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Evaluating our FIRE Possibility with a Well-Defined Post-Retirement Withdrawal Plan

 
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Safe Withdrawal Rates
Last Post by andyg42 4 years ago
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Posts: 3
 stocksalt9934
Topic starter
Apr 12, 2021 10:29 am
(@stocksalt9934)
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Joined: 5 years ago
[#326]
Hello All,
 
I’ve been on the journey to FI since my early twenties, and I’ve been lucky enough to potentially have the opportunity to FIRE in 2022.  I’ve been very fortunate on the way here, and I want to make sure that I’m covering all the (known) bases I can while figuring out if this is feasible.  This post was also shared Reddit, here, with perhaps greater explanation than necessary for this crowd that is already familiar with BigERN's excellent work.
 
First, the numbers -
 
  • 34 - me, 36 - my wife.  We’re both working full time currently, and she’s planning to for at least five more years.  No kids, or plans to have them.  USA.
  • Investment Portfolio - 
    • $1,108,000
    • $719,000 in taxable accounts
      • $232,000 of which is company stock currently worth this amount after LTCG taxes
    • $271,000 in 401k/403b
    • $159,000 in Roth IRAs
    • Allocation of roughly 80% stocks (company stock included), 20% cash/bonds
  • Real estate -
    • ~$625,000 main property, $240,000 mortgage
    • ~$250,000 rental property, $97,000 mortgage
    • Estimated annual expenses: $53,000, ~$4,500/month

 
Now the plan -
 
First, I’d like to send a huge shoutout to BigERN from earlyretirementnow.com.  While I’ve been reading about FIRE for a while, his site, and his spreadsheet that I use for my calculations, have been instrumental to building my confidence that I can actually do this.
 
All of the actual $ details for the below plan can be found modeled on the spreadsheet below. The spreadsheet was daunting the first time I saw it, but it contains links to posts on his site that detail how it’s used.  For ease of modeling, the numbers there are assuming I’m retiring today, so it does not include any future earnings from my job.
 
 
Right now, the only thing I need to wait for is the ability to sell my company shares as long term capital gains, which I should be able to do in early 2021.  In the spreadsheet, I’m assuming their current value less taxes as part of the  “Portfolio Today” value.  Clearly, there’s a lot of risk here, and my plan to retire in 2022 hinges a lot on what the stock’s price does over the coming months.  I’m fairly confident in our health as a company, but I recognize that it’s still very possible that its value could drop off significantly, pushing out my retirement date.
 
Assuming I sell all the company shares for their current price, I’ll have a lot of cash on hand.  The next thing I’ll do is pay off the mortgage on our primary residence (~$240,000).  We’re not planning on moving again, and doing this helps mitigate sequence of return risk.  In short, if the market tanks as soon as I retire, I won’t be forced to withdraw more money early in my retirement than I would need to without a mortgage.  Compounding interest works in reverse in retirement - if I take a hit early on, later big gains might not be enough to prevent us from running out of money.  Subtracting the cost of the mortgage payments from our annual expenses, we’re now down to $39,000/year.
 
Now I have less cash on hand, and an allocation of 63% stocks, 37% cash/bonds.  Not bad at all, considering I was targeting a 60% stock, 40% cash/bond allocation, and I’m planning on using an active equity glidepath over 15 years or so to additionally mitigate sequence of return risk.  I’m targeting a final allocation of 90% stocks 10% cash/bonds.
 
Now since my wife is still working (thanks hun!) after fully funding her 403b and Traditional IRA, she’ll be able to contribute $2,300/month to our monthly expenses, which are now down to $3,200/month without our mortgage, but also adding in the additional cost of my health insurance after I quit my job, and umbrella insurance which I just need to get off my butt and do.  So I need to contribute ~$900 a month for us to meet our estimated living expenses while she is still working.  (Quick side note - it’s actually a good bit cheaper to go on COBRA for 18 months rather than an ACA plan immediately.  I’ll be doing this, but I’m not including this “bonus” on the spreadsheet.  Both COBRA and ACA are cheaper than going on my wife’s insurance.)
 
