goal: zero to retirement in 7 years?

[KTP]

My wife and I decided we want to get out of the rat race in 7 years. Ok, so we are not at zero exactly. No credit card debt, always pay them off every month but I do use them a lot to get cashback.

I have gone over our finances and I think we can manage to save about $70,000 a year for the next seven years if we live a lot simpler than we have been. Probably could save a bit more but wife unwilling to live without heat and cable tv I humor her because she makes 5x what I do.

So...we will be about ~45 in 7 years and have a separate 401k account which got creamed by the stock market crash recently but hopefully will provide all of our income from age 62 till death.

The plan is to turn the 70k a year x 7 years plus whatever we will get for selling our house and goods into enough cash to live on our sailboat from age 45 to 62. Sail around the world a few times and all of that

Figure the sailboat is going to eat about 20k a year or so (more in some years when you need new sails, rigging, bottom paint, etc., hopefully less in others). I figure we need another 30k a year to live for food, medical, entertainment, and insurance if we can get it. I hope that isn't too low.

So we need a income of 50k. Since our tax rate will go from absurd to almost zero, I am thinking the best investment plan would be something that is somewhat tax defered. The two things that come to mind are spiders (S&P500 index shares purchased like stocks SPY) and inflation indexed 30 year US I-bills. I think you can only purchase 10k a year per person in I-bills, so that would be 20k total for that and then the remainder 50k a year put into spiders. The I-bills do not pay out the interest until you cash them in, so tax defered, and the spiders are sort of tax defered since you will not realize any gain other than dividends until you sell them. This seems better than a mutual fund which might have to distribute gains several times a year.

Can we do it? I mean, assuming we manage to cut spending and actually save 70k a year, will the above strategy net us 50k a year from age 45 to 62? I guess aside from the I-bills, a lot would depend on the stock market recovering over the next 10 years. Although ideally it would wallow around at low levels for the first few years while we are dollar cost averaging into it. Any other saving or investment strategy that might be a better way to go?

Alternative strategy: win lottery, find rich uncle.

[tripods68]

I think your goal is admirable, but UNREALISTIC. First off, the market is so uncertain to even rely how it will perform in the next 7 years. The best bet you can make is save 70K a year x 7 = $490K sock in a regular savings account. 2 people x 40 years of expected retirement. That's rough $6,125 per person or $12,250 a year living on a boat. That's not taken into account, inflation or uncertainty in the market or emergency (medical).

The alternative would be: Not retire and continue working until you can actually afford it.

[noppenbd]

I would say it is possible, although maybe not probable. You need 17 years @ $50K=$850K (he said he has a separate 401k for 62+). If you save $490K and get some decent appreciation you might make it. It all depends on how much you can cut your expenses and sock away, and how the market performs between now and then. The worst thing that happens is maybe you have to work to 47 instead of 45. Just working that 2 extra years would give you 2 more years of saving and cut your needed funds by $100K. Plus you will prepare yourself for a lower standard of living, which you will most likely have to accept. Why not give it a shot?

As for whether the other 401k can support you from 62 on, that is a different issue.

[KTP]

I sort of forgot to mention that we own a house currently appraised at $360k and it will be almost paid for in 7 years. Figuring we can clear $300k from the sale of the house and other assets, that would pump our total up to $790k with zero appreciation in our capital. Rigging our boat for blue water sailing is going to knock 100k off that total though.

The hard part will be adjusting to the lower standard of living. But then again, is eating some chips and a hamburger watching the sun set while anchored at some secluded island in the south pacific really that much lower of a standard of living than dinner at TGI Fridays and a hollywood remake movie?

The real question. Do I have the stomach to watch the $50k a year that goes in the the S&P500 go up and down. The 20k in the US bonds should be ok. If the USA goes bankrupt I am getting on the sailboat with as many canned goods and guns as I can find and getting the hell out anyway.

Edit: The 401k account is separate and should have about $400k in it in seven years at our current 15% contribution level. Allowing it another 17 years to grow untouched and I am hoping for at least a million in there by age 62. Then maybe we will get something from SS considering how many thousands we have pumped into that.

