Ask Big Ern: A Safe Withdrawal Rate Case Study for “Ms. Almost FI”

Welcome to a new installment of our “Ask Big Ern” series with case studies on safe withdrawal calculations. This is already the seventh part, see here for the other parts of the series! Today’s volunteer is Ms. Almost FI and that’s not her real name, of course. She’s planning to retire early in 2019 and this causes a lot of anxiety: Does she have enough money? When should she take her pensions? What about long-term care insurance? All very valid questions, all impossible to answer without a careful customized analysis!

Ms. Almost FI’s situation:

I think I am close to FI and planning to quit my job in 2019, but I am anxious and having sleepless nights about that big decision and worried about sequence of returns after I quit my job. I highly respect your opinion and would value your advice and input on my financial situation. I would so appreciate it if you would pick me as a case study!

I am a single (divorced) 47-year-old woman, and I am in a committed long-term relationship with another divorcee who is 58 years old. Neither of us have children. We are not married due to financial and tax reasons, but we may get married someday down the road when the time is right. We file our taxes separately as single filing status. My boyfriend plans to work until 67.

Oh, no, I hope you get over your sleepless nights! Let’s look at the financial details:

My Financial Data (Total $1,403,900):

• Cash = $239,200
• Taxable Investment (mostly in equity) = $439,000
• Traditional IRA (rolled over from former 401k accts) = $242,400
• Roth IRA = $101,000
• Inherited IRA = $5,500
• 401(k) from former employers (have not rolled over to IRA) = $257,000
• 403(b) = $119,800
• House (in my name only, not counted in financnial net worth): current FMV $520,000, mortgage $120,000 at 3.25% (I plan to pay this off in 10 years)

That looks like a pretty impressive nest egg! How about pensions and Social Security income?

Retirement income:

• Pension 1: $486/mo (at age 65), or $530/mo (at age 67), or $600/mo (at age 70).
• Pension 2: current employer = $467/mo (at age 65), or $350/mo (at age 62), or $295/mo (at age 60), or $194/mo (at age 55)
• Projected Social Security (if I stop working in May-2019) = $1,647/mo at age 65

Nice! That’s a very nice supplemental income and will make a huge difference in the safe withdrawal rate calculations. We will get into the pros and cons of taking the pensions at different ages!

How about expenses?

Projected annual expenses after I “retire” in 2019 ($48,000 plus inflation from years 2020 to 2027; $33,600 plus inflation thereafter):

• I’m expecting the annual expenses to remain fairly constant until Oct-2027 when the mortgage will be paid off.
• After I quit my job, I plan to do the yard myself (saving $720/year).
• Auto related expenses would reduce by $2,000 due to downsizing to 2 cars and no more long work commutes.  But medical/dental insurance will be higher by $??.
• I plan on getting a dog which will cost ~ $1,200/year.  So overall expenses may actually be slightly higher.
• Once the mortgage is paid off, I expect annual expenses to drop to $33,600.
• After boyfriend retires, our plan is to move to a more affordable state with no state income tax.  Hopefully, the move will further lower our annual expenses.

It sounds like your expenses will go down by $14,400 per year ($1,200 per month) when you paid off the mortgage. Sounds like a plan!

Questions:

1. Do you have any recommendations on whether I should take my pension and/or social security earlier than age 65?
2. One of my main concerns is the possibility of long-term care expense.  My mom had Pick’s disease for 15 years.  My dad and I took care of her for the first 10 years and she had to be in a memory care facility for the last 5 years until she passed away.  The memory care facility was very expensive and it practically drained all of my parents’ retirement savings.  How do I prepare for this scenario?  Does it make sense to pay for expensive long-term care insurance?
3. After I quit my job in 2019, I plan to do the Roth conversion ladder each year unless the rules change by then.  Does it make sense?
4. I am worried about the sequence of returns.  Are there any preventative measures I can take?
5. Until the house is paid off (in 10 yrs) and my boyfriend retires and starts getting social security and pension payments (in 9 yrs), I’ll be withdrawing money from my savings/investments to cover expenses.  Is this feasible and will I have enough money to last 45 years?  Do I need to work a couple more years past 2019?  If I need to do a part-time job after I “retire early”, then I’d rather just work a bit longer at my job since it pays better than any part-time job I can think of.
6. I have quite a bit of cash savings and have been transferring a bit at a time this past year to my Vanguard VTSAX.  I know I should probably invest it lump sum, except for emergency fund, but I’m worried the market will tank right after I invest it.  Any suggestions for how to invest $140k cash?

All great questions. We will get into that soon!