Next, I will open a 10 year draw/20 year repay $300,000 home equity line of credit on our mortgage-free primary residence.  Ideally this would be a 20 year draw period, but I haven’t been able to find one with these terms, and I would plan to refinance around year 10 to another HELOC to extend the draw period another 10 years.  With the HELOC, I would withdraw the ~$900/month needed for our living expenses, even after my wife stops working and we begin drawing from our portfolio.
 
Why do this?  This is a way to additionally reduce sequence of return risk by leveraging the equity I have in our primary residence, and using the future sale of our rental property to pay off the HELOC at the end of the draw period.  The HELOC would be paid off in full as a lump sum in 20 years, when I finish paying off the mortgage on the rental property and sell it, plus additional funds from our portfolio (about $110,000 worth!)  In a market downturn, the HELOC will decrease the amount we need to liquidate from our portfolio.  Won’t it cost a ton?  Yes, but even with conservative estimations, it drastically decreases risk.  I’ve gotten a quote for a 5% fixed rate HELOC, but I’m modeling a 7% fixed rate HELOC after inflation in my estimations.  I’m also estimating a measly $4/month initial profit on the rental property, factoring in all of the overhead of renting (I’m using a property manager).  This amount should trend upwards with inflation, while the mortgage payments remain constant.  I’m also only assuming a 2% p.a. property value appreciation beyond inflation, though our area’s population has been rapidly growing, and property values have been going up much more quickly than modeled. (This property has appreciated 59% since 2012.)  During the interest-only period of the HELOC, I plan to use HELOC funds to make the interest-only monthly payments, so I’m modeling this as a simple compound interest calculation and paying off the full amount at the end of the draw period.  See this blog post for more information on this strategy and how it’s represented in the spreadsheet.
 
With the mortgage paid off and the HELOC in place, I quit my job.  Woohoo!  I’m not including it in the spreadsheet, but I’ll probably work at least long enough in 2022 to max out my 401k and a traditional IRA for another year.  I’ll shoot to keep my taxable income as close to $0 as possible that year too to reduce my capital gains taxes on the company stock sale as much as possible.  I don’t need to withdraw any money from our investment portfolio for five more years (or until my wife decides to stop working) since I’ll be drawing the rest from the HELOC.  I’ll also roll my 401k into a traditional IRA.
 
Five years later, my wife retires.  She rolls her 403b into her traditional IRA.  Our health insurance costs will go up, but theoretically not by much.  From here on out, we’ll keep our AGI as low as we possibly can to maximize tax benefits.
 
At this point, we’ll begin converting our traditional IRA funds to our Roths.   After my wife makes an additional 5 years worth of contributions, and assuming a 5% appreciation rate, the sum of our traditional IRAs will be roughly $490,000.  Doing rough estimates, it looks like we’ll need to do more than our standard deduction’s worth of Roth conversions in order to clear the traditional IRA’s before RMDs kick in, but I’m not going to try to figure this out now, as a lot can change in the next five years, and it shouldn’t make much difference in the overall retirement plan.  During this time,  I’ll also harvest capital gains in the taxable accounts up to the $80,000 ceiling of the 0% long term capital gains tax bracket.
 
Fifteen years later, we sell the rental property and pay off the HELOC.  This requires us to pay about ~$110,000 out of pocket from the appreciation on HELOC.  Since we’re now 20 years later in our retirement, our retirement horizon is that much closer, and the appreciation that our portfolio has had over the years is more than enough to handle this, assuming conservative 3.5% stock market returns for the next 10 years, and 5% returns after that.  Stocks and bonds I’m estimating at 0% return for the next 10 years, and 0.25% after that.
 
Next major event is social security at age 70.  I’m assuming benefits will be slashed by 30% by the time we’re old enough to start collecting.  We’ll start collecting at the latest possible age as a hedge against longevity risk.  If we need a lot of money later on for an extended period of time for assisted living or nursing care, this will help buffer that cost too.  Monthly estimates in the spreadsheet are based on benefit amounts as of today.  I’m also having to estimate my wife’s SS benefit due their website being dumb, but conservatively, this will be around $540 a month.
 
So, all of that being said, if we opt for a static withdrawal rate, we can get a “failsafe” annual withdrawal amount of $45,000.  If this seems high (equivalent to a 4.25% withdrawal rate!), keep in mind that my wife will continue to work for the next five years, she’ll be contributing to tax-advantaged accounts, and I won’t be drawing on the portfolio value at all (only the HELOC) during this time.
 
