This weeks post is courtesy of a semi-famous internet personality: The Landshark. I met the Landshark when we participated on a panel discussion about FIRE on the What’s Up Next Podcast. The Landshark subsequently reached out with some questions and we agreed to do a case study around his own family’s debate of early retirement. This is a longer case study that includes the concept of “enough”, the mechanics of accessing funds with a concentration in retirement accounts, and a longer discussion and exchange of questions around many of the non-financial aspects of financial independence and early retirement.
Thank you for giving Landshark the opportunity to ask for help determining whether or not the Landsharks have “enough.”
Getting behind the concept of financial independence is easy for the Landsharks. Establishing a system that automates savings was not complicated. For those of us who are fortunate enough to have a stable, higher-than-average income job and who avoid making huge spending mistakes, over time you will watch your net worth grow. But, for how long… and for what? It’s easy to default into spending decades toiling away at a job that you dislike to pad the net worth well past what you actually need to retire early.
Landshark is 40 years old. Mrs. Landshark is slightly younger. The Landsharks have two elementary school-aged pups. They live in Colorado, where the cost of living is moderate. Real estate values are high, but property taxes are relatively low. Landshark is an attorney. Mrs. Landshark is an engineer. Their pups go to public school. They own their home outright and have no debt. They drive 10 year-old and 14 year-old cars, but because Landshark takes mass transit to work and Mrs. Landshark works from home, those cars will hopefully last them a while.
The Landsharks’ household income fluctuates each year. Mrs. Landshark gets paid a salary, but Landshark’s varies. Over the past ten years, their household income averaged about $275,000 per year. The Landsharks max out their 401(k) accounts and make backdoor Roth IRA contributions each year. Last year, Landshark was able to make a Mega Backdoor Roth IRA contribution thanks to his employer allowing after-tax contributions and in-service withdrawals from his 401(k) plan at work. In addition to their retirement savings, the Landsharks have recently started contributing $24,000 per year to their pups’ 529 accounts and save an additional $36,000 per year in a taxable brokerage account at Vanguard.
The Landsharks’ household net worth is $2.6 million. $1.4 million is in retirement accounts (split equally between traditional and Roth accounts). Their home is worth about $750,000 and they pay about $5,500 per year in property taxes. They have $330,000 in a taxable brokerage account, with the rest of their net worth in HSA accounts ($30,000), 529 accounts ($20,000), emergency funds in cash ($20,000), partnership equity in Landshark’s employer ($30,000) and the value of their cars ($20,000).
As to their asset allocation, 85% of the Landsharks’ investment accounts are in domestic equities (VTSAX), 10% is in international equities (VTIAX), and 5% is in REITs (VGSLX). The Landsharks do not hold any bonds. Because they own their home free and clear of any mortgage, the Landsharks view their home as their bond position, which makes up about 30% of their net worth.
The Landsharks spend about $70,000 per year. The largest line items in their budget are food/groceries (sharks eat a lot of meat and fish); travel (they need ready access to warm waters); and camp/activities for their pups. Insurance, taxes, and utilities also make up a sizable chunk of their expenses. There’s probably room for improvement with what they spend, but Landshark admittedly doesn’t track his household spending as closely as he probably should.
Based on their earnings history to date (and using Physician on Fire’s excellent social security calculator), Mr. and Mrs. Landshark should each reasonably expect to receive $30,000 per year in Social Security earnings, before indexing that amount for inflation. They don’t anticipate taking Social Security until they are 70.
The Landsharks would like to help their pups pay for college and would also like to leave them a legacy… preferably in the form of Roth IRA funds (which hopefully will still be able to be stretched over their pups’ lifetimes instead of the 10 years currently being considered by Congress). So they are hoping to not have to touch their Roth IRA accounts and instead, will let the magic of tax-free compounding do its trick.
