Author Topic: The Shockingly Simple Math Behind Early Retirement  (Read 9014 times)

apricity22

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The Shockingly Simple Math Behind Early Retirement
« on: August 07, 2017, 10:56:48 AM »
Hi All,

I found the MMM blog towards the beginning of this year (2017) and have been bouncing around to various articles as well as reading through them chronologically to make sure I don't miss anything (I'm only to about mid-2012 presently). Anyway, one article that has been on my mind is the "The Shockingly Simple Math Behind Early Retirement". I've included the url for this article and the url to another blog that discusses the same concept below.

My question regards how taxes during retirement are accounted for. To demonstrate I will use a simple example:

$100k take home pay (gross income minus taxes, as defined in the blog post)
$75k saved per year (75% savings rate)
$25k living expenses per year x 25 (4% SWR) = $625k
Saving $75k per year at an interest rate of 5% will yield $625k after 7 years just as the table in the article shows. However, when I start drawing $25k per year from my accounts to spend I will need to pay tax on that in the form of income tax and/or capital gains tax which does not appear to be accounted for in the calculations presented in these articles. What am I missing?

http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/
http://the-military-guide.com/2011/01/03/how-many-years-does-it-take-to-become-financially-independent-2/

kenaces

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #1 on: August 07, 2017, 11:08:05 AM »
The article is simplification to make the point that savings rate is THE KEY factor in reaching FI quickly imo.

A more details plan requires one to think about taxes and make tax-smart investment decisions.  As an example based on your numbers if one retires at 25K of income:
~ they will not be paying taxes on LT-gains and dividends
~ they may have some of their money in Roth IRA = no taxes on withdrawal
~ they may have some of their 625K in a paid off home
~ they may have other income from side hustle, SS.....
~ money in HSA that they can withdrawal from for medical cost tax free

2Birds1Stone

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #2 on: August 07, 2017, 11:24:41 AM »
As Kenaces pointed out, someone drawing 25K/yr from a portfolio will barely crack into the 15% tax bracket. Most of your withdrawals will be tax free or very low tax.


Frankies Girl

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #3 on: August 07, 2017, 11:36:58 AM »
What they said. I'm already FIREd, and it works. Staying below the 15% bracket means zero cap gains/dividend tax. We take a bit more than $25K for yearly expenses, and we still pay zero tax.

I owe nothing. I've got one account I still have a tiny bit of federal tax withheld (as a cushion to my health insurance subsidy calculations through the ACA), but I get every single penny back at tax time.

We're lucky in that we live in a LCOL area, have a nice house with a low rate on a small mortgage and lots of fun stuff to do that costs very little if not free. We eat out lots, we buy nice food, we wear nice clothes and we have lots of nice things (actually too much as we're in the middle of a junk purge).

MDM

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #4 on: August 07, 2017, 11:25:12 PM »
As Kenaces pointed out, someone drawing 25K/yr from a portfolio will barely crack into the 15% tax bracket. Most of your withdrawals will be tax free or very low tax.
+1

In round numbers, assuming $18K/yr goes into a 401k, $5500/yr into a Roth IRA, and $51,500/yr into a taxable account*, when the total stash reaches $625K there will be
$425K in taxable
$150K in traditional
$50K   in Roth

*Requires gross income ~$131,700 for a single person with no state tax and $25K/yr non-tax expenses.

Drawing proportionally from each of those (doable without penalty if one is 59.5 or older) to fund $25K spending the federal income tax is $0 because the amount coming from traditional accounts is less than 1 standard deduction and personal exemption.

Or, one could convert $10,400/yr from traditional to Roth for $0 tax and withdraw $25K from traditional, also for $0 tax even with a $0 basis, as long as all the gains are long term.

For those with annual spending higher than $25K, taxes will become an issue at some point, but for a one line equation the the simple math isn't too bad.

