Last week, we published the Tenth Safe Withdrawal Rate Study! Amazing how time flies! I did about one case study every three weeks for the last 6 months! And I could even include another one if I were to count the one I did for the ChooseFI podcast back in 2017. In fact, the ChooseFI appearance (Episode 23R and Episode 26R) started the idea because our first volunteer reached out to me after he heard me on the podcast. Since then I’ve published 10 posts, worth almost 30,000 words that generated tons of clicks, feedback and encouragement:
- “John Smith”: Seven-figure net worth, but not quite ready for FIRE yet. Big ERN would recommend a few more years in the workforce!
- “Captain Ron”: Early retirement on a sailboat. How much can they withdraw from their $3m portfolio to stay afloat (pun intended) in retirement?
- “Rene”: No need to worry about the recent layoff: You are more than ready for early retirement!
- “Mrs. Greece”: More than ready to retire due to large portfolio size and moderate living expenses, especially if the husband keeps working!
- “Mrs. Wish I Could Surf”: Alternative investments (real estate hard money loans). Keep the mortgage or pay it off? Either way, more than ready to retire!
- “Mr. Corporate”: Geographic Arbitrage by moving to a low-cost European country. Roth Conversions and zero tax liability!
- “Ms. Almost FI”: Your name is a misnomer. You are ready to retire now even when self-funding substantial long-term care expenses in the future!
- “Mr. Corporate Refugee”: How to deal with a large portion of the net worth tied up in a house in a high-cost-of-living area?
- “Mrs. Wanderlust”: Substantial supplemental cash flows due to buying an RV and then selling it later.
- “Mr. and Mrs. Shirts”: Ready to retire this year, but should Mr. Shirts work for another nine months for some additional big payday?
But, alas, all good things have to come to an end! I have decided to take a break from the case studies, at least for now. I might revive the series again later but for next few weeks and months, I will pursue other topics! Thanks to all volunteers who submitted their data. And thanks to all other folks who didn’t get their case studies published. I’m not even sure I properly responded to everyone whose request was denied. I think I may have some inquiries from October last year that I haven’t responded to. If you submitted a request for a case study and haven’t heard from me back, sorry, I’m just a bit disorganized!
Sooooo, ten case studies: what have I learned from them? Plenty, because that’s the topic for today’s post…
1: A case study is a lot of work!
I realized how much of a can of worms every case study became. Numerous email exchanges to get all the information and clarifications. Putting all the data into my spreadsheets, creating some custom Excel Sheets, calculate the whole thing and then finally write the post, usually two to three thousand words. The time commitment for each case study was probably more than for other posts and I think this includes the Safe Withdrawal Rate series posts! So many things to consider! From state taxes to cost basis of taxable accounts to issues of cash flows before age 59.5. And let’s not forget the timing of pensions, pension lump sum vs. annuity option, etc. Maybe it’s just selection bias because I accepted only the requests that seemed really hard. Requests like “I have $8m today and need $200k a year. Can I retire yet?” would have been pretty easy. It’s a one-word reply, “Yes” but that would have been less enjoyable for the readers, right?
2: Withdrawal Math is a lot harder than the “Saving for Retirement” Math!
Accumulating assets for retirement is relatively simple; just save a significant share of your income, invest it in low-cost index funds and eventually you’ll get there. What if market returns don’t cooperate and you don’t achieve your goal after 10 years? Simple: just work for another year or two! But retirement is different: if the money runs out at age 75 we can’t say “Just die a few years earlier” and, likewise, we can’t turn back time and work some more side hustles in our 40s and 50s. So, living off your money in retirement is a lot harder. In other words, we’re obviously exposed to the uncertainties of capital markets both while accumulating and while in retirement, but the consequences of miscalculations are a lot more serious in retirement! So, the saving for retirement math might be shockingly simple, as Mr. Money Mustache pointed out, but living off our money in retirement requires a) serious simulations to study the tail event probabilities for running out of money and b) optimizing the timing of when to withdraw from what account.
3: Safe Withdrawal Rates are all over the map.
All. Over. The. Map!!! Another suspicion confirmed, of course! Depending on your age, depending on how generous your other retirement benefits may be, and other highly idiosyncratic parameters, Safe Withdrawal Rates have to differ wildly. In nine of the ten case studies, they came in anywhere between 3.75% and 4.60% and one was even 6.00%. And if I had received more volunteers in their early 30s the SWRs would have been much lower, probably around 3.25 to 3.50%. So I use my old saying again (see SWR Series Part 17): The only thing more offensive than the “4%” part is the word “Rule”
4: The ideal Asset Allocation is between 70/30 and 80/20
Contrary to the conventional wisdom derived from the Trinity Study that any equity weight between 50% and 100% is A-OK, I found in the historical simulations that 70-80% equity weight was the most robust number. Both 50% and 100% would have generated very unpleasant and unacceptable failure probabilities. There was one outlier in the case studies, Ms. Rene in the third case study where I recommended a 60/40 allocation, but that was a bit of special case: High expected Social Security income and a husband (who keeps separate finances) with a stable and predictable income stream.
5: People are a lot more prepared for FI/RE than they think!
