a cliche but make sure you don’t just retire from work but also retire to something you like. Don’t throw in the towel at work. Try to alleviate what’s bothering you or look for a different company (maybe with a big pay raise?!) and haul in some more cash for a few years. I know four more years will seem like a long time, but I’ve been planning FIRE for more than that and I have another year to go now. Retirement will be more relaxing when you don’t have to worry about the Roth Conversion Ladder failing in your late 40s!

Either way, I wish you all the best! Keep us updated on your progress!

I hope you all enjoyed the first ever case study. If others want to weigh in please comment below!

61 thoughts on “Ask Big Ern: A Safe Withdrawal Rate Case Study for “John Smith”

  1. Excellent breakdown! Doing this type of analysis is something I would recommend before making the decision to retire. One way to improve this situations is to drastically reduce your expenses, which may or may not be possible.

    1. Hi – ‘John Smith’ here from the case study. I agree, cutting spending is a great way to speed up FI. Everyone has their own number that they consider acceptable for a comfortable FI expenses. In my case, I generally wanted to FIRE at our current expenses level since I didn’t want my decision to have a noticeable impact on my families comfort. This just seemed to be an easy and clear cut goal. That being said, my wife doesn’t spend on much at all and we do pick up some expenses for other members of each of our families which inflates our expenses… but we are ok with our current spending level and I think the true challenge will be in keeping it relatively the same as the kids grow.

      1. You might want to check out Root of Good. He’s got 3 kids and a wife he seems to be taking care of on about $40K/year (+ tax). He works a lot to save money, and it sounds like it’s paying off: they’re off on a 9 week European vacation for next to nothing (travel hacking).

        I bet if you and your wife put your mind to it, you could FIRE on your 40th! (E.g., instead of spending $5K for vacations, start the travel hacking).

      2. John,
        You want retirement to be one where you aren’t riddled with worry over the future of your family. We’re somewhere near(ing) the end of the greatest bull in history, and sequence of return risk is very real. I think you should think very long and hard about leaving your job until you could take a 2008 era 50% haircut to your portfolio and still be able to hit 90% confidence level in retirement.

        My guess is another 5 years of saving like you are doing should put you there, if you can make it.

        Prepare for a reasonable level of “bad times” ahead or you may find retirment not as stress and worry free as it should be.

        Good luck!

        1. Thanks. I agree. I don’t want to jeopardize my family’s future at all. However, I also don’t want to work longer than I need to if I could be spending more time with the kids earlier. This post did convince me that I need a few more years of savings, but as I (think) I mentioned elsewhere in these comments, I do think I’ll get a big dose of reality with a recession in the next 5 years and this could make my 4-5 years of extra work turn into much longer… and that kind of sucks. I figured if I could hit a number where I’m comfortable quitting, then the risk is pretty low of really putting my family into a tough situation even in a serious downturn. Yes, my investments are about 95% stocks in index funds, but I also have about 10% (almost 2 years worth of living expenses) in cash and in the case where I was starting to drastically deplete that cash, i’d just go back to work. So if the ‘worst case’ situation is the same as the ‘safe plan’ (i.e. – continue to work the typical length career), then why not go for it? I know I’m not factoring everything in this scenario, but that’s the script that plays out in my mind when I’m getting antsy to quit. But like I said, big ERNs analysis put some oomf behind my suspicion that I was a bit premature to go for it now anyhow.

        2. I agree. It might be a better option to take some time off from work, find a different job, or hang on for a few more years. That said, if you retire and the economy tanks, you could always find another job. It just might not be on your own terms then.

  2. BIG ERN, excellent analysis, as we’ve all come to expect from you! Just weighing in on your 2 options to increase returns: 1) Real Estate 2) Options. In particular, #2! I’ve been a big proponent of the conservative use of options to add income. Too many folks think “it’s complicated”, but it’s really not. I focus on selling puts for equities I’d like to buy, and selling calls on equities I already own. I encourage folks to learn more, it’s worth the effort. I, too, wrote a post on it, hope you don’t mind me sharing here:

    1. Hi – ‘John Smith’ here from the case study – I know NOTHING about options… so I will be looking into it and reading your article. Thanks.