DarkandStormy

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #5 on: January 10, 2018, 08:25:38 AM »
https://earlyretirementnow.com/2017/12/13/the-ultimate-guide-to-safe-withdrawal-rates-part-22-endogenous-retirement-timing/

Quote
Specifically, letís assume that every month, starting in 1871, we had sent off a new hypothetical generation on their path to FIRE. They start with zero savings, then save 50% of their income (adjusted for CPI-inflation), invest in a 100% equity portfolio and retire when they reach 25-times annual spending. Even though the starting dates are perfectly spread out, one each month, the retirement dates are not. They follow the big bull markets with extended gaps in between, see the chart below. The endogenous retirement dates are in red. Using the Mr. Money Mustache Simple Math method, youíll mostly retire during a bull market, and often during the last part of the bull market, right before the peak and the next bear market!


MDM

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #6 on: January 10, 2018, 09:00:38 AM »
https://earlyretirementnow.com/2017/12/13/the-ultimate-guide-to-safe-withdrawal-rates-part-22-endogenous-retirement-timing/

Quote
Specifically, letís assume that every month, starting in 1871, we had sent off a new hypothetical generation on their path to FIRE. They start with zero savings, then save 50% of their income (adjusted for CPI-inflation), invest in a 100% equity portfolio and retire when they reach 25-times annual spending. Even though the starting dates are perfectly spread out, one each month, the retirement dates are not. They follow the big bull markets with extended gaps in between, see the chart below. The endogenous retirement dates are in red. Using the Mr. Money Mustache Simple Math method, youíll mostly retire during a bull market, and often during the last part of the bull market, right before the peak and the next bear market!
And yet, even for a year 2000 retiree, it's a pretty safe bet to say that they 'succeeded', if success was the ability to withdraw 4% of their initial portfolio value, adjusted for inflation, for 30 years.

Link is to a Bogleheads thread "Year 2000 retirees using the '4% rule' - Where are they now?", in particular to a post that corrected some double counting of inflation.

BTDretire

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #7 on: August 31, 2018, 08:36:34 PM »
One important point the starting income was $40,000 in the year 2000.
 That would be like retiring on $59,717 a year today.
$27,700 in the year 2000 is equivalent to $40,000 today.

Jamese20

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #8 on: September 04, 2018, 09:38:35 AM »
Sorry to hi-jack this thread topic but I have a serious question on it,

How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I love the idea of gaining financial independence in 5 years but saving rate of 75% ? Seems a pipe dream without basically living on the street or living with 6 or so people who share the mortgage / rent payments - either way unless you severely sacrifice a basic standard of living or earning significant money this is a pipe dream it seems ?

AnswerIs42

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #9 on: September 04, 2018, 12:57:54 PM »
How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I'm in the UK, while I haven't calculated my exact savings rate, I'm in the ballpark of 75%. How?
  • I have a decent (although not ridiculously high) salary
  • I bought my small flat in the early 2000s, the mortgage is almost paid off by now so I'm paying very little for housing
  • No dependants
  • I already have most of the material goods I want, so don't need to spend much on them any more
  • Practicing the general Mustachian "only spend money on things that are actually worth it" philosophy

Jamese20

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #10 on: September 05, 2018, 01:23:02 PM »
How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I'm in the UK, while I haven't calculated my exact savings rate, I'm in the ballpark of 75%. How?
  • I have a decent (although not ridiculously high) salary
  • I bought my small flat in the early 2000s, the mortgage is almost paid off by now so I'm paying very little for housing
  • No dependants
  • I already have most of the material goods I want, so don't need to spend much on them any more
  • Practicing the general Mustachian "only spend money on things that are actually worth it" philosophy