[noppenbd]

Originally Posted by KTP

I sort of forgot to mention that we own a house currently appraised at $360k and it will be almost paid for in 7 years. Figuring we can clear $300k from the sale of the house and other assets, that would pump our total up to $790k with zero appreciation in our capital. Rigging our boat for blue water sailing is going to knock 100k off that total though.

I think your plan is definitely workable. Like I said, if you don't have enough at 45, you just push the plan out one year.

Don't forget to put some of that house money in an account for when the sailing trip ends. You'll need somewhere to live at that point.

[LivingAlmostLarge]

No way. I will lay down bets you couldn't do it because of the lack of medical, unless you are retired military or government workers?

Sounds good in theory, but individual insurance when you are in your 40s is crazy expensive and covers nothing. And in your 40s, 50s, 60s, is when you really start needing care and treatment.

Sounds great, but can you really cut your spending down that much as well?

Good luck, I hate being a debbie downer, but price our health insurance and see if it's really even a dream.

[KTP]

Hmmm, so I examined some current health insurance rates for non smokers age 48, which is 11 years older than we are now. For $483 a month we can get a policy with Regence BlueShield, 25% copay, max annual out of pocket $10,000. So let us put that in a proposed budget:

Investments:

Stocks: 500,000
average expected return including dividends: 9%

Inflation indexed Treasuries: 200,000
average expected return: 5.5%

Total yearly income: $56,000

Taxes: $6000

Adjusted yearly income: $50000

Boat maint. including moorage fees and permits (annual): $20,000

So $30000 a year to live off of, but we don't need a house. That works out to $2500 a month.

Typical monthly budget:

Medical: $483
Food: $600
Diesel: $200 (it is a sailboat, but you still use some fuel)
Sat. phone: $100
Entertainment: $300
Misc. supplies: $300
Boat Insurance: $300

total: $2283.00

leftover: $217

Ok, so flaws in this plan are these are todays dollars vs dollars 7 years from now. Still, it seems doable maybe with a bit more savings than the 700k. Possibly when we get into our 50s the medical costs could eat away at our principle, but even with a 10,000 a year drawdown on the principle it seems we could easily live till age 62 when we start drawing SS and money from the 1 million dollar 401k. Probably be tired of sailing by then anyway

[MonkeyMama]

Health insurance doesn't make it impossible. But definitely something to think about.

I'd also be wary about the "my tax rate will be 0" thing. Sounds like you are in a pretty high tax bracket and that will probably go down. But you also won't have any deductions. (No mortgage, no 401k, no IRAs?). Assume a flat 20% tax unless you can manage your investments extremely well tax wise. (Even well managed investing can be pretty hit and miss. Too many factors; taxes extremely complex). {I am a tax professional and my moderate-income retirees pay far more income taxes than most working people would guess}.

Retiring so early comes with lots of risks. Expenses go up, inflation, dynamics change. Who knew healthcare would be so astronomical today, when a decade ago it was quite reasonable? What's next?

But I don't see the harm in trying. It would certainly put you in a good place, even if you are not ready to retire in 7 years. You'd be WAY closer, and nothing wrong with that.

[KTP]

Originally Posted by MonkeyMama

I'd also be wary about the "my tax rate will be 0" thing.

Ok, I am not thinking 0, but a married couple, filing jointly, with a ~50,000 income and 0 deductions (taking just the standard deduction) are not really going to pay much right?

I just ran TaxCut with an input of $40,000 in capital gains and $10,000 in qualified dividends and nothing else (no W2 income, no deductions other than standard). My tax liability for 2008 was zero.

Now I think there might be some special rules for 2008 that says you pay no capital gains if you are in the two lowest tax brackets so I do not know how it would be in future years?

But on the other hand, I did not include any medical expense plan in the deductions. Isn't there some way of paying into a fund and then having that fund pay out your monthly insurance costs and getting to deduct that?

I can't see that making 50k a year in interest and dividends that we will be paying 20% in taxes as you say. Can you provide any examples? It would really help me grasp this as I can't find where the tax would come from.

[jIM_Ohio]

Originally Posted by KTP

Hmmm, so I examined some current health insurance rates for non smokers age 48, which is 11 years older than we are now. For $483 a month we can get a policy with Regence BlueShield, 25% copay, max annual out of pocket $10,000. So let us put that in a proposed budget:

Investments:

Stocks: 500,000
average expected return including dividends: 9%

Inflation indexed Treasuries: 200,000
average expected return: 5.5%

Total yearly income: $56,000

700k giving 56k in income is a 56/700=8%. This is an 8% withdraw rate, and conventional wisdom is 4%, with 5% being "living on the edge" and 6% being "I am going to die REALLY young".