Newsflash: You are already able to retire

Yeah, you heard that right! I started calculating the scenario of a January 2019 retirement but I realized that you are actually able to retire now. If you still like your job and want to go for another year, no problem. You also mentioned that you are planning to have some medical procedures before leaving the workforce. Maybe also prop up that 401k some more. But even under the relatively conservative assumptions, it looks as though you can retire now:

• I assume your expenses after paying off the mortgage are $38,000 per year, a little bit higher than your $33,600, just to be sure.
• I assume you and only you cover the expenses during retirement with no help from your boyfriend. You indicated that your boyfriend can chip in up to $14k per year, but he is older and has much less saved for his retirement. Let him save that for now to catch up on his own retirement savings but you can always ask him to contribute later if the stock market doesn’t cooperate.
• I assume that you will require an additional (!) $8,000 per month (in today’s dollars) for long-term care starting at age 87 (in 40 years). That is an extremely pessimistic assumption. You will probably be able to get in-home care for much less. But you might also require care earlier than age 87, so use the level of service to adjust for that.
• I assume that you stay in your current relatively high-cost-of-living area. Selling your house, buying a cheaper house in a lower-cost and lower-tax (or zero-tax) state will give you at least another $250,000 in investable cash.

Mortgage vs. Cash

I believe you have too much cash. With equities sitting at nosebleed-high valuations I can understand your anxiety of putting more money into the market now. But I’m sure you had the same uneasy feeling when the S&P500 crossed 2000 points, right?

To make the cash reduction easier, I would encourage you simply to pay down the $120,000 mortgage. You’ll save 3.25% times $120,000 =$3,900 per year in interest. I wrote a blog post on exactly this issue a while ago: The Ultimate Guide to Safe Withdrawal Rates – Part 21: Why we will not have a mortgage in early retirement. If you no longer enjoy the mortgage interest deduction and claim the standard deduction, and your cash returns are hovering at around 1-1.5%, you’re better off to just pay off the mortgage.

Long-term care insurance?

In the calculations here I can’t really do the pros and cons of LT-care insurance because I don’t have a personalized quote for you. My suspicion is that it’s best to not get this insurance. Fritz over at The Retirement Manifesto had a post on why he’s going to self-insure: This insurance is prohibitively expensive! Especially if you have to disclose that both of your parents required care.

Health insurance

One item I couldn’t adequately examine from this far away is health insurance. Even though you’re not married, you should be able to sign up for “spousal” health care through your boyfriend since you live in a committed long-term relationship and under the same roof. Another option would be Obamacare. Because you should be able to keep your adjusted gross income relatively low in the beginning (withdraw from cash holding, sell shares with highest cost basis from the taxable account), your “visible” income might be so low that you qualify for generous subsidies.

Pension and Social Security Timing

I looked at the numbers and concluded that it’s pretty much a no-brainer to take both pensions at age 65. Under a pretty wide range of parameters (different discount rates, different lifespans) claiming at 65 was always the best. That’s because the first pension rises way too slowly between ages 65 and 70 to justify forgoing 5 years of benefits. And the second pension has benefits that increase so rapidly between ages 55 and 65 that it’s actually worth to wait.

For Social Security, let’s stick with the assumption of benefits at age 65 for now. You want to revisit this decision later and see how your health holds up. I believe it might be worthwhile to delay Social Security until age 70 to max out benefits in the later years when you might face those huge potential long-term care expenses! If you and your boyfriend decide to get married in the future there’s is also the joint Social Security timing issue to consider!

Safe Withdrawal Historical Simulations

The SWR calculations are in this Google Sheet (you will not be able to edit this, so please save your own copy). I assume a 53-year horizon to age 100 and plug in the supplemental cash flows as follows:

• Social Security at age 65, though I apply a “haircut” of 10% to factor in potential future benefit cuts
• Both pensions at age 65, but since they are nominal I have to discount them by an estimated 2% inflation p.a. and then further deflate them every year by that rate.
• Long-term care expenses starting at age 87 (40 years after retirement) of $8,000 per month. In today’s dollars. And this is over and on top of your withdrawals!
• A zero final value target.

I played around with different equity/bond/cash shares and found that 80%/17%/3% equity/bonds/cash generated the best overall safe withdrawal rates. That’s a bit of a surprise because for someone in their mid-to-late forties with substantial pension and Social Security benefits I would have thought that a higher bond share would be ideal. But you also have that potentially huge future expense 40 years down the road that requires the high expected return from equities.

