4% Withdraw

[crshieh]

Hello everybody.  I am John, new to the forum, but have been following MMM blogs for close to a year now. 

Sorry if I missed this information elsewhere on the forum...  But my question is, say a person budgets 2k a month for living, which at a 4% withdraw rate can be sustained FOREVER with 600k (2k x 12 x 25).  If this person finally saved 600k at the end of 2007...  What happens for 2008, or 2009?  I know "in the long run" returns will regress to the mean...  But for the short run, there is not a whole lot of money in 2009 to support the expenses?  Please help me with my understanding, thank you so much!

[Frankies Girl]

4% is the average.

In your scenario, if a person had the bare minimum they need to be FIRE at the end of 2007, and then retired with no other revenue streams, then they'd have unfortunate luck and probably need to draw down much less, and/or supplement in other ways (part time job or sell stuff/junk) in order to get through the the next few years until the portfolio recovered.

That's why I think most folks that plan FIRE tend to err on the side of caution and go for a bit larger than the bare minimum amount to retire early, and most also have a plan to do something that produces money on the side that they enjoy doing anyway.

If you're lucky, you retire during a time period that your portfolio gets in several good years so it grows enough to get through the less than stellar market years, but in general, you adjust your draw down during bad market years.

[Abe]

Take a look at this page's table: http://www.fpanet.org/journal/CurrentIssue/TableofContents/PortfolioSuccessRates/
going over the Trinity study which looked at withdrawal rates, and % of time periods wherein the ending value was positive.

In general, you want to have enough living expenses in a more secure  investment such as CDs or TIPS (Treasury Inflation-Protected Securities) to ride out several years of down-turns in the market. I am planning to keep 2 years of expenses in the bank, then another 5 years in TIPS. This seems like a lot, but will be a small fraction of our total savings. That way we don't have to rely on withdrawing money from stock investments if they are performing poorly.

[Khan]

A better case crshieh, is someone retiring at the height of the .com boom.

An important addendum to the 4% rule, besides not going for the bare minimum(and having personal flexibility in your spending, maybe 30k is comfy spending, whereas 20k is survivable), is that you probably shouldn't "retire" in a rip-roaring market. If you retire during a bust, or work a couple years into that bear market after having already reached the 4% rule, then you are giving yourself a much greater margin of safety.

The other alternative, is of course, not to completely drop out, but to do things you love doing that still could pull in -any- income whatsoever.

Another great margin of safety, is if you add the 4% rule and plan to be retired less than 30 years till social security becomes available, and don't count social security into any calculations.

[chasesfish]

I think you're forgetting dividends in this analysis.  The S&P pays around 2% right now and most of its companies aren't cutting dividends even when the recession hits. (Some did, most didn't).

If you're nearing retirement, it probably isn't the best fund.  If you had invested in the Vanguard Wellington fund in late 2008, you've enjoyed a 14% annual return.  10 year return is around 8.5%. This is an actively managed balanced fund for about 0.20% in fees if you're buying the admiral shares

[SwordGuy]

If I remember correctly, the 4% rule for safe withdrawing had really important limitations:

1.  It covered a 30 year period.
2.  Success was defined as not running out of money in that 30 year period.  Running out of money 1 second later was still considered success, because you were assumed to (a) retire at 65 and (b) be dead within 30 years.

In other words, if you intend to retire early and count on the 4% rule to automagically work no matter what over the course of a 50 year retirement, it would not be surprising to find you are greatly disappointed.

Make sure you can get by on less than the 4% withdrawal if things go bad.  Or make sure you can make extra to supplement your income if things go bad.  Or plan on a lower withdrawal rate - plus the first two options I mentioned if things get really, really bad.  :)

There are no guarantees.  Just likelihoods.

[mjs111]

Don't forget about taxes.

If you need $2,000 to live on each month you'll want to find out what pre-tax amount that takes at a 4% drawdown rate.  If your tax is at the 15% rate, for example, you'd need $2,000/(1 - 0.15) = $2,353. That works out to a $705,000 capital base instead of $600,000.

Mike

[bacchi]

The Trinity study also has the 4% being increased each year from inflation. In year 2, you would be taking 4% + inflation and so on until in year 10 you're at >5%. Survivability can obviously be increased by not adding in the inflation during lean years, which is the same as decreasing withdrawals.

