I am constantly making improvements on my already healthy financial situation. As we learned previously, having an attitude of constant optimization leads to some pretty sweet improvements from time to time. If you are open to change, new ideas seem to find their way in and benefit your life. Just a few months ago one of these sweet discoveries wound up on my doorstep, and guess what, is was one hell of an epiphany.
This may be one of the most impactful posts I ever write, because it outlines a way to reduce what a typical reader of this blog needs for retirement by $100,000, cutting nearly 1 year off of your working life.
How? By saving for retirement, twice.
You and I know all about the 4% rule and how a person simply needs 25 times their annual spending stashed away in order to live off the appreciation for life. This being said, a person who lives off of $25,000/year (easy to accomplish with some good old frugality), needs $625,000 saved to quit the job.
This amount will safely kick back your annual spending forever, making your savings 100% self-sustaining, it will never deplete. However, lately I have got to thinking, what if you withdrew more than 4%? Say, 5%? Obviously, the total amount you would then need to support your living expenses would decrease to times 20 your annual spending. The problem with this would be you now introduce some risk:
- Your Funds will have the chance to deplete over time, given the market’s behavior
- If your funds do begin to deplete, say during a recession, the constant withdrawing of greater than 4% could allow this depletion to accelerate.
As your account value decreases, the gains decrease each year, all while the amount take out to live off each year does not change. We all know what happens when there is an exponent at work. Someday you will find you are down to zero, and its back to work for you.
So taking out more than 4% introduces the risk of your funds not being sustainable. However, what if you allowed your funds to deplete, but in a controlled manner? What if you found a way to make your stash statistically last, say, 100 years? As nice as it would be to have a 100 year retirement, odds are you will not live to be 130. (Life is short, carpe diem!) so your money would still outlive you, but the amount you need saved would be less!
But wait, don’t get too excited, there are still some HUGE issues with this….
Sadly, early retirees are a rare breed. We have a unique situation with some unique hurdles to clear. Someone retiring at 60 or 70 may easily be able to go by the plan above, taking 4.5,5, or maybe even 5.5% depending on their situation. You and me are planning for a much longer span of time, so there comes some difficulties in breaking the safe withdrawal rate. With a 60-70 year long retirement, can you anticipate changes in medicine? Technology? What will a human lifespan be in 50 years? With a larger window of events to take into account, early retirees actually run the risk of seeing the average lifespan increase by some substantial amount during their retirement, allowing them to outlive their savings.
Talk about good news being bad news….but wait! I still wasn’t ready to give up on this thought. With a little math, I managed to figure out a happy middle ground between no depletion and too much depletion.
Going back to spending $25000/year, a person would need $625000 in order to retire. However, if you split your retirement time span in half and deal with them separately, things change drastically.
Tax advantaged retirement accounts such as Roths and 401k’s have a penalty on them if you withdrawal your earnings before age 59.5. So let’s split your retirement into two sections, pre and post age 59.5
One this side, if you have $625000 in retirement accounts, you will receive your sustainable $25,000/year forever. Using the rule of 72 and market history, we can see that the doubling time of your investments in the market is about 10 years.
With this information, we can back-calculate what we would need saved by age 30 in order for it to grow to $625000 by age 59.5. Since your investments double every 10 year period and we are talking about 30 years, it will double three times. So take your end amount, $625000, and cut in half three times. This will be about 80,000. In other words, $80000, saved in tax advantaged retirement accounts at age 30 will be about $625000 by age 59.5.
Congrats, your are set for life from age 59.5 on into forever! Now lets take care of the first 20-30 years of your retirement, ages 30-40 to 59.5.
You now know precisely how many years of retirement you are saving for aside from the $80000 in tax advantaged accounts. With this information comes great power. No more morbid guesswork of trying to figure out how long you will live, just finding that magic number that will get you to age 59.5, where a limitless supply of livelihood will be waiting to take the reigns. This new amount will deplete until it is near zero at age 59.5, the traditional retirement age. Safely assuming 4% appreciation per year and withdrawing $25000, this magic number is $450000. This added with the $80000 in tax advantaged accounts totals $525000, a savings of $100,000!!!
You now have $25000/year for each year of your retirement, best of all, you got it at a $100,000 discount. You can even get a portion of that $80,000 in retirement account through your employer matching.
Never accept that a situation cannot be made better, even if it is already great. This epiphany came from being open to improvements. Maybe you even find a way to improve on this idea further! If so be sure to email me and I will share them.
Thanks for reading! Enjoy the 15% discount on your retirement!