I could understand somewhat if you have a one bedroom flat with little to no mortgage, but again this is somewhat extreme - i have a family so this is a non starter option, which leads me to the same question, how does one get to that level of saving rate in the UK just starting out on the housing ladder with a family - the maths just don't work in reality for me at the moment

onlykelsey

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #11 on: September 05, 2018, 01:32:35 PM »
How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I'm in the UK, while I haven't calculated my exact savings rate, I'm in the ballpark of 75%. How?
  • I have a decent (although not ridiculously high) salary
  • I bought my small flat in the early 2000s, the mortgage is almost paid off by now so I'm paying very little for housing
  • No dependants
  • I already have most of the material goods I want, so don't need to spend much on them any more
  • Practicing the general Mustachian "only spend money on things that are actually worth it" philosophy

I could understand somewhat if you have a one bedroom flat with little to no mortgage, but again this is somewhat extreme - i have a family so this is a non starter option, which leads me to the same question, how does one get to that level of saving rate in the UK just starting out on the housing ladder with a family - the maths just don't work in reality for me at the moment
I think you probably have to adjust the numbers slightly because of the differences in healthcare in the US v the UK, as well. Certain costs that we pay (and save for) out of pocket are picked up by taxes before they hit your paycheck. So Americans usually have higher earnings, but bear more risk in providing for their own future so need to save more for that.  I had an uncomplicated vaginal birth with a midwife and no drugs, and would have paid nearly 20K without insurance. I'm not saying this a criticism of either system, just as an observation.  I imagine there are other differences, as well. 

It seems like the UK is relatively well-suited for the early retirement scheme compared to, say, mainland Europe, but that the ERE and MMM models are really built for the American style of income and taxation.

AnswerIs42

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #12 on: September 05, 2018, 03:49:54 PM »
I could understand somewhat if you have a one bedroom flat with little to no mortgage, but again this is somewhat extreme - i have a family so this is a non starter option, which leads me to the same question, how does one get to that level of saving rate in the UK just starting out on the housing ladder with a family - the maths just don't work in reality for me at the moment

...and that's fine, nobody's saying you have to hit 75%. If you've just started out on the housing ladder with a family, of course it's going to be harder. A 50% savings rate is still pretty impressive, you'll still build up a stash in a reasonable amount of time.

Dabnasty

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #13 on: September 06, 2018, 02:22:00 PM »
Sorry to hi-jack this thread topic but I have a serious question on it,

How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I love the idea of gaining financial independence in 5 years but saving rate of 75% ? Seems a pipe dream without basically living on the street or living with 6 or so people who share the mortgage / rent payments - either way unless you severely sacrifice a basic standard of living or earning significant money this is a pipe dream it seems ?

Your question is much too broad. What I can say is, there's no need to save 75% or any specific amount, save as much as you can. There's no simple answer because you can optimize every aspect of your spending. Groceries, housing, cars/transportation, electric, internet, insurance, too many to list. And lots of areas that can be cut out entirely like eating out, TV subscriptions, event tickets. And that's not to say you have to do all of those things, but the more areas you optimize, the better. You may see some of these things as extreme but they certainly don't require living on the street or with 6 other people.

Based on your question I'm guessing you haven't read much of the blog, I would recommend you do. I would also recommend submitting a case study if you're serious about reducing your spending. You didn't give numbers on what you consider "decently paid" but just in terms of expenses, as a couple we are right around $22,000 annual spend and that includes a warm comfortable place to live, two cars, one 30 mile commute, two cats, and a healthy diet of mostly fresh whole foods. There's really quite a bit more we could save if we optimized everything.

If you're not interested in a case study, I would recommend not worrying about a 75% savings rate but rather start reading articles from the blog and trying to implement those strategies. You will be surprised at how little sacrifice you have to make for substantial savings.
« Last Edit: September 06, 2018, 02:23:31 PM by Dabnasty »

Jamese20

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #14 on: September 07, 2018, 12:30:24 AM »
Sorry to hi-jack this thread topic but I have a serious question on it,

How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I love the idea of gaining financial independence in 5 years but saving rate of 75% ? Seems a pipe dream without basically living on the street or living with 6 or so people who share the mortgage / rent payments - either way unless you severely sacrifice a basic standard of living or earning significant money this is a pipe dream it seems ?