As for taxes, some of the withdrawal would be the cost basis so it wouldn't be 15% on the entire $2000.

[chasesfish]

The Trinity study also has the 4% being increased each year from inflation. In year 2, you would be taking 4% + inflation and so on until in year 10 you're at >5%. Survivability can obviously be increased by not adding in the inflation during lean years, which is the same as decreasing withdrawals.

As for taxes, some of the withdrawal would be the cost basis so it wouldn't be 15% on the entire $2000.

+1.

The 4% withdraw rate account allows for inflation and for market fluctuations.  The taxable income is entirely dependent on the situation, but in the $600,000 base, I'd imagine its almost zero.  There are things that can be done that earn tax credits verses payments at that level (like go earn 5k on a part time job, put it all in a retirement account, and take a savers tax credit).

[medinaj2160]

The Trinity study also has the 4% being increased each year from inflation. In year 2, you would be taking 4% + inflation and so on until in year 10 you're at >5%. Survivability can obviously be increased by not adding in the inflation during lean years, which is the same as decreasing withdrawals.

As for taxes, some of the withdrawal would be the cost basis so it wouldn't be 15% on the entire $2000.

+1.

The 4% withdraw rate account allows for inflation and for market fluctuations.  The taxable income is entirely dependent on the situation, but in the $600,000 base, I'd imagine its almost zero.  There are things that can be done that earn tax credits verses payments at that level (like go earn 5k on a part time job, put it all in a retirement account, and take a savers tax credit).

Yes taxes will probably be almost zero

[Cheddar Stacker]

The Trinity study also has the 4% being increased each year from inflation. In year 2, you would be taking 4% + inflation and so on until in year 10 you're at >5%. Survivability can obviously be increased by not adding in the inflation during lean years, which is the same as decreasing withdrawals.

As for taxes, some of the withdrawal would be the cost basis so it wouldn't be 15% on the entire $2000.

+1.

The 4% withdraw rate account allows for inflation and for market fluctuations.  The taxable income is entirely dependent on the situation, but in the $600,000 base, I'd imagine its almost zero.  There are things that can be done that earn tax credits verses payments at that level (like go earn 5k on a part time job, put it all in a retirement account, and take a savers tax credit).

Yes taxes will probably be almost zero

If any of you guys haven't read Go Curry Cracker's post on taxes yet, you really are selling yourself short. There is no need to ever pay taxes again after ER if you are only living off $2K/month and you strategize properly. I ran some numbers for myself based on my own situation (married with 2 young kids) and with the proper strategies/assets in place I can actually generate an AGI of $96K and pay no federal taxes.

http://www.gocurrycracker.com/never-pay-taxes-again/

I am a CPA so I do taxes for a living and I can confirm all of this is perfectly legitimate.

[Abe]

Just to clarify, the $96k for a couple is from the standard deduction of $12k + exemptions of $7.6k + capital gains of $70k, which is the the top of 15% marginal tax bracket?

Do people living in states with income tax have to pay for capital gains if they are in the bottom two brackets? Does this vary a lot from state to state?

Thanks!

[Cheddar Stacker]

Just to clarify, the $96k for a couple is from the standard deduction of $12k + exemptions of $7.6k + capital gains of $70k, which is the the top of 15% marginal tax bracket?

Do people living in states with income tax have to pay for capital gains if they are in the bottom two brackets? Does this vary a lot from state to state?

Thanks!

That's roughly correct - it's for a couple with 2 young kids. It also includes 2 more exemptions (2 kids) + $2,000 in child tax credits + some IRA to Roth IRA conversions + the 10% tax bracket (17,400 in 2012). It all depends on your personal situation and goals. I believe when I reach FI I will have far more in tax deferred accounts than taxable accounts, so my strategy would include a lot of Roth conversions as well.