Based on their savings history, and when adding their expected Social Security benefit, the Landsharks feel comfortable that their retirement savings will be more than sufficient to last them. After all, in 20 years at 7% interest, that $1.4 million should grow to $5.4 million (before accounting for inflation). Assuming they continue to work for at least a few more years and add to those accounts, that number will grow even larger. And assuming they don’t touch their retirement accounts until age 70, those accounts will be worth over $10 million (before inflation).
Landshark doesn’t love his job. While the pay is good, it’s high stress, long hours, requires a lengthy commute, and most importantly, keeps him away from his wife and kids. Landshark also doesn’t want to access any of his retirement accounts early to fund an early retirement. Instead, Landshark would prefer to fund the early portion of retirement out of his taxable brokerage account. Landshark has also been questioning his decision to fund 529 accounts and could instead, divert some or all of those amounts into his taxable brokerage account. If the Landsharks retire early and reduce their income, hefty 529 accounts may actually work against them when their kids are ready to start college and fill out their FAFSA applications.
So, Landshark feels a bit stuck. While he acknowledges he’s in a fortunate position with a paid-off house and a lot in retirement accounts, his taxable brokerage account is not where he would like it to be to fund an early retirement… and Landshark isn’t exactly sure how much he really needs in that taxable brokerage account to feel comfortable pulling the trigger and retiring early. Sometimes, he throws out $1 million as a savings goal for the taxable brokerage account, but assuming they’re only contributing $36,000 per year and getting 7% returns, it will take more than 8 years to hit that $1 million target in the taxable brokerage account. And, admittedly, there’s more gut than thought put into that $1 million target.
So what do you think? Does Landshark have enough? What should Landshark do differently? What advice do you have for him?
We’re going to break this land loving shark’s case study into five parts:
The Withdrawal Strategy & Taxes
The Non-Financial Stuff
Q&A and Followup
Part 1: The Numbers
The Landshark family has achieved the magic number in the shockingly simple math of early retirement. $70,000 in annual expenses would require a total portfolio balance of $1,750,000 to meet the 4% rule and/or 25x expenses. Their portfolio sits at $1,830,000 as of the time of this writing. Since I’ve run this scenario hundreds of times before personally getting up the courage to leave my career, I can tell you that backtesting the portfolio is going to fail under only two starting points: 1929 right before the great depression (under a 100% stock allocation) whacked the market by 90% and starting in 1966 (under any stock/bond allocation) due to combination of the nifty-fifty stock bubble coupled with stagflation of the 1970s and rising interest rates.
Using cFIREsim, we’ll run two simulations to confirm these results.
Simulation #1: $1,830,000 Portfolio, $70,000 in Spending, Inflation Adjusted, 100% Stock Allocation, and 30 Year Retirement Horizon*
The results? 99.12% Success Rate.
1966 is the single point of failure in the 30 year simulation. I also tested this simulation based on a portfolio of stocks and bonds, but since this point of failure coincides with a fifteen year rise in interest rates to the highest level in history, a bond allocation does not protect against this single year failure. The more common result was a portfolio that grows well beyond what the sharks would need to figure out the daily challenges of being on land for the next thirty years. The lowest ending value is the single outlying result from a 1966 start date.
A median portfolio size of $5.88 mil is not too shabby if the Landsharks swim out to warmer waters right now.
$1,830,000 Portfolio, $70,000 in Spending, Inflation Adjusted, 100% Stock, 50 Year Retirement Horizon, Including Social Security of $30,000 Starting at Age 70
On a fifty year time horizon, there is a 100% success rate with 1929 being a really close call. This analysis did not include the 1966 starting point which would have failed, so we’ll call this one a 99% chance of success. The ending portfolio balances are more varied with fifty years of returns, with a couple of scenarios crossing into nine figures at the end of the time horizon. If that happens, the Sharks probably own the fanciest assisted living facility in the sea instead of just being a resident.
The average ending portfolio balance of $23.9mil will help leave a generational legacy.
I ran a number of different scenarios with adding some bond allocation, but it did not change the results. The starting withdraw rate is 3.825%, which holds up under some of the most stressful market circumstances. It would take an extraordinary style market to fail.