Your question is much too broad. What I can say is, there's no need to save 75% or any specific amount, save as much as you can. There's no simple answer because you can optimize every aspect of your spending. Groceries, housing, cars/transportation, electric, internet, insurance, too many to list. And lots of areas that can be cut out entirely like eating out, TV subscriptions, event tickets. And that's not to say you have to do all of those things, but the more areas you optimize, the better. You may see some of these things as extreme but they certainly don't require living on the street or with 6 other people.

Based on your question I'm guessing you haven't read much of the blog, I would recommend you do. I would also recommend submitting a case study if you're serious about reducing your spending. You didn't give numbers on what you consider "decently paid" but just in terms of expenses, as a couple we are right around $22,000 annual spend and that includes a warm comfortable place to live, two cars, one 30 mile commute, two cats, and a healthy diet of mostly fresh whole foods. There's really quite a bit more we could save if we optimized everything.

If you're not interested in a case study, I would recommend not worrying about a 75% savings rate but rather start reading articles from the blog and trying to implement those strategies. You will be surprised at how little sacrifice you have to make for substantial savings.

Thanks for the feedback, I am probably not being clear, but from what I have worked out is that 1. I really would like to save 75% but probably realise it is not possible for me (very annoying ) and was hoping someone with a family could show me the light.

Without detailing all the numbers due to time 40-45 looks realistic in a year's time which would mean I am FI in 15 years (46-47)

My next aim is to see where I can maximize income to trim some years of that 15 as expenses will only take me so far

SpreadsheetMan

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #15 on: September 07, 2018, 01:40:18 AM »
Sorry to hi-jack this thread topic but I have a serious question on it,

How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I love the idea of gaining financial independence in 5 years but saving rate of 75% ? Seems a pipe dream without basically living on the street or living with 6 or so people who share the mortgage / rent payments - either way unless you severely sacrifice a basic standard of living or earning significant money this is a pipe dream it seems ?
If you look round the UK FI blogs there are very few that hit 75%+ savings rate. The ones that do tend to be either very highly-paid professionals, or no-mortgage houseowners with few dependents living a spartan lifestyle.


Hula Hoop

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #16 on: September 07, 2018, 02:22:01 AM »
I'm not familiar with the UK as I live in Italy but with our high taxes here and lower salaries it's hard to do MMM type saving.  We have a family and local salaries and save a LOT less than 75%. 

One of the few positive things we have going for us here though is that the COL is a lot lower in our Italian city than it is in many other European cities - let alone American cities.  Good food and wine is way cheaper and so is housing.  Kids activities and child care also cost very little. And, of course, health care is much cheaper.  So, if you are in London or another expensive large UK city, you might think about moving somewhere with a lower COL.  Of course this also depends on your jobs and whether you have family nearby who help out with the kids.  I have British friends who have moved from London to Yorkshire (where they are from originally) and they say the COL is like night and day.

We also choose not to keep up with the Joneses (or Rossis in our case) - Italian style lifestyle inflation consists of lots of expensive beach and skiing holidays, owning and running a car, expensive private classes for the kids, English language schools for the kids (we don't need this as I speak English at home), cleaning staff and babysitters, living in the "right" neighborhoods and nice clothes/phones etc.  We don't do any of that - no car, no beach or skiing vacations, a lot of second hand clothes and inexpensive classes for the kids.  I'm sure there are similar supposed "must dos" (especially for kids) in the UK?  IMO every culture has it's own slightly different unnecessary things to spend a lot of money on.
« Last Edit: September 07, 2018, 03:15:48 AM by Hula Hoop »

Prairie Stash

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #17 on: September 11, 2018, 11:40:08 AM »
Thanks for the feedback, I am probably not being clear, but from what I have worked out is that 1. I really would like to save 75% but probably realise it is not possible for me (very annoying ) and was hoping someone with a family could show me the light.

