Could you talk more about safe withdrawal rates? I get 25 and 33, but where did 40 come from?

Two questions:

1.) What are safe withdrawal rates?
2.) Is it 26 because of interest rate factored in?

“Candidates”? Have you been watching Lost?

Hola Jacob, when are you going to reveal your net worth, or your net worth range to the community so they stop asking questions? 🙂

Best, Sam

I pay a lot of attention to how much income producing capital I have, but I don’t pay too much attention to my traditional net worth number. Most people seem to include the value of investments in 401ks (or similar accounts) and simply add it in with post-tax investment worth– clearly not an accurate measurement of worth because the pre-tax investments will be subject to tax in the future.

@WtWL, I try to use my credit card for all expenses. It’s very easy to track expenses by category and time period. The card’s loyalty program gets me around 2-4% in return. I know many people run into ruin with credit cards, so it isn’t a good idea for everyone. But, if you’re really on the ER path, I don’t know why that would be the case. If I have the discipline to save most of what I earn, and have over $100k in liquid capital, and spend under $2k per month– why would I get into trouble with a credit card? Strangely, I seem to be less disciplined with my money if I deal with it as cash.

Jacob, as one who retired recently (as you know) in 2008 at age 45, I can relate to your piece here. But I have some comments (echoed by others in some cases).

In (1), an early retiree will be more concerned about assets which will provide income prior to turning age 60, for example. For me, I excluded stuff such as my apartment I own outright as well as my personal possessions. I also excluded my retirement savings (IRA) for now because I do not wish to tap into it and incur all kinds of extra taxes and penalties I would mostly avoid if I withdraw from it at a better time later.

In my budgeting spreadsheet, I do account for them when I am able to withdraw from them without additional taxes and penalties (i.e. age ~60). But for now, I include them in my SWR but not for any income-producing assets. They are my “reinforcements” I will draw upon in 14 years. I have also estimated my reduced Social Security benefit by not working any more and have factored in my frozen pension and small cash-balance amount, all able to be tapped into at various ages starting at age 55.

Using retirement and non-retirement assets, my ratio in (2) is about 46:1. Even without the IRA it is about 31:1. In my budgeting spreadsheet prior to retiring, I had to redo it to estimate my lowered income taxes, the elimination of Social Security taxes and commutation expenses, and increased health insurance costs. My day-to-day cash expenses went down a bit because I got rid of those costly lunches while at work.

In (3), I have in my budgeting spreadsheet different inflation rates for medical costs versus everything else. This way, I can try out variable rates for each component instead of trying to guess an overall inflation rate which can change even if each component remains the same because their weights can change over time. Similarly, I have different projected investment rates of return for my different income-producing assets as well as the separate components of my IRA.

Your (4) is for me a by-product of (3), as I recalculate my overall portfolio’s value in my projections as well as viewing it daily and recording it monthly.

In (5), I assume you are referring to the point at which one can retire, early or otherwise, once one’s assets can generate enough current and projected income to cover one’s current and projected expenses. For me, this was when my former company’s ESOP hit a specific value ($300k) so I could cash it out and live off its dividends, according to my spreadsheet which was reviewed by an investment advisor.

@Mo – I would argue that you CAN include IRA/401Ks in your net worth.

For instance, if I had $200k in normal accounts and $100k in a retirement account, then using the 4% safe withdrawl rate, I could pull out $12k/yr from the normal account (and adjust upwards for inflation), provided the normal account is not wiped out before “official” retirement age.

Crap! I know none of this…except that my net worth is negative and I therefore probably avoid knowing it. You’ve given me some good stuff to work on though. Thanks!

I’ve heard you can also tap into IRAs early w/o penalty if you use 72(t)exception.

http://www.irs.gov/retirement/article/0,,id=103045,00.html#2

http://www.mymoneyblog.com/archives/2007/07/early-retirement-planning-taking-early-withdrawals-without-penalty-from-your-401k-or-ira.html

@George

I’m not arguing that you can’t include a retirement account in your net worth calculations. My argument is that I don’t find the common practice of adding pre-tax to post-tax dollars to be accurate.

From your scenarios:
1) $200k in normal account, $100k in retirement account
2) $300k in normal account

Many net worth calculators look at both scenarios as a net worth of $300k. I propose that they aren’t necessarily equal.