Part 1’s conclusion: The numbers are a resounding yes, there is enough to retire. The probability of running out of life before running out of money is near 100%. I’ll get into some recommendations around the numbers at the end that will add some additional margin of safety.
Part 2: Withdrawal Strategy and Taxes
The Landsharks have done a great job at maximizing their tax deferred accounts and getting to the security of a free and clear home for their family by the age of 40. This itself is an incredible accomplishment they should be proud of. The challenge that Mr. Landshark is concerned about is the relatively small taxable brokerage account size compared to the family’s overall net worth. Once the shark leaves his legal partnership and redeems his equity, after-tax assets account for $380,000. This comes out to ~ 5.5 years of living expenses plus whatever investment earnings from the account over that same time period.
The shark said they “did not want to touch IRAs”, so this creates a challenge since they have 5.5 years of living expenses but have 19.5 years until they can access pre-tax IRA earnings or any earnings from their Roth IRAs. His initial strategy was to work another eight years, accrue up to $1,000,000 in a taxable account, then spend that down until 59.5 when regular IRAs are accessible. I would discourage this approach, unless they desire flying around in a private jet, they’ll ultimately just end up sending a lot of extra money to their heirs and Uncle Sam.
I would encourage the Landshark to view their retirement accounts in three buckets: Roth Contributions, Roth Earnings, and Traditional IRAs/401ks. The Landshark family appears to be comfortable with their lifestyle, knows what provides value to them, and spend a reasonable amount of money relative to a sizable income. Mr. and Mrs. Landshark have been diligent in utilizing their Roth IRAs and Roth 401k accounts and have built an additional accessible reserves up in Roth contributions available. In some back and forth with the Landshark, we determined the exact retirement account splits are as follows:
Traditional 401ks: $619,000
Roth IRAs/Roth 401ks: $812,000.
$290,000 of the Roth dollars are contributions since they’ve stored away the maximum available in Roth IRAs since 2008 and have maximized a Roth 401k since 2015 including utilizing the Mega Backdoor Roth. This also shows the power of investing early, using low cost mutual funds, and picking up a better than average 10-year run in the market.
The choice of after-tax Roth 401k contributions is a little different than the scenario I usually see: A married couple at this income level and tax rate more often elects to use a traditional 401k during high income years then worries about the tax consequences post-retirement. If the Landsharks do go through with early retirement, they will have front loaded almost their entire lifetime tax liability through the Roth 401k strategy. (more comments on this later)
Here is the first part of the simulation for the Sharks, showing how the accounts would operate with an 8% growth rate, 2% increases in annual spending, and performing $70,000/year in Roth conversions each year. This illustrates how the account balances move by year with living expenses and conversions.
|Rate of Return||8%||Annual Spend||$70,000|
|Spending Increase||2%||Roth Conversion||$70,000|
The Landsharks should withdraw from their regular brokerage account first, which they will exhaust by 2025, when the withdrawals for living expenses need to move to Roth Contributions. If they convert $70,000 per year from their Traditional IRAs to the Roth IRAs, they will finish conversions by the year 2034 and have no further tax obligations.
The second part of this strategy is figuring out the total amount of Roth IRA/401k contributions and if this strategy can hold up until 59.5. The Landsharks can withdraw contributed dollars once they have been in the Roth account for five years but can’t touch the earnings until age 59.9. Total accessible dollars in the chart below includes the taxable brokerage balances plus Roth IRA contributions, including conversions, that have met the five year rule needed before they are available for withdrawal.
|Year||Roth||Seasoned Roth Contributions||Total Roth Contributions||Total “Accessible”|
Total Roth contributions grow to $698,000 with conversions before the Landsharks begin using these to support their steady diet of meat and fish. They add $70,000 per year 2033 and make a partial conversion in 2034. The total accessible dollars then decline quickly as they approach 2039, when all of the Roth dollars become accessible.
