How Much Money Do You Need to Never Work Again: Part 2

You are looking at all those digits on your investment account balance and thinking back on the journey.  Maybe this is you today or maybe it will be you in a few years.  Maybe you built a business or made your startup fortune. More likely, you took the simple but challenging traditional steps to wealth, and you have started to build a vision of what life looks like beyond having to work to make ends meet.  However, you have questions. 

From Part 1 of this article, you understand what a safe withdrawal amount is based on and you have looked at some average situations.  However, almost no one is average and hence financial lives are a little bit more involved.  Is your personalized financial plan sound?  

You will have questions as you actually examine your number and get close to making life changes based on being financially independent. You will want to really understand the risk and the likelihood that your pile of cash will last as long as you need it to.*

What if my Budget is Wrong?  What if I Want to semi-retire but still have some income?  How does my number change if my net worth is in things beyond just a split between the S&P500 and high grade bonds?  How does it matter if my money is in a 401K vs a Roth IRA, vs a non-tax advantaged account?  Let’s look at some resources and some examples to understand some of these specifics and more.

How Does One Budget for 40-60 years?

I once asked a financial planner friend how much analysis he uses to plan for retirement expenses in an annual budget for his clients.  He explained that he offers a guidance document (like this one or this other one) and then relies on the client filling out the worksheet to provide the estimate.  He further explained that it’s tough to make a business model work when offering financial planning alone.  Instead it is almost always rolled into portfolio management and a 1% management fee just doesn’t allow for many hours of consultation.  Like so much else in life, if you want it done right sometimes you have to take charge yourself.

Create Your Own Retirement Financial Model

Financial models may be the least sexy kind of models of all but are totally worthwhile.  Your model will be unique to you.  Here are some tips on how I created my initial retirement spend estimate.

Your Retirement Financial Model Step 1:

Understanding expenses and having a budget are of course foundational pieces to calculating a work optional financial number based on a safe withdrawal rate.  Starting with annual spend today is a reasonable baseline.  I personally used 3 years of data to smooth out some variance.    

Your Retirement Financial Model Step 2: Categorize Spend. 

This helped me to understand where the money goes. Labelling necessities versus discretionary spend can help in understanding the flexibility of my budget.  For example, if 40% of the budget is discretionary spend, you will know that you have lots of flexibility to tighten the belt on spend if something unforeseen arises.

Your Retirement Financial Model Step 3: Model.

What will your expenses look like over time?  How many years are left on that mortgage?  What large purchases didn’t appear on your spend from step 1?  How many years will you support children?  When I initially created my plan, I modeled spend every year until age 100 and then adjusted to an average annual spend to get my number.  Yes I am going to live to age 100 at least. 😉  Here are some commonly overlooked things that one may want to consider:

• Taxes. If your nest egg is in taxable accounts this becomes especially important to factor in.
• Raising Children.  How much incremental cost does each add and in what years will you be supporting your kids?
• One Time Children Costs.  These include childbirth, cars, college, graduation gift, wedding costs, any other gifting?
• Cars.  include periodic car purchases.
• Your Home.  How many years are left on the mortgage.  Will you downsize?  Will you buy a vacation home or cabin?
• Home Improvements.  Your home will not stay the same.  New roofs, siding, decks, etc.
• Healthcare costs.  These will jump when you no longer have an employer subsidizing them.  Expenses also go up dramatically as you age.  Model this. 
• Insurance.  Will you require any additional over the years?
• Travel, hobbies, or bucket list items.  When will they happen and how much will they cost?
• Senior care for yourself and your spouse?

Your Retirement Financial Model Step 4: Managing Risk and Uncertainty. 

I recommend that the tighter a budget is, the more time one should spend ensuring that it is accurate. A general concept that I learned from project management is that greater uncertainty means greater variance in the cost and time to complete anything.  However, I also need to be careful about how I account for this variance. 

What if I use a worst case estimate for each future purchase cost, then I add a 10% misc. expenses box on my annual expenses, then I decide to not factor in social security payouts to be on the safe side, and then I add 20% to my final number needed to retire just to have a safety net?  This may end up wildly overestimating my expenses with unseen nested safety nets. 

3 points estimating is a method that accounts for worst case, best case, and most likely case.  I used a version of this when estimating my expenses.  Then in one spot at the end, I added my safety net by not including social security payouts (I have no faith in politicians) and adding what I felt was a reasonable emergency fund. These are some steps to help think about a long term budget, but what if you make mistakes?  

What If My Budget Is Wrong?

Are you looking at the steps I took above and skeptically asking, how am I supposed to know what I will spend 30 years from now or more?  What if I accidentally get pregnant during a drunken bender at age 45?  How about if I get married and/or divorced?  What will healthcare cost in 2050?  How can I possibly predict what I will spend each year through all stages of life for the next 60 years?!

If this is your question, I would like to offer a useful reframe on how one might think about a long term retirement budget.  Rather than worrying about being 100% right about your annual expenses every year for 60 years lest you go broke, understand that your spending is not fixed.  Think of it as having $XXk this year and you can adjust spend accordingly.  Much like the Tour De France, this is a long ride and you can make up for losing some stages by winning others.  Every racer trains and puts together a solid plan.  This robust plan is then well positioned for the unexpected.  After all, winners of the tour have overcome flat tires, crashes, and huge time setbacks on the way to eventual victory. One often overlooked setback is taxes.  

Let’s Talk Taxes.  Does It Matter What Kind of Account Your Savings is in?

