We discuss a lot in the Millionaire Money Mentors forums.
Sometimes we are fun, sometimes we are practical, and sometimes we get into theory and philosophy.
This post mostly covers the last two areas.
It came about in a discussion of extravagant purchase members had made or were contemplating. This topic was a spinoff from an initial conversation about moving from being a saver to a spender in retirement (an issue many people have trouble with). We also had a related thread on the balance between saving for FI and enjoying life now.
Millionaire Interviewee 18 had some insightful comments on the subject and introduced the group to his concept of ISE (the reverse of ESI). I asked him to elaborate on the subject and that’s the post that follows…
A long and rewarding career followed by a traditional ten-to-fifteen-year retirement where your home is paid off, social security covers the basics, savings covers the rest, and the government pays most of your medical expenses is no longer the goal of many people today. If you are on this site and you believe that the Earn, Save, and Invest strategy will give you a longer “retirement” and free you from work then you are headed in the right direction to get there “early”.
But what comes next? Many people actually do not include the after part as a continuation of the first. Today we will talk about that, specifically what happens in the “spend” down years.
We will go through what I call the ISE phase of FIRE. It’s the Invest, Spend, and Enjoy phase of the journey.
Spending money sounds easy but believe it or not without a plan for how you will spend your money, your plan for how you SAVE and GROW your money is incomplete. We will address what holds many back, how your relationship with money during the ESI phase can help or hurt your ISE phase, how you have to have a withdrawal strategy for your money and most importantly what does it take to actively manage that phase of your FIRE journey?
Moving from Saving to Spending
Leaving a career in your 30’s, 40’s, or 50’s means having to cover items that traditional retirees get from the government (income in the form of Social Security and healthcare in the form of Medicare) for possibly decades before the government pays those medical expenses and provides that financial safety net. While you may get a subsidy for your medical care, the fact remains that adding an extra 15 to 20 years to your retirement means you must think more about the first 20 years of your professional life and how that would enable you to FIRE. But before then you really have to think through the spending profile of your retirement phases (yes there are more than one).
The ESI mantra is there to guide you and help you achieve the goal of getting to financial independence. Many however greatly underestimate the cost of replacing these two items (and for social security the lower benefit in your 60’s and beyond will be lower than the average retiree because of not putting in a full 30 years of work). When you underestimate these things upfront the ability to put more money into the ENJOY phase will be at risk.
There are no secrets to what the foundation of a successful FIRE strategy is. You must accumulate and grow enough assets so that regular work is no longer needed to provide for your basic living needs and you can then be free from regular structured work to do as you please (which may still be work in some form though I believe the NEED for some GIG work means your plan isn’t truly complete financial independence).
Ok but what comes next? Is just covering the basics the goal? What role does money play in retirement? What SHOULD it play?
When I created my plan in college and started my work and married life, I had thought through the accumulate phase and the spend phase. I looked at it as one plan. My plan was not based on being lean and frugal to maximize the accumulation and growth of my assets.
In fact, when I started following the FIRE movement much later in life, I found a great deal of emphasis on frugal living. I often referred to this as the “shelter in place” strategy, a life built around minimizing spend to maximize savings, often to the point of living near the poverty line in terms of annual household expenditures. That was followed by the post work phase of living life minimally too as the asset base was only designed to deliver that value. A bad few years in the early second half of the game and it could be back to work.
This approach just didn’t resonate with me and while I know that there are families with incomes near or below the median income executing FIRE strategies, I also know that if you are in that income bracket a 40 year work and saving horizon can make you a millionaire. You will just work into your 60’s but retire comfortably. You will have more security than if you retire at 40 with $500,000 in the bank trying to stretch that money for 40 years or more.
So frugal across the journey was not going to be my approach, but being a smart spender and saver and investor was, and the goal was to have an oversized retirement. When FIRE took off and I learned how people were discussing their accumulation phase, as I mentioned above I saw a big emphasis on the frugal approach and the denial of experiencing as much life as you can as a blind spot in the FIRE movement and where I felt many FIRE proponents were missing the point of both the accumulation phase and the post work phase of life.