  3. When I did the math, a Roth IRA conversion on top of an otherwise low income turned out to be horribly expensive because of the reductions in the ACA subsidy.

    I needed IRA withdrawals that took me to a little over double the federal poverty level, so any extra dollar caused a ~25% tax as a result of the subsidy decline. (I see no value in not conflating health insurance premiums and taxes at this point.)

    It made no little sense to me to pay a ton in taxes to do a Roth conversion…

    Doing a side hustle (which I simulated by just doing a part time real job for a few weeks) was likewise financially unrewarding. 15+% for payroll taxes, ~25% for ACA reduction, plus starting to pay federal income taxes. 40+% marginal tax rate ain’t pretty! (but the job was fun, so I had that going for me).

    1. That’s a very important limitation of the Roth conversion ladder! I never computed the marginal cost of an extra dollar of ordinary income. Thanks for providing the number!

      1. Hi ‘John Smith’ here from the case study – I’m not sure I understand… was the Roth conversion not worth it because the income you took in was too high?

        1. Hi John–the conversion wasn’t worth it for me because I deemed the tax burden (including loss of ACA subsidy as a tax) too high a price to pay.

          Without a Roth conversion, I’m at about 200% of the poverty level, which gives me a pretty darn nice subsidy: I pay $3/month for a bronze plan, essentially catastrophic care. Every additional dollar I get in income reduces that subsidy pretty harshly (I lose 25 cents of that dollar to pay for the same plan, 15 cents for payroll taxes that will marginally increase my social security, and a few pennies on federal income taxes).

          I’m early in my retirement (year 1), and would rather err on the side of frugality than squander so the idea of tax inefficiency is odious.

          Before the ACA, Roth conversions were more likely to make sense from a tax efficiency standpoint. Lots of people set things up so that the federal income tax was 0 on their Roth conversions, so they effectively dodged taxes altogether on the retirement funds.

          During ACA, Roth conversions may make sense if you want to manufacture income so as to avoid putting your family on medicaid (different %ages of income depending on which state you live in).

          But if you already have enough income to avoid Medicaid, then a Roth conversion costs you ACA subsidy loss on top of income taxes.

          Of course, if you’re getting your health insurance somewhere else, or unless you’re making too much to get the subsidy, then the ACA subsidy loss is irrelevant.

          Here’s the article from gocurrycracker that made me change my plans on doing a Roth conversion:

          I haven’t read up on the Senate plan, but I suspect ACA will be in force until 2020 or later (that was the House plan).

          If there’s a personal income tax reduction this year, I’ll rerun the numbers…

  4. It’s always helpful to see other ‘real life’ scenarios to spark thoughts about our own situation, so thanks for sharing! I really like the table you built in Figure 1 (Roth Conversion), and this article has inspired me to recreate a similar view for our estimated outlook … can’t have enough spreadsheets, HA!

  5. Good analysis. I also recommend working a bit after ER to reduce withdrawal as much as possible.
    ACA is a tough one. We’ll just have to wait and see how it goes.
    I think working 4 more years is a good plan. You’ll have a better idea of your annual expense and see how the market goes. If we get a correction, then ER will probably have to be put off for a few years..
    Good luck!

    1. Hi, ‘John Smith’ here from the case study –

      Yes… ACA (or health coverage by any other means) is a bi pain to plan for. I’m starting to narrow in on what a prudent number to plan for may be.

      Im pretty certain I’ll continue to work for a few more years. However, I fear my exposure to a major downturn in the market is too high. I’m currently around 95% stocks for my invested assets and I hedge a bit with enough cash holdings to last me a few years… But as you said, if (which is more like ‘when’) we get a correction, I may be looking at 9-10 more years of work instead of 4-5. That makes me not feel too great because I think there is a good chance of that happening.

