I’m going to define retirement as age 65. If you want to call it something else be my guest but that’s my definition. The society is defined around age 65 retirement in terms of social services. The problem with FIRE is there is no definition and you can’t “quantitative” a non definition, you can just blubber about simple math and bullet points. How you get to 65 is your business. How you fund beyond 65 is your business. Understanding the post 65 landscape however greatly informs how to get to 65, so MY analysis starts aimed at the end not aimed at the middle like most FIRE mumbo jumbo. Once you have a clear working model of what happens after 65 then you can start screwing around with the precedents. Included in the model are typical retirement amounts one might acquire by 65 in the upper middle class married brackets. I chose the numbers because they point out places of optimization. Whether and how you optimize is your business. I’m interested in an understanding and not a precise how to guide, but enough detail that you can make choices.
My choice is to Roth convert at least some of my TIRA money. There are several cliffs in the tax code as well as progressiveness in the tax code and they are on goingly cliffy and progressive. In addition everybody dies. It’s a known known. When you die is a specific expression of your genetic phenotype and is a known unknown and that introduces the risk of longevity, since you need enough money and a well controlled enough burn rate that your money will out live you. Forget about dying the richest person in the cemetery. Richest, poorest, the point is to die with the security and dignity money buys you and not forced to live a substandard life. This model is about the relationships of portfolio survival not about the fantasy of yacht ownership. Since we have a known unknown you should insure that unknown. Some people buy SPIA which I think is a waste, you wind up paying the insurance company for what you can do yourself. In my analysis the Roth provides that insurance against a high risk and catastrophic situation, as well as some buffer to ongoing unforeseen WR issues as well as some tax relief in the long term and a divorce from the government from control of your retirement accounts, since Roth’s don’t RMD. To own a Roth you have to fund a Roth and funding a Roth can be expensive but there are means to optimize that funding.
I chose a TIRA value at 65 of 1.4M and I analyzed what is the “best” ongoing outcome post conversion. A common maneuver would be to convert to the top of the 24% tax bracket which would virtually eliminate the TIRA. This maximizes future tax relief at the expense of high early cost of conversion. A 340K “top of the 24%” conversion will cost you 65K in taxes per conversion year. A conversion of 250K will cost about 35K so for 90K more conversion you pay nearly twice as much in taxes. In addition income passed 250K for marrieds starts to pile up excess penalties like a 3.8% tax surcharge and double or triple Medicare costs beyond the excessive taxation, it truly is about soak the rich. My conclusion was media via, middle way. For a 1.4M TIRA a plan aimed at 4x 250K conversion was about most efficient in my estimation. You could go to more years but each year has considerable expense on it’s own that needs to be funded. I further analyzed the best conversion time is likely between 65 and 70 because of Medicare eligibility which is likely cheaper than the commercial alternative. You also don’t have to convert equally, so you could convert biggly early and smaller later, but it’s good to convert the most earliest to get the tax free compounding going.
The Cost of Conversion
The cost of conversion is determined by the cost of living plus the excess taxes. The cost of living is not different that non conversion cost of living so if you live on $9000 a month your 4 year cost of living is $432,000 the taxes on 4 years of equal conversion is about 140,000 for a total of $572000. The taxes on the 432,000 cost of living over 4 years for the non converted life, if you are married is 40,000. So in the end your conversion costs an additional 100K in taxes over and above just the cost of living. If you convert 1M, you basically pay a dime in taxes per dollar and you are done with taxes on that money forever. If you convert to the top of the 24% you convert 1.36M and you pay 256,000 for the privileged or a net of 216,000 in extra taxes for an average tax rate of 15 cents on the dollar. You go AH HA I could convert less and save even more! While true the point is to pay the taxes now while living on cash not later when you have other income streams like SS and RMD generating taxes. Also the point is to get at least about 60% out of the TIRA to reduce the RMD and it’s tax burden to a better level. This is how to do the analysis, I’m not telling you what to do. This is what I did. I made a spread sheet to explain conversion. Using 4% growth and 2% to adjust for inflation as the constraints
My conversion is over 4 years starting at 66. The income stream includes Roth conversion investment income and SS income both gross and taxable. I actually chose 245K since I wasn’t 100% sure of my investment income and Roth now has a rule that you can’t re-characterize the contribution, Once contributed you owe those taxes. SS is tax advantaged in that you pay on only 85% of the benefit. SS is also inflation adjusted but I forgot to include that in the example. More on SS to come. You can see at 4% growth there is still a lot of money left in the TIRA even with conversion. My goal is around 500K-600K in the TIRA at the time of age 70 RMD. More in the TIRA generates a bigger tax bill forever, less in the TIRA generates a bigger tax bill sooner (10 cents v 15 cents). Remember this is a concept piece not a how to guide.