Run through a monte carlo analysis (see my blog link for a retirement calculator I recomend). You are probably at a 70% of running out of money if your retirement lasts longer than 30-40 years

Originally Posted by KTP

Taxes: $6000

Adjusted yearly income: $50000

Boat maint. including moorage fees and permits (annual): $20,000

So $30000 a year to live off of, but we don't need a house. That works out to $2500 a month.

Typical monthly budget:

Medical: $483
Food: $600
Diesel: $200 (it is a sailboat, but you still use some fuel)
Sat. phone: $100
Entertainment: $300
Misc. supplies: $300
Boat Insurance: $300

total: $2283.00

leftover: $217

Ok, so flaws in this plan are these are todays dollars vs dollars 7 years from now. Still, it seems doable maybe with a bit more savings than the 700k. Possibly when we get into our 50s the medical costs could eat away at our principle, but even with a 10,000 a year drawdown on the principle it seems we could easily live till age 62 when we start drawing SS and money from the 1 million dollar 401k. Probably be tired of sailing by then anyway

You have more flaws than the ones you listed. What happens when the investment portfolio does not earn 8%? You are planning to withdraw 8%, but have a 71% equity portfolio whose std deviation (of returns) is probably close to 13. That means -5% is as likely as +21% returns. If 2-3 consecutive years hit where your porfolio returns less than 8%, you will wipe out your entire savings in 3 years.

You need to research withdraw techniques. Conventional wisdom for a 30 year retirement and a 60-40 portfolio allocation is a person can withdraw 4% (which means you need 25X your annual expenses in savings).

60-40 has a deviation higher than its return (I think return is 8% and deviation is 10%- meaning -2% happens as often as +18%). 40-60 is first portfolio I am aware of (using monte carlo) which has a deviation less than the expected return (return of 7% with a deviation of 6% I think).

Here is what I would suggest-
save a little less (than 70k) and take a few vacations now
plan for retirement in 14 years (not 7) giving the 50k you can contribute each year more time to compound.

If you have 25X the expense calculation (25X56k=$1.4 M), you are probably good to retire.

The 25X/4% rule has inflation built in (meaning you withdraw 56k year 1, then 56+3% year 2, then 56k+3%+3% year 3... increasing withdraws by 3% each year).

There are techniques to retire on less than 25X, they would include using an annuity, controlling withdraws (not increasing them when market is down) and controlling costs more.

Another flaw with your plan is you need $$ to buy a new house once you stop sailing at age 62... so if you sell a house for 300k, you don't want to spend that money, as you will need a place to live at age 62 and whether you rent or buy, you will need that cash again.

[noppenbd]

Originally Posted by jIM_Ohio

700k giving 56k in income is a 56/700=8%. This is an 8% withdraw rate, and conventional wisdom is 4%, with 5% being "living on the edge" and 6% being "I am going to die REALLY young".

Run through a monte carlo analysis (see my blog link for a retirement calculator I recomend). You are probably at a 70% of running out of money if your retirement lasts longer than 30-40 years

Jim, this money only has to last 17 years (45-62). He has an additional 401k that he is not considering in the 700k, which, with SS, would fund 62+.

The housing issue post sailing needs to be addressed though.

[jIM_Ohio]

Originally Posted by KTP

Ok, I am not thinking 0, but a married couple, filing jointly, with a ~50,000 income and 0 deductions (taking just the standard deduction) are not really going to pay much right?

I just ran TaxCut with an input of $40,000 in capital gains and $10,000 in qualified dividends and nothing else (no W2 income, no deductions other than standard). My tax liability for 2008 was zero.

Now I think there might be some special rules for 2008 that says you pay no capital gains if you are in the two lowest tax brackets so I do not know how it would be in future years?

But on the other hand, I did not include any medical expense plan in the deductions. Isn't there some way of paying into a fund and then having that fund pay out your monthly insurance costs and getting to deduct that?

I can't see that making 50k a year in interest and dividends that we will be paying 20% in taxes as you say. Can you provide any examples? It would really help me grasp this as I can't find where the tax would come from.