      I didn’t ask ERN about it since I’d already asked enough of him, but I really am curious to know what stocks/bonds mix he would choose if he were in my situation?

  6. I agree. I think maybe he should look into moving onto something else. Sounds burned out. A lot of people mistake frustration with their CURRENT work with what could be possibly a lot better (different work environment – and still make money). Either way $1.1MM at 37 is a really healthy place no matter how you dice it. They’re doing well!

      1. Hi ‘John Smith’ here from the case study. Thanks ERN, I’ll check out the link.

        @Tim Kim – I am burned out and it’s in a career I never really liked when I started about 17 years ago. Amazing how a decent paycheck can keep you in something you don’t care about for almost 2 decades! I’ve always liked the people I work with, even if I didn’t care for the industry, so it hasn’t been all bad… but I am ready for a change. There are a few (longshot) items on the horizon at my current position that may make things much more interesting to me, but looking elsewhere is probably good advice too. I finally have an incredible short commute which is sort of acting like handcuffs for me to just stick it out a few more years at my current job.

        I agree, we are doing pretty well with our current situation. I was lucky in that my wife and I didn’t discuss our finances much, but we both understood that we both had decent money habits. When we finally combined finances, it turned out we were esssentially financial equals, so that was a big help for us to combine our assets.

  7. Very thorough (as always). I agree with the recommendation – too early. Things that jump out at me:

    1. Healthcare, dental (hello, orthodontist….here is a large check for your good work on my child) and vision for family of four – budget should be much higher if you are looking for a very robust plan that will take care of arguably the most important piece of any FIRE strategy. Especially with young kids. I would budget $15,000. Short-changing your family’s health by trying to put together something cheaper is something you do not want to do and may ultimately regret. You may not spend this in all years but need to plan in case you need to. Are they able to invest in an HSA?
    2. Kids get more expensive as they age. Trust me, they do. Sports, food consumption, tech, clothes, late teen years car insurance (hello GEICO…’s a very large check for that 5yr old Corolla) etc will all need a budget.
    3. Taxable accounts need jacking up. Should be shooting for 50% taxable, 50% tax deferred IMHO
    4. You have a wonderful opportunity to travel more at FIRE. Maybe even globally. Don’t short-change the travel budget. With copious travel hacking, make it $7,500 and have 2 or more fantastic vacations.
    5. Gym membership – cut. Mountains, rivers, lakes, outdoors are all free. Embrace the fantastic opportunities that nature provides – for free. Or buy a couple of cheap bikes and pedal your way to fitness.

    Walking a super tight fine-line in FIRE with respect to spend/SWR is not what FIRE is all about. Put in those extra years and you’ll enjoy retiring a helluva lot more. Good luck, you are nearly there!!

    1. Hi ‘John Smith’ here from the case study –

      1) I agree – and strangely enough, 15k was the first number I pulled out of thin air about a year or so ago when I first started doing FI spreadsheets… then a few people told me that was too high. It’s just something I’m going to have to dig into more to get a clear picture.

      2. I agree again. I’m going to be trying to control the rising costs of the kids where I can, but I’m trying to be realistic too. One thing that gives me hope is thinking of how many luxury items from15 years ago are now bundle into my cell phone. But of course, there will be new ‘must haves’ for my kids generation. I’m hoping to help them learn to save up their own money for the items they want, but I think the real challenge will be on me to resist the easy out of buying stuff for them. I already see myself giving in on this area more often than I’d like to. And as you mentioned, it will get more expensive as they get older.

      3. What is the reason for your target of 50-50? Would you prioritize that ratio over taking advantage of the tax deferred options available?

      4. Good point. I’ve started travel hacking a bit in the last year, but with young kids… I actually think my travel budget was too high since it’s a pain in the butt to travel with kids and we see ourselves actually doing less exotic trips for the next decade. This doesn’t bother me too much since I’ve seen some amazing parts of the world already and so has my wife – but we feel there is a lot of the US we need to check out. So maybe some more local trips are in our future.