This is the schedule of my conversion the numbers are slightly less because my conversion amount was reduced by SS and investment income, but still nearly 1M is in the Roth by age 70 which was the goal. I had about 15K in my Roth to start. From this point the Roth just grows unmolested unless needed. You have a million bucks in the bank just in case. A spare million IS true financial independence.
My wife worked early in our careers but then became a SAHM and raised my daughters. We home schooled so I assure you she was employed just uncompensated. Given her earning record at age 62 she is eligible for 800/mo and I am eligible for half of her 800 or 400 for a net 1200/mo or about 14K/yr. An extra 14K pays half the tax cost of conversion for a year and that money is tax advantaged so I can use tax advantaged money to pay for conversion and save my cash for other uses. My SS plus her SS at age 70 will generate 55,000/yr of which 46750 is taxable. Max payout for SS is 59000 for a family. So “our” earning record taken as a whole is 93% of max SS. SS is not a trivial benefit especially because of the tax advantage. Depending on your tax bracket SS essentially pays it’s own taxes up to the 15% average tax rate at which point the marginal rate over takes the advantage. People blow off SS in their analysis but what it allows for is a lower WR early in retirement because it replaces some of the WR burden on the portfolio. This is anti-SORR and desirable for portfolio longevity. SS has therefore more subtle utility on the end game than doing the “bent finger” analysis might suggest.
I’ll include my budget analysis more as an example of how to think about it than suggestive. When I retired I wasn’t sure what to expect. I read all the dope on “being happy” money and the “80% rule” and bla bla bla. None of it means anything. Your budget has a lower limit and it’s not the same lower limit as your W2 budget. It’s not the same because the W2 budget has part of the actual cost of living subsidized by your employer in the form of benefits. This is not a trivial benefit. It includes insurances, paid vacation, fees, sick days etc as well as retirement benefits and management of your life in terms of filing taxes. Your 100K in W2 terms may be 125K or more in terms of the risk that is paid for. When you quit all that extra risk befalls you. In addition W2 tends to give one a sensation of having “time”. Need a new roof? You got some “time” to cover that with the W2 and shuttle some dough toward the roof. Need a new roof when retired? Get out the check book and you better do it pronto because ignoring it only costs more. I just mention that since while you have the W2 you have some luxury to save up for the know known one off expenses like a roof or A/C or car etc.
In my case I had all of my early retirement “one offs” planned for in a separate account. I settled on 10K/mo as my “target”, did my planning around that and initially it worked out to be a rational choice. After 1 1/2 years 9K is what it averages out to be. That 9K covers all the additional risk of living beside the bottom line cost. I left the estimate at 10K and use that extra 12K/yr as pin money for splurges. The extra 12K pretty much means I never have to say no or feel constrained. I retired with 2 kids in college. One is launching, the other still has 2 years but #1 may go to grad school, such is life. If I need more I’m adequately funded but I like having a plan to use as a governor. In my working life I never budgeted. Once retired I strictly budgeted till I understood the moving parts using Mint. Now I check Mint twice a month and export the month data into a spreadsheet for further analysis.
The Post RMD Plan
Given that I now understand quantitatively and relatively precisely my actual needs and cash flow, I wrote a spread sheet which incorporates the plan including RMD, SS income, investment income, and taxes. By mapping out the plan year by year I get a precise and predictable picture. Notice the analysis has not thus far even engaged “net worth”, only “net need” and “net available cash flow” namely SS, investment income, RMD and self insurance. This analysis is a quantified picture of my future with contingencies in built, not shockingly stupid math.