My long-term plan had the basics covered in retirement AND a bunch of extras. The freedom to travel anytime, a second house, lots of leisure activity, and disposable income for when some new adventure presented itself. Today it’s often referred to as FAT FIRE, but if you think your goal will only just cover the basics and FAT FIRE is out of reach, or even possible, you may be surprised what a complete end to end plan may reveal to you. I believe that more discretionary income post work is out there you just have to develop a more in-depth plan and expand into a new way of thinking about what your money is for. Do you live for work, or work to live?
Now do not get me wrong it can be very rewarding for some to get to FIRE as soon as possible by frugal and or spend-thrifty living and building the wealth as fast as possible that will be needed to cover the basics for the next 40 to 50 years because they really value their time and want as much of it as possible (as opposed to working 9 to 5 for 30 years to reach a bigger type of post work goal) but for me the greatest joy in life is accumulating experiences that enrich us as a family and bring us joy. Not extravagant mind you but giving yourself permission to not let saving dictate everything you do.
I apologize if you think I am being negative on the live frugal approach to saving for not working / early retirement from regular work but see the next paragraph for why.
Saving for Future Versus Living Today
Recently a Motley Fool article outlined the 5 things retirees wished they could have told their younger selves. Four were traditional items about finance and health, but one stuck out to me and affirmed my thoughts on the issue of how a FIRE journey could best be played out.
That item was this: Balance saving for the future with living for today. In other words do not sacrifice so much that you miss out on opportunities that can truly make a difference in your life. If your twenty-year FIRE plan must change by five to ten years in order to accommodate this goal, retirees felt that was worth it. Do not let life pass you by while you are saving up so you can stop regular work to enjoy life later. Seek and find and execute on that need for balance. Enjoy ALL of your life, not just the end. You may never get there since none of us are guaranteed tomorrow.
I personally believe more in a FAT FIRE approach and my plan (decades before any of us knew what FIRE was) was built on a thirty-year horizon for two reasons. The first was that we would save but we would enjoy life and make sure as a family we created those joyful moments we could all share. We bought a house when we married, I finished my masters before the kids were born, we started our family early and planned that at the thirty year mark we were finished educating the kids and they would both be working adults by then.
The second reason is that peak earning years tend to be (for men) in their mid 40’s to mid 50’s – women tend to plateau almost a decade earlier. It would have been difficult to compress this sequence. I created this plan when retiring in your early 50’s was really rare and a luxury. I still believe thirty years gives enough time to achieve a healthy and well-financed early departure from work.
While it’s critical to save early and save a lot in those early years to build that foundation that will have the longest time to compound, it is also important not to lose sight that the third decade of work is when you can really add to your assets both in contributions and in compounding on a larger base before you begin to spend them. If your goal is to retire at 35 you just may miss grossing another one to two million in income over another 10 years. Or more.
I became a millionaire around age 37 but exceeded $10 million by age 50. My goal was never the quintessential one million in the bank. It was initially $2.5 million (in 1989 dollars), which became approximately a $5 million goal by 2018 with inflation.
When I reached $5 million it was easy to see how a few more years of work (about 4) would turn that into $10 million or more which happened in late 2016. I was in those peak years and it was too good to pass up. We had learned to enjoy our money (not let it control us) and when we hit $10 million we were ready to quit full time work.
That extra work would provide both an incredible safety net as well as a foundation to enjoy life in what I called earlier the spend down phase. We were now in the ISE part of the journey!
Wait you say, you are not typical and that type of outcome isn’t the average FIRE outcome. Perhaps that is true, but my asset base isn’t the point of this article — you can have a retirement with extras and never worry about running out of money if that is what you plan for. Again most people under-estimate what they will spend so their plan is built to provide that when in fact your plan may really require another five more or ten more years if your first plan was to retire at forty-five. An early exit of the ESI phase may mean a very different post work life than one that a few more years working would provide.