      That being said, if I had tons of time off and a cushion of money, I’d love to slow travel with the kids to some global destinations to expose them to other cultures at a young age.

      5. Yea, I realize this is a completely droppable expense. It’s more there as a Finacial placeholder and reminder that my wife and I both need to concentrate more on our health. We currently both do only free exercising options . However, I’ve noticed that my wife only seems to take time for herself to get away and work out if she has bought a discounted package of classes at some local overpriced studio. If that’s what it takes to get her to do something ‘selfish’ for herself, then I’m more than happy to budget for that. Maybe if I RE and can be home for longer durations, she’ll feel more comfortable taking some extended time for herself and I can drop this budget item.

      So all good comments… thanks for your thoughts!

      1. Hello John.

        Glad some points resonated with you.

        I am biased on the tax:tax-deferred ratio because ~50:50 is our plan!! The bottom line is you want those IRA’s to grow tax free as long as possible without touching them and you want your ROTH converted money to be “hands off” for as long as possible. Therefore need a healthy post-tax stash.

        Depending on how you are accessing healthcare, and the required size of conversion, doing too much “conversion” can be problematic with income thresholds.

        We wrote a blog post on our drawdown vs preservation strategy in retirement if you want to take a look.

      2. John, so I embarked on a travel hacking experiment last October and honestly it is so darn easy and we aren’t getting cheeky and doing any manufactured spends or buying any gift cards and reselling them. Between my reimbursable business expenses and our regular family expenses, and paying a bit of fees to put our property taxes on one chase sapphire reserve card, we have well over a million points to play around with. Once I stop working on 6/30, we won’t accumulate those points quite as fast, but I’m hoping our bank of points gets us through the next 4-5 years before we have to buckle back down and churn some cards again. I’m anticipating covering 80-90% of our travel costs with those points which helps to reduce my budget by 8-10%/year.

        1. Well done! That’s a crazy amount of points. I got a handful of cards and got the sign up bonuses, but then i didn’t keep up with it after about 3 cards. I’ll need to find some time to get back into it. I was following some forums and a few FI bloggers who do the travel hacking stuff, I guess i just felt I didn’t have time for it.

          1. I didn’t have much time for it either… I had a partner “in crime” – I got my husband to buy into it and do the same thing I did. I actually ended up using the madfientist travel cards site to strategically pick what worked the best. And still, no manufactured spend/gift card spending – that’s more time and effort than I am willing to devote to this pastime. I will say that I didn’t start at zero since I had a couple hundred thousand Delta points and maybe 70,000 alaska points. And I run work expenses that were reimbursed through my personal cc. But, like I said, it’s super easy and I didn’t devote a lot of time to it.

    2. Oh, and as for the ‘you are nearly there’ comment – see one of my comments above. I’m concerned a downturn in the market will mean my 4-5 years of working may turn into 9-10. That doesn’t feel as ‘nearly there’ as I’d like. 🙂

      1. Of course that market downturn event is something you cannot control or really plan well for. Focus on that 4-5yr plan and you will get to that point with more knowledge, money and “the smarts” to make a more informed call. Keep calm and invest on.

    3. All really great points! Thanks for stopping by, Dr. PIE!!!
      Especially the cost going up is once kids get older is noteworthy. Everything is a lot cheaper with a 3-year-old than a 13-year-old! For example, she still eats for free at a buffet (little do they know how much she can eat, haha), or stays for free in a hotel room, but that might all change soon!