In any case, here are the results:

With an elevated CAPE between 20 and 30, you’ll be OK with a 3.75% SWR. Some folks will note that today’s CAPE is actually above 30, but I counter and note that the CAPE will soon drop again when we roll out the bad earnings in 2008/9. So I consider even today’s CAPE of 31 to be more comparable with the elevated CAPEs in the 20-30 range and not so much with the crazy bubble CAPEs in the late 1990s.

In any case, with 3.75% and an initial portfolio of $1,283,900 you can draw over $48,000 per year. Even at the absolute failsafe SWR of 3.35%, you can still draw roughly $43,000 per year. More than enough to cover your expenses and a moderate tax bill.

Just as an aside: I also ran the SWR simulations without the $8,000/month long-term care expenses. You’d look at a 4.15% withdrawal rate to target a 5% failure rate or 3.84% overall failsafe rate. Self-insurance costs you around $6,000/year in lower withdrawals. But given how low your budget is that shouldn’t be a problem!

Cash Flow Simulations

As I always do in these case studies, I like to check if you run into problems with not having enough reserves in taxable accounts and/or overaccumulation in the 401k account that would trigger large required minimum distributions at age 70.

So here are the assumptions:

• The mortgage is paid off, you transfer $27,200 of cash into the taxable account and you keep $100,000 in cash in the beginning.
• I lump together the 401k, IRA and 403b into the column “401k”
• Taxable and Roth are both 100% equities and the tax-deferred accounts have 70/30.
• Retirement expenses are $38k initially, then increase by 2% inflation every year. All numbers in the table are nominal $, except for the column “Real.” Duh!!!!
• For the first few years, you fund your retirement through a $10,000 annual withdrawal from cash, the interest income in the cash holdings, and dividends and withdrawals from the taxable account. That should help somewhat with Sequence Risk.
• You withdraw $10k from the money market account until you reach 1-times annual expenses. At that time you’ll just let the cash account grow with inflation and withdraw only the net interest income.
• You do a Roth conversion to max out the newly created $12,000 standard deduction (for singles) under the Trump Tax Plan. Since you create some ordinary income from the cash holdings already the Roth conversion is slightly below $12k per year, though. If the old tax rates prevail you might want to look into maxing out the zero percent range (std deduction plus exemption) as well as the 10% bracket for the Roth Conversion.
• I assume you live in a state with a 5% marginal tax, and with a $10,000 deduction. Out of privacy reasons, we won’t reveal what state that is and your actual numbers might differ a bit, but not much!
• You draw from taxable savings until age 59, and at age 60 you take money from the 401k. (I wasn’t sure when you reach age 59.5, so you might start with the 401k distributions penalty-free even in 2030).
• I assume relatively conservative returns for S/B/C, as in previous case studies. The 5.75% equity return for 10 years comes from my recent post on that topic.

Results:

• Looks pretty good! You draw down your taxable account pretty substantially. It’s something to keep an eye on! But keep in mind that you’ll still have other means of income if the market doesn’t cooperate: the boyfriend can help out, you have a Roth from which you can withdraw the principal penalty-free, you got the SEPP/72(t) route, etc. And let’s not forget the 1x spending in the money market account!
• Your assets increase even in real terms up to age 70. You do have a little bit of over-accumulation in your 401k. That’s despite the Roth conversions and relying heavily on 401k distributions after age 60. But it’s a good problem to have: Too much money! You would still have a huge Roth IRA cushion you can tap in emergencies!
• So, your plan is in very good shape if you retire on January 1. It would look even better if you delay it a little bit.

Additional safeties

Not only does your retirement plan work if you retire now, you have a significant number of safeties built in that you can rely on when things don’t work out as planned:

• You can rely on some of the savings that your boyfriend has already accumulated.
• You can ask your boyfriend to chip in some of the cash flow he’s currently saving (up to $14,000 p.a.) to help with expenses.
• You can sell your house in your relatively high cost-of-living area, buy a cheaper place somewhere else and pocket the difference.
• If it comes to this and you find yourself with cash running low at age 80 or 85 you could consider a reverse mortgage on your (paid-off) house. I really, really hate reverse mortgages so this has to be the last resort!

Conclusion

You should work for as long as it’s fun, but to the extent that you are already a bit annoyed by the corporate B.S. you might as well pull the plug already on January 1. Or today! Because your budget is so low and you expect a decent size Social Security and generous pension benefits you can still afford a pretty decent safe withdrawal rate of almost 4%. Long-term care is a serious issue, but your case would probably call for simply self-insuring. No more sleepless nights, please! You are good to go to retire early! Best of luck!!!

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