In a couple of the early scenarios run, the Landsharks risked running out of Roth contributions available before hitting age 59.5. In a steady growth scenario this works, but the market is volatile and this may not work out perfectly. Roth contributions can be withdrawn five years after conversion, but earnings can’t be withdrawn penalty free until 59.5. This was the first case study I’ve seen where the early retiree ran the risk of over-funding Roth accounts at the expense of all other accounts could create an issue in early retirement. Tax rules are also subject to change in the future, having tax diversity is important, and there is a case to be made in switching back to pre-tax 401k contributions at the Landshark’s current marginal tax rate.
The Landshark brought up paying for his pup’s college. I am not an expert at this,check out this recent episode of ChooseFI talking about the student aid and some of the advantages financially independent types may have. Retirement accounts and real estate assets are not counted towards aid while 529 plans and regular brokerage accounts are. Spending down the regular brokerage account could help by the time college expenses roll around. You may also want to consider using your HSA and saving medical receipts as future college education vouchers.
Part 3: The Non Financial Concerns
Financial Independence is for everyone, but the early retirement piece of financial independence may not be. Some questions for the Landshark family to consider: Are you prepared to separate from your professional identities? What do you think you’ll tell people when the small talk begins with “what do you do?”. Most people your age will be working during the day. I personally wouldn’t trade this lifestyle for anything, but life in early retirement is still life with its set of challenges. I think it’ll take six, twelve, or even eighteen months to fully digest the change. Other early retirees I’ve been fortunate enough to meet have said similar things to me. If you pull the plug next spring, it’ll probably feel like a vacation in the beginning, a summer of your lifetime with your kids, then come the fall you’ll be figuring out how to settle into this new reality and might miss some things about your prior job. These thoughts and an adjustment period will be normal.
One of my favorite writers on this topic is Chris Mamula. Chris is a co-writer at Can I Retire Yet, recently led the ChooseFI Book, and can now be found all over the internet. I personally recommend listening to an interview Chris gave prior to the ChooseFI book being announced the FIRE Drill Podcast: Being Financially Independent as a Team | Can I Retire Yet? . It helped me set some reasonable expectations on the early challenges of the lifestyle change and absorbing this level of change
Part 4: Recommendations & Further Reading:
Do The Landsharks Have Enough?
Yes. The Landsharks have enough to execute on their early retirement plan. Twenty six times annual expenses may feel a little bit tight, but they have an advantage with so much of their savings accumulated in after-tax funds plus a paid off house. The market is also at an all time high, but the reality is you’re almost always going to be faced with this challenge.
If the markets aren’t hitting an all-time high, then a significant pull back probably just happened happened and the early retirement decision would be questioned anyways.
I would encourage the Shark family to look at Karsten aka Big ERN’s Equity Glidepath post inside his safe withdrawal rate series. You can’t predict the future, but you can tailor your investments based on the probability of outcomes. Karsten is a PhD, Chartered Financial Analyst, and fellow early retiree and this series is the best that’s ever been written regarding the risks of withdrawing from a portfolio. I too have a long retirement and was always a near 100% equity investor while working. I never could understand the thought of permanently holding hundreds of thousands in bonds until this series served as my “ah hah” moment.
My compromise to reducing risk in early retirement was entering into an equity glidepath: I currently own 65% Equities and 35% Bonds. This started at 40% bonds with a five year plan to slowly move back towards 100% equities. There’s risk either way: If you go 100% equities, you could suffer a crippling loss of capital and have the risk of doing something you shouldn’t after seeing a 20-40% drop “just to make the pain stop”. The market goes down a lot faster than it goes up and humans (and maybe sharks living on land) can be emotional creatures. If we added a 20%, 30%, or 40% bond allocation, we have to deal with the fear of missing out on big returns. I wanted to help protect the portfolio against a large, crippling drop that would risk me going back to work. I could tolerate that in exchange for missing a little bit of return on the upside.