  8. Wow… very cool analysis. And spot on recommendation. Big ERN, I have been playing around with your chart and that is also very cool… Lower withdrawal clearly affect the final results, as expected, but the difference between 3.5% and 3% was greater than I expected, especially if you aren’t earning any supplemental income. I will say though looking at the historical data that someone would have had to have been very brave to stay unemployed from 1975-1985! However, back then you would probably have more in government backed bonds that had solid returns offsetting that really lame stock market. I expected supplemental income in the beginning would offset the downside in those 1975-1985 time periods, but it didn’t make it that much of a difference (I just had it last for 10 years like in your test case and had a more conservative 10,000/year income). I’m about to test my theory out in real life, so I’m curious to see how this will play out and if my strategy works. I’m counting on Peer Street and my Private Equity Investment to provide the hedge, but only time will tell. I will have to play around with the chart more to see if I can replicate what I actually have going on more precisely. Thanks for sharing all the data you have painstakingly laid out in the chart as well as the spreadsheet that we can manipulate. Love this early retirement sharing community. 🙂

    1. Thanks for sharing! Yes, I too like the idea of alternative investments. Anything that cushions the fall and generates income even during a recession should help with the sequence of return risk: especially real estate. Let’s see how those alt investments work out in the next bear market!

  9. Hi Everyone. ‘John Smith’ from the case study here…. Interesting comments here and I’m going to try to come back to reply to then all when I have time.

    First off, a BIG thanks to ERN for running the numbers for me. I’m going to have to read the article a few more times over the next week to really understand everything – there are some terms and concepts I need to look up which I’m not 100% certain I understand… but it looks like it’ll give me the framework I need to track and account for going forward. I haven’t even been able to really look at the spreadsheets yet since I’ve been on mobile all day. I can’t wait to dig in!

    Yes, working a bit longer is what I assumed would end up being part of the true solution. That was just based on my back of the envelop calcs that I know how how to do combined with my super conservative mindset. It’s a bit disappointing to have that confirmed since a little part of me was hoping I could turn my financials over to a numbers-wiz like ERN and he’d magically come back and say – ‘here’s your income plan to retire now with tons left over’… but now it’s confirmed that I need more cushion – so time to roll up my sleeves and build more cushion.

    ERN and some of the commenters here are correct that a perspective shift at work would help and i really have been working on that.

    Also, clear goals are a challenge I’ve been trying to tackle. Both for what I define as meaningful work and for personal life goals. A goal of FI at our current lifestyle without other clear goals is somewhat empty…. but I flip flop between ‘retire to something’ vs ‘retire to allow myself the headspace to discover something’. I’m also aware of the risks of the second option… so I hope I can clarify this now while working.

    I’ve done some real estate wholesaling and I know the power that can be had with wholesaling as well as buy and holds of single family homes and duplexes. In fact, I got my buddy started into real estate investing and he now has a few duplexes and he’s doing very well now… however, I’m still licking my wounds on a bad real estate investment that has dragged on for 4 years (and likely will continue for another 3). This is going to end up in me saying goodbye completely to an initial investment of a very large chunk of money and the returns I could have had on it during this bull market…so that has made me gun-shy on REI for now, even though that fear may not be logical nor lead to financially optimal decisions.

    Like I said, I’ll try to come back to reply to other people’s comments later, but for now I hope the article helps others. Thanks again to ERN for his time and insight.


    1. Thanks, John, for being the first guinea pig on the ERN blog. I learned a lot doing this exercise:
      1: 4%+ SWR are feasible when both spouses expect large Social Security benefits (even when applying a 20% haircut already)
      2: The Roth Conversion Ladder is of limited use when the annual consumption target is too far above the “0% tax bracket” (=standard deduction + exemptions) and the taxable account share is significantly below 50%.
      3: There isn’t a one-size-fits-all solution to the withdrawal strategy. It has to be a customized solution to account for all the idiosyncracies.

      Best of luck!

      1. Thanks ERN. I’ll come back and give an update whenever needed and we can see how this all plays out.

  10. Hi Big Ern,

    ‘John Smith’ from the case study here – I’m still trying to sort out how to read the spreadsheets you developed for my case study. I have a ways to go because a lot of it is still a mystery to me. I’m working through it though. It’s pretty humbling to find out how ignorant I am when I looks at those spreadsheets.