Yes it does very much.  I mentioned in the examples from part 1 of this article that taxes are not included in the 4% rule tables. Taxes highly depend on what kind of account you have your money in. Here in the USA, common ones are:

Roth: If you are over 59.5 years old, you can withdraw cash from your Roth IRA totally tax free (you already paid tax when you put it in).  

401K: If you are over 59.5, you can withdraw from your 401K but must pay income taxes on that cash like it is ordinary income.  

Standard Investment Account: You can withdraw money from your non tax deferred investment account at any time and have to pay capital gains taxes on any gains. 

This means that in a somewhat worst case scenario, if you were relying only on a 401K and withdrew 100K per year, you may actually only have around $73K in spending money after federal and state taxes. Ouch! However, there are countless strategies for minimizing and sometimes avoiding taxes.

Minimizing Taxes Can Change The Game

In the USA, we have a progressive tax system. This generally means that the more you make, the more % you get taxed and also the more you spend in retirement each year the harder it is to avoid taxes. Many smart people have spent many hours working to minimize taxes and I will introduce some of the high points. Some early retirees such as this one or this one for example have lived off upwards of $100K per year and used combinations of these strategies to pay no further taxes!

Some strategies such as tax efficient fund placement, also referred to as asset location, revolve around what asset types you have in what accounts. For example, if one has tax free municipal bonds it may be better to hold them in a taxable investment account. Mutual funds with high stock turnover, however, are very tax inefficient and may be best purchased in a Roth or 401K. Of course your situation, however, is unique to you.*

Drawdown strategy involves which assets and from which accounts your draw down cash over time to fund your non-working life. Many have shared their strategies and this or these is a good place to start.

There are also some straight up tax hacks that look to shrink the slice of your cash pie that goes to taxes. Here are some very useful ones:

•  Tax loss harvesting
• Back Door Roth and how to do one 
• Using an HSA as a retirement account
• Minimizing taxes through real estate

The links in this section are a good start to optimize your journey of minimizing your taxes when planning how much you need to never have to work again. However, tax optimization and asset location are of course unique to your personal tax profile.  

What If I am Not Fully Retiring or a Spouse Continues to Work?

There are loads of reasons one might choose to continue to work for reasons beyond money.  Not fully retiring or having a spouse that works changes your income tax situation and also reduces the budget needed during the applicable years of the budget model that you created in step 3 above.  Even a job at Starbucks is sometimes worth it just for the health insurance.

What About Social Security?

An easy way to factor social security payouts into your financial model is to start by viewing your social security statement and click on the “earnings report” area. Copy your earnings table and paste it into this ssa.tools calculator. Then you can see exactly what payouts you can expect for each year to plug into your financial model.

While I do not factor social security payout into my safe withdrawal model at all, I realize that this is an extremely (some might say overly) conservative approach. There is no guarantee what social security will look like 30 years from today for me. However, there are no guarantees of anything right?

If you are retiring early, social security may feel a long ways away. Here are some specifics to remember:

• You need to work for at least 10 years (40 total quarters) to qualify for a payout later around age 62, 65, 70 or so.
• The payout changes dramatically depending on when you choose to start taking the benefit.
• Your expected S.S. payout also changes based on you hitting thresholds or “bend points” based on your average income.

For more on these “bend points” in social security payouts, check out this post by the Physician on Fire, or this one by Joe from Reitre By 40.

What If My Portfolio Is Not Just S&P 500 and Bonds?

The 4% rule and safe withdrawal rate discussion from part 1 of this article, is largely based on the Trinity study which assumes that your portfolio is invested in only the S&P500 and high grade corporate bonds.  However, most of us have money in weird investments beyond this.  I for example have individual stocks, municipal bonds, t-bills, startup equity, income properties, and lots of other weird complex stuff in my portfolio. 

It is important to understand that the average yield of the asset classes in your portfolio as well as the overall volatility of those assets greatly affects your returns and your % chance of long term “success” under 4% rule guidance. If your average long term blended yield based on your asset classes is below that of the SP500 for example, you can’t expect the tables from the Trinity Study to hold for your unique portfolio. I have written in the past more about the basics of portfolio construction, alpha, and beta. To really understand how your portfolio stacks up, a comparative tool like this one is a good place to start.

The Final Word on How Much You Need To Never Work Again?

How much do you need to never have to work again?  In part one of this article we looked briefly at the mindset side of this question and then explored safe withdrawal rates and the 4% rule.  In this 2nd part we have looked at some of the common question areas around how much you need to never have to work again such as:

• How to assemble a budget.
• How to minimize taxes and factor them into your plan.
• What if I want to work part time or a spouse still works?
• How about social security?
• What if my money is not cleanly invested only in the S&P500 and bonds?

While it is my hope that this two part series jumpstarts your thinking and answers lots of your questions quickly, it likely does not answer them all. Rather, it gives a view of how one fairly knowledgable dude thinks about his finances and safe withdrawal rate. Congratulations on being in the position where this article applies to you. That alone, means that you are ahead of the game in terms of financial security and creating a work optional life.

Feel free to ask any additional questions or post any helpful thoughts in the comments section below.

I’m passionate about financial independence, happiness, success, and adventure. Consider subscribing below to get a weekly email directly from me with a few thoughts and latest articles. It’s totally free and totally worth it, I promise.

*I am not a financial professional. Consider everything on this site and in this article for informational purposes only. It should not be considered financial advice for any individual. Your financial situation is unique to you.