Speaking of withdrawal rates, I’m planning on adopting a CAPE-based withdrawal strategy with a=1.5% and b=0.5, based on BigERN’s comparison of withdrawal strategies.  When I start withdrawing from the portfolio in five years, we should have approximately $1,363,000, which, with today’s CAPE, should give us an annual withdrawal of $39,000.  Sounds pretty good since it matches our annual expenses, especially when you consider I’m going to be pulling ~$10,800 p.a. out of the HELOC.  That gives us a cushion of 28%!  Assuming a severe market downturn, if the portfolio withdrawal based on CAPE isn’t enough to cover expenses, I would draw more from the HELOC, then draw less from it per month once the market has recovered.
 
There are a couple criticisms I’m aware of for using CAPE-based rules, but all of them should leave us in a better position if they prove to be correct.  The first is that the CAPE does not take into consideration that stocks pay less in dividends than they used to, and that value is made up for in the stock price itself.  If this were true, the “actual” CAPE would be lower than the CAPE value used in my calculations, meaning I could safely withdraw more money than it currently allows.  Secondly, CAPE based withdrawal strategies have lower allowable withdrawals in the earlier days of the portfolio than other methodologies, possibly overly so.  I'm not opposed to capital depletion of our portfolio over the course of time, and would be comfortable with only 10% of the portfolio remaining at the end of our investment horizon.  CAPE rules don’t take into consideration retirement end dates, so are by their nature assuming an infinite investment horizon.  Another win, and I always have the option later to switch to a withdrawal strategy that does take finite investment horizons into account (i.e. VPW).
 
There are a few weak parts to this plan that I can see.  In case of an early market downturn when my wife is no longer working, I’m not sure if withdrawing more from the HELOC to cover expenses actually make sense in this scenario.  I’m assuming there’s a “sweet spot” in how much I should withdraw from the HELOC vs the portfolio, but I’m not sure how to go about figuring that out.  I’m also not sure how easy it will be to refinance a HELOC right before the end of the draw period, especially with neither of us being employed at that point.  Does anyone have any experience with refinancing a HELOC?
 
The company stock is the biggest wildcard right now, and not just because of price volatility.  We’re fairly newly publicly listed, but on a small equity market, though we’re on track to be listed in a larger one this year.  This is a good thing - the amount of shares I need to sell is over 100% of the company’s average daily volume today.  Hard to sell something when there’s not enough people wanting to buy it!
 
Thanks for making it this far!  My question to all the smart people out there - what are the holes in my plan?  What did I miss, and what haven’t I thought of?  

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 earlyretirementnow.com
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Apr 12, 2021 9:16 pm
(@earlyretirementnowcom)
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Joined: 10 years ago

Wow, thanks a lot for sharing. I looked at the Google Sheet and I found several small issues in your cash flow sheet:

1) You assume the HELOC cash flows are in the "real cash flow" column (column E in the sheet). But that should be in the nominal column.

2) I think that 2% rental appreciation above inflation is a bit aggressive.

3) minor issue: I get "=-FV(0.07/12,252,881.19,0,1)" = $506,074.27. Not sure what you used to calculate the FV of the HELOC after 21 years. Not a bit difference, though.

4) the 7% HELOC rate seems excessive. I'd use 4-5%.

But apart from that, the math looks OK. You will notice that the current failure rate of a $53k annual budget is around 10%. That would be not acceptable for me. But maybe you get better results with a lower HELOC rate and putting the HELOC cash flows into the nominal column.  (currently, I can't edit this file)

Also: The problem with using the VPW, CAPE, etc. is that they are normally calibrated for a retirement problem without major supplemental flows. But with the initial work income, the HELOC, and the home sale, this doesn't really work very well!


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 stocksalt9934
Topic starter
Apr 13, 2021 6:28 am
(@stocksalt9934)
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Joined: 5 years ago

Thank you as well for the excellent blog and outstanding work you've done in this space 🙂

1) You assume the HELOC cash flows are in the "real cash flow" column (column E in the sheet). But that should be in the nominal column.

My thinking here is that the HELOC draw would be adjusted for inflation as time goes by and not be a constant $881.  I'm not sure if that would be reflected if it were moved to the nominal column.

 

2) I think that 2% rental appreciation above inflation is a bit aggressive.