If, in situation 1, the $100k is in a 401k, and you’re under 59, then you can’t draw $100k out of the account. In fact, if you’re single, without any other income and tried to draw the full amount out in a lump sum, then you’d likely pay a significant amount of tax on that withdrawal (est. roughly 30%). If you’re over 59, you’d pay less tax, but likely still pay some (probably 20%ish)– enough so that, to me, situation 1 has a lower net worth than situation 2. This is what frustrates me about the net worth calculators in most financial software: 401ks are simply added to bank accounts. In my current situation, my 401k is ‘worth’ roughly 1/2 whatever the statement says- because if I withdrew the money tomorrow, that’s about what I’d get.

Not all retirement accounts are the same though. If, in situation 1, the $100k in a Roth IRA, then I think it’s legitimate to add the two together, because you can pull the money out of the Roth without having to pay taxes– just like you can pull money out of your bank account without having to pay taxes. To be fair about it though, if situation 1 does have the $100k in a Roth, then situation 1 is potentially worth more than situation 2, because of the advantages of the Roth, though figuring out how much more is speculative.

Does this seem accurate to you?

@Mo, I see what you are saying, but consider this scenario (of mine):

Each of my funds (stock, muni bond, corporate bond) have different amounts of unrealized cap gains/losses because I bought the shares at different times and at different prices compared to their current values. Should I revalue my net worth based on the level of taxation on the cap gains or losses I would incur if I were to redeem the entire value of each fund (i.e. use an after-tax value)?

If I were to make an early withdrawal from my IRA, I would still receive the total amount of the redemption but would be taxed at a high rate including any tax penalties. I do not discount my IRA’s value because I would pay more taxes on it once I start taking redemptions.

Another reason to include retirement accounts in one’s net worth is to maintain a level of consistency (in calculations such as NW and SWR, for example) when I eventually become old enough to withdraw from the retirement assets without incurring any tax penalties. Otherwise, one’s NW would make a big increase based only on one’s age.

@deegee&mossy, good points.

As for the unrealized capital gains in investments held in taxable accounts, I don’t try to adjust those for capital gains tax, because withdrawing them after retirement would incur a 0% tax rate for me (based on current tax structure), so valuing those investment at face value seems reasonably accurate to me.

My 401k and 403b accounts though, are a different story. If the stated value of these accounts were to be $100k, I wouldn’t value them as such because they won’t be worth that amount to me for nearly 30 years, by which time the value of what’s in the account will be different (hopefully!). As I age, and keep my expenses low, the difference between the stated value of these accounts and what I can actually withdraw will become less, so it will eventually be less significant. Currently though, in my low 30s, it seems reasonable to recognize this discrepancy.

@ Mo, deegee, etc: Once you’re (early) retired, can’t you just roll the 401k or traditional IRA into a roth IRA and take advantage of the 0% tax bracket? Then you never pay taxes on it.

Just a question–if you were to buy a home cash, would you count its value toward your net worth? I realize it would not be able to produce any income (unless you rented out a room). . . or if you had solar panels on it and the government paid you 2-3000 euros a year for energy (as in France).

Gosh, I’m glad to know I’m not the only person who converts significant financial spending decisions into the degree of net worth lost (hell, I’d do it with trivial ones too if I were sufficiently super-smart!)

Many people presume having a checklist like this is very onerous, but it’s really just a way of replacing your current checklist – which for a lot of people is a checklist of worry.

Readers may find this table of US historical asset class returns helpful when deciding asset allocation.

http://monevator.com/2010/03/10/us-historical-asset-class-returns/

I guess a potential problem for ultra-early retirees is that the best-performing asset class, stocks, may be too volatile over your short time-to-retirement horizon?

@Monevator, I followed your link, and I don’t understand how the real return on TIPS for 2009 can be 5.8%. You quoted your source, but I don’t have access to the data. Do you know where I could find any information to help me understand this a bit better?

[…] Retirement Extreme:  Five things every early retiree wannabe knows – The title says it […]

$7000 in expenses per year times 0.02% cash back return card = $140. $140 may be worth the risk and hassles of a credit card. Weight the pros and cons i guess. The likeliness of 29.99% interest accruded in a moment is not worth the reward.