Here's the breakdown of the scenario I ran, which isn't necessarily a maximum amount any particular situation might allow:

Roth IRA Conversion           46,500
Qualified Div/L-T Cap          50,000
Total AGI                           96,500

Less:
Standard Deduction            11,900 (this is 2012 #, 2013 is 12,200)
Exemptions                        15,200 (this is 2012 #, 2013 is 15,600)
Taxable Income                  69,400
Tax                                     2,044 (The tax is from the Roth conversion, not the $50K QDiv/L-T Cap)
Child Tax Credit                   2,000
Federal Tax Due                       44
State Tax Due                      4,227 (You are correct, state taxes are not part of this strategy)

In my post I specifically said federal taxes in one spot, but I should have clarified the state part. A few states (TX, NV, FL, WY) have no state income tax. Other states might follow the federal rules more closely and have a smaller tax. My particular state return would result in around 4.5% income tax due using this strategy. If you live in a state with income taxes, it's likely you would have to pay taxes on Roth conversions and capital gains, but luckily those rates are much lower than the federal ones so it still makes a lot of sense to do this.

The 10% bracket should be considered in any Roth conversion strategy. That portion of this strategy allows for up to $45,650 without paying any federal income tax if you are married with 2 kids (17,850 10% tax bracket + 12,200 std ded + 15,600 exemptions x4). These are 2013 amounts.

None of this factors in any other income you might have, so if you own rental real estate, receive social security, have interest from a bank or brokerage, work part time during FIRE, these would all affect this strategy. However, some of them could have a positive impact on this, like a rental real estate loss.

[Jeremy]

If any of you guys haven't read Go Curry Cracker's post on taxes yet, you really are selling yourself short. There is no need to ever pay taxes again after ER if you are only living off $2K/month and you strategize properly. I ran some numbers for myself based on my own situation (married with 2 young kids) and with the proper strategies/assets in place I can actually generate an AGI of $96K and pay no federal taxes.

http://www.gocurrycracker.com/never-pay-taxes-again/

I am a CPA so I do taxes for a living and I can confirm all of this is perfectly legitimate.

Wow, thanks Cheddar Stacker, I appreciate your kind words on our post on taxes.  I wrote it because I was excited that we were going to have a $0 tax bill this year and every year hereafter.  Apparently a lot of other people are excited about that too, as it has been a really popular post

We have another post coming that has been in the works for awhile in regards to our take on the 4% rule, which coincidentally will answer the OP's question.  A lot of people seem to over-complicate things and end up planning for margin that they don't need (meaning they work too long.)

Cheers

Jeremy
www.gocurrycracker.com

[Cheddar Stacker]

It was an eye opening post, even for someone very familiar with this sort of thing. It's amazing what you can do with the tax code when you have no earned income.

I found your blog from the mad fientist, after finding him through MMM. All very good stuff and all the FI bloggers seem to complement each other well. Some overlap, but you all have a unique approach and perspective, plus different goals beyond just FI, such as your permanent travel. Good luck to you Jeremy. I'll keep reading, and I'll keep plugging your idea of never paying taxes again.

[crshieh]

Wow...  Thank you all for your information...  This is a lot for me to learn and digest!!  I greatly appreciate all of your inputs!!

[dadof4]

Hello everybody.  I am John, new to the forum, but have been following MMM blogs for close to a year now. 

Sorry if I missed this information elsewhere on the forum...  But my question is, say a person budgets 2k a month for living, which at a 4% withdraw rate can be sustained FOREVER with 600k (2k x 12 x 25).  If this person finally saved 600k at the end of 2007...  What happens for 2008, or 2009?  I know "in the long run" returns will regress to the mean...  But for the short run, there is not a whole lot of money in 2009 to support the expenses?  Please help me with my understanding, thank you so much!

This is actually a pretty easy example, since the market has already rebounded from that hard 2008 slump.
For simplicity's sake, let's say you had all your money in one ETF, say the Vanguard total market VTI. You withdraw 20k, inflation adjusted, every 1st of January.

start 2008 -  VTI at 69.72, 600k - 20k = 580k
start 2009 - VTI at 46.03.  383K - 20k = 363k
start 2010 -VTI at 56,37    445k - 21K = 424K
start 2011 - VTI at 65.53,  493K - 21K = 472K
start 2012 - VTI at 65.38   470K  - 22k = 448K
start 2013 - VTI at 75.41   516K -22k = 494K
start 2014  - VTI at 95.54  626 -23k = 603K

Back to square one :)