That's fair.  I was going back and forth on this number and was having trouble coming to a conclusion.  A lot of the information I found on the local housing market was coming from realtors and property management companies that of course only talk about how great the market is.  Looking at the historical trends, the market seems very strong, but I'm not sure how to evaluate it properly.  Maybe it makes sense to think about this market as stock-like in volatility.  More research to do here.

 

3) minor issue: I get "=-FV(0.07/12,252,881.19,0,1)" = $506,074.27. Not sure what you used to calculate the FV of the HELOC after 21 years. Not a bit difference, though. 

Thank you for that formula 🙂  I was using the compound interest calculator here, but I'm not sure how they calculate it behind the scenes.  I also selected a daily compounding frequency, as my understanding is that is how HELOCs operate.

 

4) the 7% HELOC rate seems excessive. I'd use 4-5%.

I arrived at this number because I was unsure what kind of terms I would be able to get a year from now and was hedging against an increase (I have a quote for 5% fixed-rate now.)  I'm curious your thoughts on fixed vs variable rate HELOCs too.  The rates today are attractive, but historically quite scary.  I'm thinking that a fixed rate would be safest and best for our peace of mind. 

 

You will notice that the current failure rate of a $53k annual budget is around 10%. That would be not acceptable for me.

Agreed, I would not be satisfied with that failure rate either.  Fortunately, the $53k annual budget is what we spend today.  After the mortgage is paid off when I retire, our budget will be reduced to $39k, which is below the "failsafe" budget of $45k.  I don't appear to be able to edit my original post - I should have referenced this in my beginning number set.

 

The problem with using the VPW, CAPE, etc. is that they are normally calibrated for a retirement problem without major supplemental flows. But with the initial work income, the HELOC, and the home sale, this doesn't really work very well!

Yes, this definitely makes things stickier.  I need to give some thought to how to best plan withdrawals given these supplemental flows.  I'm thinking that the conservative nature of CAPE-based withdrawals (less the HELOC flow) will be a "safe" baseline, and actual "failsafe" withdrawal rates will be higher.


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 stocksalt9934
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Apr 13, 2021 9:20 am
(@stocksalt9934)
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Joined: 5 years ago

Another thought - I wonder if it would make sense in practice to make HELOC withdrawals similarly to bonds.  Rather than making static withdrawals from the HELOC every month, instead base it off of market conditions.  With a high CAPE, you theoretically want to realize more of your stock gains as the risk of a market downturn increases.  When the market actually does turn down, you can withdraw a greater amount from the HELOC without having to sell as much of the stock portion.

There would be additional risk here if there is a market downturn early in retirement, and a large amount is withdrawn from the HELOC that can then compound for a longer time than it would have otherwise.  Perhaps setting an upper limit on the amount you can withdraw being equal to the amount you would have withdrawn if you used a static withdrawal approach.

There are capital gain tax considerations to be made here too, but I think this could fit in nicely with an active equity glidepath strategy. 🙂


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 earlyretirementnow.com
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May 12, 2021 8:22 am
(@earlyretirementnowcom)
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Sorry, missed this one.

If your HELOC is large enough, why not. But the problem with this strategy is that it may take a long time for equities to recover. And remember, the market has to recover not just to a level higher than when you made the withdrawal but the SPX has to also recover the HELOC interest. There have been recessions where that would have taken years, even decades.


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 figuy1
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May 12, 2021 8:37 am
Reply toearlyretirementnow.com

@earlyretirementnowcom I tried back testing a strategy similar to this this with 1990-present data for those in the contribution phase.  It was basically pick a cape ratio of 25-30 and when it drops below that threshold use margin at 2% interest to buy stocks on sale and then when cape gets above a threshold, pay off that margin loan and couldn't find a strategy that beat simple buy and hold DCA.  Also, HELOC's will almost definitely have higher interest rates than margin loans from IB and borrowing at 2% would have been hard to find in the 90's.


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 earlyretirementnow.com
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May 12, 2021 4:59 pm
Reply tofiguy1

@figuy1 Very true. I think I may write a blog post about this and simulate the HELOC as the MM interest rate +3%. As I said before, with unlimited credit you can pull this off because the SPX will inevitably reach the old high+MM+3%. The only question is how long will it take?


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