Long term tax planning can be futile. I would look to maximize current deductions (use a 401k or IRA) and save now (you have a high bracket NOW, so save $$ NOW with deductions NOW).

If money is in a 401k or IRA, then the capital gains tax rates DO NOT apply and ordinary income rates do apply.

[jIM_Ohio]

Originally Posted by noppenbd

Jim, this money only has to last 17 years (45-62). He has an additional 401k that he is not considering in the 700k, which, with SS, would fund 62+.

The housing issue post sailing needs to be addressed though.

The 401k balance should be factored into the 700k then. There are ways to access this money without penalty (see rule 72t) prior to age 59.5.

[LivingAlmostLarge]

View Effective Tax Rate Calculator

Gosh that is a nice tax calculator. I think. For two people earning $50k it's 9% federal taxes. Then state income taxes. So definitely around 15% maybe?

For medical expenses you can use a HSA. So if you assume you'll hit the $10k/year in OOP medical you have $40k to live on. Then the budget doesn't really work right?

Can you really withdraw 8%?

[KTP]

A few flaws in your analysis of my analysis but I do apreciate the comments:

1) How can three years of not getting 8% returns wipe out a 700k nest egg when you are only drawing 50k a year??? Was that a miscalc on your part?

2) Everyone seems to be forgetting that we will have another million dollars or more in a separate 401k account that we can access around age 62. So instead of thinking of it as needing 30 or 40 years of retirement out of the 700k we only need it to last 17 years. It can be virtually zero when we hit 62 and we should be able to live off the 401k plus SS.

3) When we need a house again, we will be selling the sailboat, which will probably fetch 200,000 or so considering we will have kept up the maintenance by spending 20k a year on it.

Still, I understand all of the points and it may be that we would want to take some contract work or something down the road to supplement our income. Both of us are engineers (software and hardware) so it probably would not be too hard to get a few 6 month contracts here and there if we decide the main fund is getting a bit low.

let me edit this: Ok, if we have another depression like we are in now, I guess the portfolio could take a 50% hit in a really bad scenario. So the 700k would drop to 250k + 200k = 450k. Even still, drawing 50k a year off that would last 9 more years. And you would not pay any taxes considering the huge capital losses you could claim each year.

[KTP]

Originally Posted by LivingAlmostLarge

Gosh that is a nice tax calculator. I think. For two people earning $50k it's 9% federal taxes. Then state income taxes. So definitely around 15% maybe?

For medical expenses you can use a HSA. So if you assume you'll hit the $10k/year in OOP medical you have $40k to live on. Then the budget doesn't really work right?

Can you really withdraw 8%?

No state taxes. We don't pay them now, and would be pretty stupid to register the boat in a state with income taxes while we are sailing around the world

Good question. I guess you can't draw 8% without a drawdown on your principle. I need to run the numbers, but I am going to guess that 700k would last longer than 17 years even with a significant yearly drawdown.

[KTP]

Originally Posted by jIM_Ohio

Long term tax planning can be futile. I would look to maximize current deductions (use a 401k or IRA) and save now (you have a high bracket NOW, so save $$ NOW with deductions NOW).

If money is in a 401k or IRA, then the capital gains tax rates DO NOT apply and ordinary income rates do apply.

Hmmm...we are already at max contribution to get the matching funds for my wife's 401k, but might be able to increase that more. I could also open an IRA for myself, since I am self employed...

Good ideas. But we really really want to do this retire early thing, and before we get too old to handle the strains of deep ocean sailing. Possibly consider a large increase in our 401k/IRA contributions and a smaller investment pool? If we had 2 million or more in our 401k at age 59.5 then we could certainly draw down principle and interest on our sailing nest egg...

Or is there a sneaky way of getting 401k and IRA money in your early 50s?

[jIM_Ohio]

Originally Posted by KTP

A few flaws in your analysis of my analysis but I do apreciate the comments:

1) How can three years of not getting 8% returns wipe out a 700k nest egg when you are only drawing 50k a year??? Was that a miscalc on your part?

Here it goes.

700k invested
take out year 1 income
650k left
market takes away 50%
left with 325k
take out year 2 income
275 left
market takes away 50%
138k left
take out year 3 income
88k left
market takes away 50%
You have 44k left and not enough for year 4.