Maybe this is selection bias because I only accepted case study requests that looked interesting to me. Or maybe it’s because my Safe Withdrawal Rate Series scared the daylights out of everybody! But a significant number of people were afraid for no good reason. Both among the ten published case studies and among the unpublished cases, some of them I just answered with a quick Big ERN 5-minute guesstimate, it turns out that folks were pretty well positioned for early retirement! Well done everybody!
6: A lot of savers have too much money in pre-tax retirement accounts
Not that anyone did anything wrong because the asset location (as opposed to asset allocation) is what it is. For people in high-income brackets during the working years, the incentive to put money into a 401(k) vehicle is just too strong. And it should be: it’s better to have $1,000,000 in a 401(k) than $600,000 in a Roth unless you have a really high marginal tax in retirement. The good news, of course, is that despite the slightly lopsided account mix, not a single volunteer will likely face penalties on early withdrawals, see the next point!
7: The Roth Conversion Ladder works
Related to the point above, despite their lopsided asset location problem with way too much money in 401(k) Plans and Traditional IRAs, all retirees in the case studies I worked on should be able to tap their tax-deferred retirement savings without the dreaded early withdrawal penalty and without the cumbersome 72(t)/SEPP approach. Simply convert 401(k)/TradIRA balances into a Roth and then withdraw the principal after 5+ years. In some case studies, of course, the Roth Ladder wasn’t even needed, but for those volunteers that needed extra cash flow before age 59.5, the Roth ladder delivered! Every single time! Good to know!
8: The Roth Conversion Ladder idea of zero taxes in retirement is (mostly) a myth
As beautifully as the Roth Conversion Ladder worked in shifting money out of the 401(k) into the Roth and then eventually into people’s checking account to finance early retirement spending, being able to that all without getting taxed is largely an illusion. The completely tax-free Roth Ladder works beautifully in “laboratory” conditions but in reality, it likely won’t. There are multiple reasons for this:
- State taxes. Unless you live in one of the select states without a state income tax FL, TX, WY, SD, NV, WA, AK, TN*, NH* (* means that some income is still taxed) you will likely still owe state income taxes even if you are able to avoid all federal tax liability.
- Other supplemental income eats up some or all of the “zero percent” tax bracket (standard deduction): whether it’s a pension, a spouse’s income, interest income, etc., retirees will likely not be able to utilize the entire standard deduction for the Roth conversions.
- Cash flow needs are too large. That means in some cases the conversions had to be much larger than just the “zero percent bracket,” i.e., the standard deduction (plus personal exemptions pre-2018)!
- Overaccumulation in the 401k (see #6 above) will push you into the third federal tax bracket (now 22%, previously 25%) once RMDs kick in at age 70, so it’s worthwhile to do the Roth conversions all the way to the top of the second federal bracket (now 12%, previously 15%) in early retirement.
The only volunteer who can largely escape almost all future taxation was Mr. Corporate who could use the Roth conversion ladder in combination with utilizing the 0% tax bracket for dividends and long-term capital gains and very low cost of living in a foreign country. Of course, even that assumes that the tax laws don’t change in the future.
9: People avoid alternative investments
In the ten case studies, I was shocked how few people had any meaningful exposure to asset classes outside of the regular Stock/Bond world. Only Mr.Corporate Refugee has rental income and Mrs.”Wish I Could Surf” had some PeerStreet loan investments and Private Equity (Real Estate) investments. Everyone else had mostly liquid stock/bond/cash investments.
Maybe it’s my bias in picking the ten volunteers. Maybe it’s selection bias because the real estate magnates don’t bother to read the ERN blog. Maybe it’s because folks who invest in real estate never even worry that much about running out of money in retirement. That might be a good explanation, just look at Coach Carson’s recent post on why rental properties are a great retirement strategy. Real Estate is a great fit for early retirees because it generates a (roughly) inflation-adjusted cash flow and it avoids having to dig into principal during downturns as in the case of equity investments (think Sequence Risk!).
I encourage folks in the FIRE community to at least consider some diversification into other asset classes (I know it’s not for everyone). If you need some encouragement, on the excellent new podcast Millionaires Unveiled, a significant number of the interviewees have had great success in building their seven-figure net worth with real estate. (and just as an aside because that’s brought up all the time: No, REITs are very likely not a good substitute for owning actual real estate!!!)
10: Homeownership rules!
Now that’s a surprise considering #9 above! Even though folks seem to avoid real estate investments, every single volunteer reached FI as a homeowner. Coincidence? Maybe but I think it’s more likely that a home is a good investment after all. It’s also in line with the post from a few months ago “See that house over there? It’s an investment!”
And in addition, nine out of ten volunteers plan to remain homeowners in early retirement (some plan to downgrade, though). And it’s my understanding that the one renter, “Mr. Corporate,” prefers renting presumably because homeownership in another country might be too much of a hassle.
In any case, homeownership in retirement makes sense because it alleviates some of the Sequence of Return Risk nightmare. In other words, mandatory expenses like rent are poison for retirement plans when the market is down! In addition, the implicit rental income that homeowners derive doesn’t show up on any W-2 or 1099 tax forms and doesn’t have any negative consequences on means-tested benefits from programs like O-care. Homeownership clearly doesn’t make sense for retirees with a nomadic lifestyle but for the overwhelming majority of retirees who like to stay put in one place, it’s likely the better option.