Without detailing all the numbers due to time 40-45 looks realistic in a year's time which would mean I am FI in 15 years (46-47)

My next aim is to see where I can maximize income to trim some years of that 15 as expenses will only take me so far
I don't think anyone has a constant saving rate for 15 years; especially with kids. Some years I had daycare, then University savings. My expense side fluctuated every year as the children grow, as expected. On the income side, if your wage increases match inflation then its a constant, however most people get a few small raises over 15 years.

The important part is to do your best and realize it'll finish at some point. Maybe it takes 15 years, maybe 12 or maybe 18, its all better then retiring at 65. In my case my 12 year plan was cut in half eventually, its funny how life changes. 15 may seem like a reasonable number today, I doubt everything will go according to plan and you may see some surprises over the next decade, some will decrease the timeline even.

Dialing it in when you're that far out is impossible, the math isn't supposed to be taken too literally.

Zikoris

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #18 on: October 05, 2018, 10:10:58 PM »
You want to save 75% but don't know how? Lay out your numbers (income and expenses), and I 90%-guarantee we can tell you how to do it. But fair warning: you probably won't like the answers. It would probably involve massive lifestyle changes.

Linda_Norway

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #19 on: October 10, 2018, 05:15:39 AM »
Sorry to hi-jack this thread topic but I have a serious question on it,

How does one live on 25% of their income especially in the UK? I get it if you happen to be a CEO or an investment banker making a killing but i am struggling to see how even decently paid couples get anywhere near it - it is hard enough to do 50% which is a struggle with any kind of decent enough lifestyle?

I love the idea of gaining financial independence in 5 years but saving rate of 75% ? Seems a pipe dream without basically living on the street or living with 6 or so people who share the mortgage / rent payments - either way unless you severely sacrifice a basic standard of living or earning significant money this is a pipe dream it seems ?
If you look round the UK FI blogs there are very few that hit 75%+ savings rate. The ones that do tend to be either very highly-paid professionals, or no-mortgage houseowners with few dependents living a spartan lifestyle.

I live in a country at least as expensive as the UK and we saved 75% of our take home pay last year. That was due to:
- No mortgage on the house that we live in.
- No children.
- One good income (1,5 x average) and one very good income (2 x average). We are in our 40s.
- Having cheap hobbies that don't require money to do them.
- Going on cheap vacations (sleeping in tent most of the time).
- Buying some big things second hand, like new dining table and chairs and new sewing machine.
- Last year we were lucky not to have any cars repairs for our 2 cars.
- I had discovered MMM and stopped buying the usual shit that people buy all the time. I also found cheaper insurances and electricity, cancelled subscriptions for magazines etc.
- We don't pay for TV channels other than the standard state channels that we pay for anyway.
- We sold some bicycles and other bigger things.
- I watch out what I shop for food, pricewise. And we always watch the price when filling petrol, as that varies per day.
- We did not have any big repairs/renovations on the house.
- Cooking all meals at home.
- Not hiring people to wash the house or doing small repairs or painting. We do everything ourselves.
- Brewing beer at home.

In 2016, before I discovered MMM, we saved about 60%, which was our normal savings rate for most years. So a good amount of active mustachism, combined with luck that year in not having expensive repairs, brought in that savings rate once. But it is not easy to have that every year, without having to cut back on even more lifestyle stuff. We could of course ditch the second car, sell our cabin, skip the week's autumn holiday to the south, not buy fancy cheese, not buy wine and whisky. Without these things, we could probably reach that savings rate every year.

I should add that we will not be retiring after 7 years of work, but rather after 25 years or so. In the second half of our 40's. Still a lot better than 67, which is standard here. Our countries are not comparable to the US in matters of COL, taxes and health care. But we still can get a high savings rate and retire (relatively) early if we want to.
« Last Edit: October 10, 2018, 05:19:16 AM by Linda_Norway »