Since the Landshark family owns their home outright, a 20% bond allocation that slowly reallocated back to 100% equities would help the minimal failure risk while minimizing missing out on the returns equities can provide. Here’s another recent early retiree who spent a similar amount of time studying ways to reduce risks and came to a similar conclusion.
Timing of the Resignation & Retirement Accounts:
This is early December at the time of the case study. If Mr. and Mrs. Landshark work until March or early April, they can probably maximize their employer accounts for the year and earn up to $105,000 with a minimal tax liability. This level of earnings would allow them to maximize 401ks for another year and cover part of 2020’s living expenses. While it doesn’t seem like much, adding another $45,000 to the 401k bucket between employee contributions and the company match plus the chance of additional earnings on the portfolio will give some extra cushion to the retirement plan. Also, who doesn’t like earning money nearly tax-free?
If Mr. & Mrs. Landshark decide to work half the year or more and project their income to go past $125,000 for 2020, the traditional 401k would be better than the Roth 401k option. In our simulation the Landsharks have some additional years available to spread out the conversion ladder and this switch will create some additional dollars in take-home pay they can shift into their regular brokerage account.
Consider this a trial run but also a period to get away from the grind and really talk about this with your family. Do you have a list of what you’d like to accomplish in the first six, twelve, or eighteen months? Do you have a wish list with your current employer that would get you to stay? A lot of financially independent folks earn up with part time or highly flexible job arrangements from their employer instead of existing based on the ability to exit. I recommend discussing this with each other in advance and pre-determine what is your line in the sand (or on the reef for sharks). Unemployment is at historic lows and in addition to job experience, you both have unique experience within your respective organizations. Is it a 2-3 day a week schedule? Is it summers off? If there *is* an ideal scenario where either of you would continue to work, have it written down and talk about it with each other before breaking the resignation/retirement news to your employer.
Track Spending / Create a Budget
I’ve tracked every dollar we’ve spent since getting married and other early retirees have done the same. Do you think you really have a handle on your expenses? Make sure you are including the estimated cost of health insurance. You’re fortunate to live in Colorado, which has some of the best healthcare exchange rates in the country thanks to healthy & responsible population participating in the insurance pool for your state. You may also see a small drop in costs thanks to the healthcare subsidy once you’re fully retired if your family’s income is managed down to below 103,000 for a family of four. Don’t forget to include a small line item for state taxes as well.
Finally, ask yourself what could go right?
So many of the early retirement discussions I see out there talk about what can go wrong including poor market returns to the loss of a sense of purpose or professional identity. There’s also a lot of things that could go right:
You could love the new lifestyle: This fellow early retiree in Colorado said Early Retirement Feels Like Reverse Dog Years. This concept has resonated with me. Long hours at work happen at the expense of *everything else*. Each week will probably feel like a month of your life. More time with people you like and you start building your schedule around the things that make you happy versus work demands. Your weekend schedule becomes completely free from things *you* need to do and is completely available for family, friends, and kids activities.
Market Returns: The market will probably return more than 4% after inflation. The stock market is investors providing capital to corporations with the expectation of a reasonable rate of return. This is why the market works, capital flows to the companies providing the highest rate of return and away from the ones generating low rates of return. It requires exceptional periods in history to risk running out of money at your starting point.
Income Surprises: You will probably have some income in the future. Financial Independence allows you to say no so many times to income opportunities eventually something will manifest itself into a yes. An additional $10,000/year in income on a plan that already has a near 100% success rate would catapult you into financial abundance. Many early retirees I’ve met eventually see other income coming in.
Budget Flexibility: You suddenly have more capacity to optimize expenses in early retirement and you may realize just how flexible your budget is. Youtube plus some extra time could become less frustrating than waiting for a repair person to show up. You get to fully optimize travel rewards and more time planning luxurious trips. This family of five consistently lives on under $40,000/year or less with a free & clear house while travelling the world every summer.
What Is My Final Recommendation to the Landshark?