This is not my exact plan but close. At age 70 SS provides 55K/yr and RMD provides 25,547 of income. I just set investment income as a constant 25K because it’s there but unknowable, a known unknown but over the past decade that’s proven to be a reasonable estimate so it’s better than a guess. You can read through the columns and see what I anticipate including what I anticipate my tax load to be. If the laws change I merely redo the estimated taxes. The RED part is what happens when I die. My wife is younger and her family is long lived. In my family all the men are dead by 80. I could last longer than that but who knows? If I last longer I’ll make a new projection, in the mean time the Roth continues to grow unmolested so I have back up. When I die she goes from married jointly with 2 deductions to less SS (she will take the survivor benefit when I die) and she will have a dramatically larger tax percentage. So the inflation adjusted gross income of 137843 drops to 103069 a 34775 loss in income but the taxes effectively go up a bit. The average tax rate increases at 80 from 19.7% to 37.2% at age 81. So mama is paying more taxes on less income! This needs to be planned for. In addition there is another income drop when SS is scheduled to be cut 25% in 2034. This is another 9825 hit to mama’s income and also needs to be planned for, else mama goes from living a comfortable life style to having to make moves to reduce expenses because you followed some dumb assed simple math and a few bullet points.
The plan of course is to have enough! Now we get to the portfolio aspect
This is a schedule of what it costs to generate 9000/mo inflation adjusted, given the proceeding RMD SS investment income and taxes burden. In this plan mama still get’s her inflation adjusted 9K/mo. I didn’t run this out 30 years since that’s your job. After tax income is compared to inflation adjusted spending and a deficit signal is generated. The deficit IS the portfolio WR. In this example SS is treated as an annuity, RMD is likewise treated as annuity. In my case I reinvest my investment income yearly. That dollar cost averages money into the portfolio yearly and I (or mama) extracts money late after it’s had time to compound. Notice the deficit is small for the first decade. Maybe 18K. If my investment income is 25K that’s a net positive dollar cost average of 7K into the portfolio. At my death the WR changes dramatically, but by then the size of the portfolio has grown also. The changes also include the 2034 cut to SS. Not to worry however! The burn rate is mostly covered by the post tax portfolio but note it’s starting to decline, which is fine. Mama is now 80 and there is plenty of money left in the portfolio. At her age 80 the TIRA still has 450K left in the account. I set the TIRA to a conservative 3% which pretty well assures its longevity as an annuity and controls the tax bite. RMD is considered separately therefore from WR. If absolutely necessary you can extract more than RMD from the TIRA whenever you want. RMD is required minimum. The taxable continues to provide hamburgers and is the real source of WR since that deficit is what you need to withdraw. How foreign to the usual boggle head boiler plate an actual variable WR FREAK OUT! If you need some money look at what’s sitting next to post tax money why it’s old Mr Roth! Mr Roth is there in case mama starts to run short or has the big whammy like a cancer diagnosis or something.
The point of all this is to consider how much you need. At age 65 in this scenario you need 1M post tax, you need 1.4M TIRA, you need about 600K in cash to do the conversion. Which is 3M AT 65 for a 30 year retirement taking mama to about 95. Judiciously executed you have well over age 95 money available. I Monte Carlo’d the stuff as best I could and got about a 98% probability of success with these assumptions. What you do to survive prior to age 65 is a separate problem. If you borrow from the 3M portfolio to survive before age 65, it’s like taking out a second mortgage on your house, and the bigger the second mortgage the greater the chance of loss. You can retire at 65 with less than 3M or you can quit and screw up your % max of SS or you can fail to optimize taxes and pay a bunch when you are old. You can “max out your retirement accounts” and then wind up with no post tax account. Tons of alternate futures to play with This in my opinion is the proper way of thinking about FI and RE. When you quit you are taking out a loan on your future. If it’s a big high interest loan the odds are worse than if it’s a cheap small low interest loan. Oh I forgot you’re an investor not a speculator. The boggleheads told you so!