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| Sporting their new futbol jerseys from Spain. |
Have you taken advantage of any travel deals in the new year? We jumped on some airline deals this week, and in turn did one of our next big steps to Spain ... one-way tickets to Madrid! Before Madrid ... we also found some deals for one-way to NYC from North Carolina. And one-way to North Carolina from Houston (a budget airline was offering great deals out of Houston since it is new to the Houston area!).
Why North Carolina? This was a sort of spur of the moment trip ... we wanted to fit in some extra traveling before we left the US, and it just so happens a relative has an awesome farm and Airbnb (thank you for letting us come visit!). We can't wait to spend time with family on this beautiful farm and explore the great outdoors and nearby Asheville, etc.
We used Google Flight to find the deals below:
12 One-Way Tickets: $1,809
Houston to Asheville, NC: $302 (Allegiant Air)
Knoxville to NYC: $418 (Delta)
NYC to Madrid: $1,089 (Air Portugal) - A friend from Spain recommended this airline.
So what's next? Many things ... but Erik has been working on our withdrawal strategy for year 1 below!
-Tara
As we get closer to our early retirement (ER) date (I see you July 31st), I’ve started to formulate a plan on how to actually implement our withdrawal strategy (more on accessing your 401k early here). It's funny, all this time I have been focused on saving and investing so actually figuring out the best way to one day go about withdrawing the money took a bit of thought.
I’m not going to pretend to have the next 50 - 60 years of this mapped out because I anticipate our situation remaining fluid. Some years we will work and earn enough money to cover all of our expenses so our withdrawal rate will be zero. Some years we won't work at all, and our withdrawal strategy will be 3.5% - 4%. Then some years (most years is my guess), we will withdrawal some (let’s say 3%), pull some from our cash cushion (let’s say .5%) and also earn some income (lets call this another .5%). That said, the focus of this post is going to be on our withdrawal strategy for year 1 of ER. To help explain this, let's first go over our financial goals for year 1. Setting these goals will help paint the picture for the withdrawal strategy we choose to use.
To set up this example, let’s go back to our usual assumption of a person / family having $1,000,000 in investments / cash. We will simplify this by dividing it up as follows:
Taxable account = $450,000
IRA = $450,000
Cash Cushion = $100,000
Total = $1,000,000
Goals
Have a 3.5% withdrawal strategy when the market was up the previous year, and lower it to 3% (as a safety margin) when the market was down the previous year (remember, we choose to base our withdrawal % for a given year on the previous year’s stock market returns). For example, the market was up around 30% in 2019 so any withdrawals we make later this year will be made with the 3.5% figure in mind.
Make part-time income that equals .5% of withdrawal. So, if we have $900,000 in investments and we follow the 4% withdrawal rate, that would mean we can withdrawal $36,000 per year (adjusted for inflation) and never run out of money. Now, if we want to earn .5% of our withdrawal rate in income for year 1, we simple take $900,000 * .005 = $4,500. This seems like a nice and easy goal to help ease into year 1 of ER.
Ear mark $22,500 from the cash cushion to be set aside for those years that the market is in the tank. What this $22,500 represents is 5 years worth of .5% withdrawals. Remember, .5% equals $4,500, so $4,500 * 5 = $22,500. We will use this as the market dictates to ride out the storm WHEN it comes. It will essentially lower our regular 3.5% withdrawal rate from Goal 1 to an absolutely bulletproof 3% withdrawal rate. Note, we are choosing to start our ER with a 3.5% withdrawal rate instead of the typical 4% because we are just super conservative like that. I imagine as time goes by, once we get the hang of our new lifestyle, that the 3.5% will creep up closer to 4%. Or maybe not, who knows ...
Divide the remainder of the cash cushion up by 10. Why 10? As you start your own journey towards ER you will come across many blogs that mention the first 10 years in retirement as being one of the most important indicators for the future success of your portfolio. In other words, make it through the first 10 years with plenty of money left and you are likely golden for the next 40 - 50 years. In this example, we have $100,000 in our cash account, and we want to ear mark $22,500 as our 5 year emergency fund. This leaves us with $77,500 that we can now divide up by 10 to get an annual withdrawal amount of $7,750. To be clear, I’m not saying you HAVE to spend this amount from your cash account every year, all I’m suggesting is that it is there to add just a little bit of flexibility to your spending should an unforeseen situation occur such as an unplanned trip to Paris for example ...
Now that we have established our financial goals for the year, let's turn our attention towards actually withdrawing the money. First, let's imagine there are 3 categories for the money.
Taxable Account
IRA
Cash Cushion
So what is our spending power?
With $900,000 in investments and a goal of having a 3.5% withdrawal rate, we know that we can pull $31,500 from our investment account(s). We also know that we have an additional $7,750 that we can pull from our cash cushion that would push our spending up to $39,250 for the year (if needed / desired). For this example, $39,250 is our magic number to stay within for year 1.
Let the withdrawals begin!
IRA
I am listing IRA first on purpose because for the first 5 years of retirement we won’t be spending any money from this account. Rather, we will be setting up our Roth IRA Conversion Ladder. Keep in mind this money while not being spent at this time WILL count as taxable income in the year that the conversion is made (although by keeping income so low, the tax rate will be 0%). Once year 6 rolls around, we will start pulling from this account, but for years 1 - 5 the withdrawal rate = 0%. Withdrawal rate starting in year 6 = 3.5%.
Taxable Account
For the first 5 years of retirement, this is where the $31,500 is going to come from. For year 1 we will be pulling $31,500 from this account. We could do this as just one lump sum at the beginning of the year or as monthly payments of $2,625. I like the monthly payment idea because if we do happen to earn a little income, as the year goes along, we could reduce the corresponding withdrawal for that month(s). Withdrawal rate from taxable account for years 1 - 5 = 7%. Withdrawal rate starting in year 6 = 3.5%.
Note, don’t let the 7% number scare you. Keep in mind the important number is the 3.5% or $31,500. I promise you won’t run out of money by pulling 7% from this account for the first 5 years. Also keep in mind that your IRA during this time will have a 0% withdrawal rate so the two will cancel each other out. It took me a while to understand this part of the strategy, but as usual Mr. Money Mustache cleared it all up for me.
This one is easy. We can pull from the $7,750 mentioned in our goals above as needed throughout the year. My guess is that we won’t spend all of this most years, but it's nice to know that it is there if / when needed.
How would this scenario play out when compared to our year 1 expenses?
We can see that the $31,500 would easily cover our fixed expenses of rent, utilities, groceries, cell phone, and Netflix (don’t leave home without it) for our year in Spain. Even when spending $1,000 per month (we most certainly will stay below this), we still end up $3,960 under budget for the year that could go towards miscellaneous expenses. (Note: All expenses are for 12 months with the exception of rent / utilities in Spain for 10 months during the school year since we will be returning to the US to visit family during the summer. Plans during that time are currently TBD.)
Should we decide to take an unplanned trip to Morocco or Paris, then we could tap some of the $7,750 from our cash cushion if needed.
There you have it! Our Withdrawal strategy for year 1 of ER.
Have you thought about your strategy? If so, please share it in the comments. Need help with your strategy? We now offer Financial Consulting.
-Erik
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