I think it’s time to pull the trigger and leave the corporate & legal employment. The Landsharks have reached more than 25x expenses on a pretty luxurious budget with the security of a free and clear house. I recommend they think about how long it would reasonably take to graciously separate themselves from employment, especially since Mr. Landshark is a partner in a law firm. This is being published in December and I would encourage they pickup a couple of months of nearly tax-free income by working for the first quarter of next year. This will allow them to fully fund the 401ks and make 2020 traditional IRA contributions which puts almost $50,000 in additional funds into retirement accounts.
I would also recommend they each clearly define what their line in the sand is for any continuation of work after their stated date and what (if any) part time situation would keep them at *some* level with their employers. Continuing at some level can quickly become a slippery slope, so they should define those boundaries with one another and hold to them so they don’t risk slipping back into working at the same level. If one employer is more likely to do this than the other, they should consider exploring the options at that employer first before the other shark swims out to sea.
Questions and Answers after the Case Study
The Landshark reviewed this case study and here were some thoughts, additional information, and outstanding questions for the financially independent family to consider:
Departure Timing: I know it’s about the fourth time I’ve said this, but I encourage everyone planning early retirement to attempt to depart in the first half of the calendar year. The partial year’s pay is earned at a lower all inclusive tax rate, it allows earned income to fund qualified accounts for the year, and adds contributions into a new calendar year for social security. The Landshark agreed and shared that his annual bonus is paid in the 1st quarter. This plus partial year employment from Mrs. Landshark would allow them to add $39,000 in 401k contributions, obtain some company match, plus contribute $12,000 to Roth IRAs. Adding $55,000 to their accounts is adding nearly an additional year of living expenses for three months worth of work and moves their withdraw rate down to 3.75% from 3.86%.
Pre-Tax vs. Post-Tax Accounts: The Landshark understood my encouragement to use the traditional 401k vs. the Roth 401k. Their 2019 marginal tax rate was 28.63% between federal and state income tax. There are no guarantees on future tax rates, but as of today their tax rate in early retirement would be less than half of their tax rate today. Taking the up front savings on the traditional 401k will increase their take-home pay by $11,165 for the year, which can be saved in their traditional brokerage account. If the Landsharks continue to work and their pre-tax retirement accounts grow past $800,000, they should revisit utilizing the Roth 401k.
Bond Positions: The Landshark asked two important questions related to bonds and living expenses: What type of accounts should bonds be held in and how do I handle the current year’s living expenses? Bond interest doesn’t receive the additional tax benefits that dividends & capital gains receive, so bonds should generally be held inside tax sheltered accounts. For the current year’s living expenses, I personally hold around a year’s worth of living expenses in Vanguard’s Intermediate Term Treasury Fund (VGIT) in my regular brokerage account.
I have a personal preference towards owning treasury bonds today – I don’t see enough of a premium paid in municipal or corporate bonds to offset their credit risk. This is probably the former banker in me, but if I am going to take credit risk I want to be paid for it and today the payment is minimal. If we see a recession and the difference in yield between corporate bonds and treasuries increases significantly then I’ll revisit that decision.
Part Time Options: The Landshark shared that he has the potential to resign as a partner at his firm but remain “of counsel”. This role would allow him to do on-demand work that is a mutual choosing of both him and the firm. If the Landshark isn’t convinced he wants to fully retire, I absolutely consider this interim step to test out a slower work pace that could also leave open the opportunity to return to the firm. If he decides to retire fully after taking an of counsel role, it would likely be a quiet departure without all of the questions related to an abrupt announcement of early retirement. Any additional income the family is bringing in at this point is catapulting them past financial independence in to financial abundance.
Financial Independence is for everyone while early retirement is a personal choice. The Landshark family is faced with the dilemma of “what’s next?”. Careers may be fulfilling for some while a means to a monetary result for others. Their family has “won the game” and needs to ask themselves what happens now. What does winning the monetary game look like to them? Does financial independence change anything about their life? We all only get one shot at life and have to decide our own path. The Landsharks can now prioritize the pursuit of happiness and decide what that looks like for their family. I look forward to following their journey!
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