    I had 2 more questions for you and the other helpful commenters… With my money allocated the way it is, and being aware of the sequence of return risk you mentioned and the shortcomings of the roth conversions, what would you use as a target FI number if you were in my situation? After rereading the case study so many times, I understand that a total FI number is only one aspect… it matters more that the right amount is in the right buckets. So I think my second question is, knowing how much is in each of my buckets now, which ones would you continue to put money into if you where in my situation?

    I understand this target FI number (and which buckets the money resides in) will change slightly for each of the next 4-5 years of working (since my total period of drawdown will decrement each year) but I don’t know where to calculate this change. Chasing a net worth number may not be a noble pursuit, but I do tend to focus better and work towards something harder if I have a clear goal to head towards. This is more important for me to define now that 4-5 (or more) years of work is ahead of me rather than a year or less as I had been secretly hoping for.

    Any thoughts or opinions from you or the commenters, I’d appreciate.


    1. The target number is obviously a moving target. It depends on when you pull the plug and how many years of spending you have to finance until SocSec kicks in. And it depends on how much you can curb consumption. I would view your initial estimate of $56k as an opening bid. You can do much better than that.
      If you ask me for a concrete number: How much would I recommend as the minimum FI number for a couple with young kids? Probably $1.4-1.5m in today’s dollars.

      The Roth conversion ladder challenges in you case aside, the order of your contributions should still be:
      1: Max out a 401k (not Roth 401k!) up to the max
      2: Roth
      3: taxable
      The value of avoiding 25% marginal tax today is still huge considering you might pay only 15% in retirement.

      1. Thanks ERN. That’s what I needed. I’ll continue to fill up each of those buckets fully (in that order) and target 1.5M. I’ll also work on reducing the expenses (even as the kids get older).

        Now, back to working through these spreadsheets…

  11. Hi Jason.

    Sure. My goal is still to retire as early as I can. But I’ve also been trying to improve the work situation in two ways. First, I’ve been actively looking for a position at a company that does work that is more interesting to me. This would likely be a large decrease in pay, so it’ll be a tough decision to pursue this if I end up having the option. The second way is that I’m just trying to change my perspective and have a better attitude. I’ve always known I’m the main problem and that the job I have stresses me out because I take things too personal.

    As far as finances, the net worth amount is creeping up towards the higher numbers now. My yearly living expense hasn’t gone up. It’s even gone slightly down I think. But after some more reading and pondering, I think with my mindset, I won’t be happy unless I aim more for a somewhat fat-fire situation. I seem to go back and forth on this depending on how stressful my job has been in the last month. Anyways, I’d still like to retire by mid-year 2020, so that’s the goal time-wise, but now I will be working toward a higher multiple of my yearly spending (closer to 30x), so it will likely take quite a bit longer than 2020. I think another reason for my stretching the goal is that things were really heating up in the market in Jan and I got all excited as though I could hit my lean-fire number as early as mid-2018. Then we had the first little blimp in the market in a long time and I got brought back down to reality. So once I got the stars out of my eyes, I started thinking I’d better get my head right about working potentially many more years.

    There is also a chance my wife may want to go back to work and I will stay at home with the kids. We’ll see. I think I’m in a decent spot though because even if things went really poorly right now and I got let go from my job or something, then I might consider that an opportunity to have both me and my wife stay at home for a year or two while the kids are young. We could always get back to earning again later.

    Previously for the investments side we were at:
    $300k in Taxable Investments.
    And $812k in qualified investment accounts
    $162k in 401k
    $219k in Roth IRA
    $431k in Traditional IRAs.

    Now we are at:
    $327k in Taxable Investments.
    And $970K in qualified investment accounts
    $202k in 401k
    $248k in Roth IRA
    $519k in Traditional IRAs.

    Let me know if you’d like any more details.