You have 13 years of needing money. If you even just ran calculations on just ONE YEAR of 50% loss then minimal gains of 4-6% the following years that one down year is going to kill the plan.


700k
take out 50k for year 1
650k left
market takes away 50%
325k left
you move all of the money to a CD
you have 6 years worth of income left (when you needed 16).

You don't even make it half way with an 8% withdraw rate

Originally Posted by KTP

2) Everyone seems to be forgetting that we will have another million dollars or more in a separate 401k account that we can access around age 62. So instead of thinking of it as needing 30 or 40 years of retirement out of the 700k we only need it to last 17 years. It can be virtually zero when we hit 62 and we should be able to live off the 401k plus SS.

I missed this until another poster pointed it out. This still does not change your "8% withdraw rate" issue and the risks associated with it.

You have one retirement and you need to look at all monies and the risk profile of all that money at once.

For example if you expect 401k+IRA+taxable accounts to be "together", and those have a $2 M balance in 7 years... you need that $2 M to generate an income of 56k (2.8% withdraw rate).

Because I know that a 4.25% withdraw rate might work (SS gets added in later in life, expenses go down once sailing stops, bond funds exist which yield 4%... maybe another factor or two I don't know about) I could divide the money into buckets and use the bucket approach. In your case I would use 4 buckets.

Bucket 1- cash- keep X years of expenses in cash. Probably 5-9 years depending on risk tolerance. The more cash you have, the more likely the rest of the plan will work. If you have 2 M to invest and expenses are 56k, 9*56=504k. There is 1.5M left for remaining buckets.

Bucket 2- enough money to replenish bucket 1 with interest once per year. If expenses are 56k and you think you can get a 4.25% yield, then you need 56k/.0425=1.31 M to generate the 56k you need. This bucket might be 40-60 in allocation- designed primarily to generate interest for bucket 1.

You have 200k left for remaining buckets. I would put 150k into an equity based investment. This is bucket 3. Bucket 3 is designed to grow and be volatile- 100% stocks. In any year where bucket 3 has a return higher than A%, put the difference into bucket 1 (basically take profits out of bucket 3 and put them into income producing investments in bucket 2).

Put remaining 50k into another investment which over 17 years should grow enough to buy a condo (50k should turn into 200k with an 8% return over 18 years).

3) When we need a house again, we will be selling the sailboat, which will probably fetch 200,000 or so considering we will have kept up the maintenance by spending 20k a year on it.

Still, I understand all of the points and it may be that we would want to take some contract work or something down the road to supplement our income. Both of us are engineers (software and hardware) so it probably would not be too hard to get a few 6 month contracts here and there if we decide the main fund is getting a bit low.

let me edit this: Ok, if we have another depression like we are in now, I guess the portfolio could take a 50% hit in a really bad scenario. So the 700k would drop to 250k + 200k = 450k. Even still, drawing 50k a year off that would last 9 more years. And you would not pay any taxes considering the huge capital losses you could claim each year.

I don't think you have a good enough plan yet. "sell a boat to buy a house" has lots of risks- the boat could depreciate in value, the boat could sink, housing prices could sore much higher, taxes go up with the house, and this is just a partial list.

[KTP]

Hey, thanks for the bucket analysis. I have read about that method but had not had a clear example set out like you did.

For the cash bucket. You don't really mean cash right? Investing in 30 year inflation indexed T bonds or something would be wise for this bucket? If I understand them correctly (still researching them) they pay a fixed interest portion and a variable portion that is adjusted twice a year for inflation. So you may have say a 1.5% fixed rate plus another 4% for inflation. Thus the bond is paying 5.5% but is totally safe (well, as safe as the US government, which can always print money). So this bucket is going to grow at 1.5% if you replenish it with bucket 2 as you described. Not a lot of growth, but 1.5% of 500k compounded over 15 years is $125k.

It would almost seem as if the overflow from bucket 1 would pay for half of a house when we decide to quit sailing!

Problems: I think we can only buy 10k a year in paper and 10k a year in electronic format of the I bonds.....

[KTP]

Uhg, I just found out we are up against the limit for 401k contributions. I had no idea it was a set limit ($16,500) rather I thought it was a percentage of your income.