      1. John Smith here – I’ll post a fresh update in the comments below in case anyone is interested.

  12. John Smith here with a brief update.  It’s now about 4 years later and it’s sort of interesting how much of Karsten’s and commenters advice I took or what things played out as advised.  I never learned options trading, but lots of other stuff was foreshadowed in the article and comments from helpful readers.  

    I’m now retired!  Well, sort of.  You could say I’ve been taking an extended break after a covid-related layoff.  I had changed jobs to a field I was very interested in, but it also had a lot more stress associated with it.  I took a base pay cut, but earned quite a bit more after factoring in other compensations.  I increased my savings a bit and overall net worth increased a fair amount in the past 4 years.  I’ve now been ‘tested’ in a down market in the early months of Covid-19, although it happened so fast and was over so fast I barely had time to react; and that’s exactly what I did… nothing.  In hindsight, that was a good move but I still wonder how I’d react in a prolonged bear market.  

    So I’ve been unemployed/retired for about half a year now.  Since I was laid-off, I received a severance and was able to apply for unemployment.  Due to the timing of my lay-off, I won’t get to utilize any of the extended period unemployment benefits that were available during Covid.  I did however get expanded unemployment in the form of $300 extra from the federal government.  I will leave alone the arguments for taking or not taking the unemployment compensation when It wasn’t something I needed to other commenters who want to chime in, but I may not engage in the discussion since I’ve had those arguments in my head a few times already and have decided it was justifiable to receive the UC.

    As for numbers, I’ll keep it high-level:  We have a net worth of about 2.8M which includes approx 200k in equity of our home.  We have one highly volatile investment as part of our holdings and the rest is still very aggressively invested in index fund stocks.  Our net worth can have dramatic swings at times, but I’ve been holding steady with our investments at least for now.  Expenses in 2020 were in the low 70k range, even without ‘doing anything’ during the covid year.  I could see our expenses being in the very high 70s as we have both more opportunities to do things if Covid ever ends AND due to having more ample time to do such activities without working at a job.

    Mentally the lay-offf was a hit to my ego.  After having never been let go from any company in over 20 years, it was quite a shock.  But it did force me to pull the trigger and even though it was a financial setback from the initial plan to quit in a year or so, it had two benefits – 1) It forced me to ‘try’ retirement and I’m much more understanding of the benefits and perils of early retirement now.  And 2) It allowed me to capture some of the benefits of ‘engineering your layoff’ accidentally.      
    I hope someone finds this update useful.  Thanks again Karsten for the content and the guidance.  Keep up the great work!

    1. Thanks for the update! Congrats on your early retirement, albeit involuntary. If it makes you feel better, I wanted to leave on my own terms and then was positively surprised to be able to negotiate this as a layoff to get the severance pay. 
      Looks like your net worth has grown substantially. Very nice! What a difference 4 years and an equity bull market can make. But I was also “shocked” about the growth in the budget. Used to be 56k, now 70+k, and that seems to be the no-frills, no travel budget with upside potential later in retirement. Another reason to not budget too tight in FIRE.

      1. Great catch! I should have clarified that the low $70+k expenses number included $14,500 per year for mortgage. In my original case study numbers, I assumed we would pay off the house with savings to lower the yearly expenses number – and to lower the FI ‘goal number’. So we are still in the 56k-58k range for yearly spending as we were a few years ago if I still exclude that mortgage line item.

        I do have some potential large expenditures coming up. Thankfully they are within my control on when/if to make the purchases, but your point still stands – Its a good idea to plan for budget growth to feel comfortable.

        So far the expenses related to children haven’t been too large as some commenters predicted, however, I see those expenses looming just over the horizon and I feel less confident than I did 4 years ago about my ability to shirk all the normal expenses others warned about. I think I will do much better than other parents who aren’t as budget-minded as I am, but it turns out…other parents with older children ACTUALLY KNOW A LOT ABOUT THE ROAD YOU ARE GOING TO TRAVEL DOWN!!! 🙂

        Thanks again to all previous commenters and to you again Karsten.

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