The Spend Down Phase
Most people think of life after earning that regular paycheck as the conserve principle phase – the live off the “interest” but not the nest egg phase. Avoid the sequence of risks, tread lightly to the end of life phase.
I maintain that if your retirement is at risk if your nest egg drops 20% or even 30% in your first five years then your plan was not a good one. It was too lean and likely meant that you would outlive your money or have to cut back on essentials while you conserved cash some day.
You do not need as much as I have, this could be accomplished with $2 million (which is still a good number today if your housing is covered) as that amount in a lower cost metropolitan area should more than cover a thirty to forty-year retirement.
So while I admire those who want to quit traditional W2 work in their thirties or early forties, it is hard (though not impossible) to accomplish (and given the recent creation of the idea of FIRE itself we do not yet have data on how people did or are doing if they are now in their 80’s and have been retired for 40 years). So what truly is the goal of saving and quitting work? It is about freedom but what kind of freedom?
To me it is simply this. Freedom to pursue MORE joy. You should always have joy in your life (remember live for today is as important as living for tomorrow) but find more and treat yourself. You have earned it.
Look to bring more joy to your life and others, find enjoyment in an every day life that makes living fun and free of worrying about paying the bills. Initiate a passion project or take a job or role that is purely a passion project where the rate of pay is inconsequential. Treat yourself.
That kind of life is entirely up to you, which leads me to this: What happens after you have spent ten, twenty, thirty maybe forty years accumulating and you are now ready to enjoy a work free and worry free life? The lessons of ESI still prevail and they have an equal and opposite force that brings balance to your plan and eventually your financial journey full circle. That’s where ISE takes over.
Invest Spend Enjoy
As mentioned earlier it stands for Invest Spend Enjoy! It’s the natural culmination of the ESI mantra and an extension of the critical part – invest.
You never STOP investing. Your nest egg / money is a tool for enjoyment. Use it, let it bring you joy. Give yourself permission to spend. However you have to remember it’s still an investment and you do have to manage it. It has to last.
My belief in the ISE phase of life is that you have to spend it – you saved it not so you can simply leave it all to someone else to enjoy, or to postpone spending it until you realize you are no longer able to do the things you want to do with it.
It is ok to feel this way. I believe if you accomplished this goal you deserve to enjoy it. Give yourself permission. You can still plan to leave a legacy, donate to your favorite charity, give it away. But before you get to that point make sure you give yourself that permission. Think of it as de-accumulation.
I have spoken to many who got to the end of work by living spendthrift and frugal lives. They have a difficult time on a splurge purchase or a dream vacation, even though they could easily afford it.
There is no score keeping, no one is judging you but yourself, there is no perfect answer or outcome to how life is to be lived. But if you give yourself permission to enjoy it and share that with others I believe the outcome will be as close to perfect for you and your circumstances as it can be.
The fear of dying broke should never be a thought you have in retirement if you have planned well. Fear should never rule your decision making process. Life doesn’t have to be perfect to be wonderful. And in most instances the decision to splurge isn’t the item that will make or break your plan. Your plan should have already accounted for the splurges or extras you want in retirement.
ESI to ISE
So how does one switch from ESI to ISE?
As I have said it is actually ALL ONE PLAN. The FIRE plan doesn’t end when you stop saving and working. In fact in my opinion that’s when it REALLY starts.
The ESI phase is fundamental and over a few decades to some degree it is on autopilot. The ISE phase is to some degree a plan with frequent milestones and decision points and is a much more involved plan that I believe many people truly do not prepare for.
After years of saving, switching to SPENDING can be a traumatic transition. If you spent 30 years conserving assets that habit can be hard to break. It is why I believe during the ESI phase you MUST learn to balance saving with spending so you know how to spend when you do retire (see that important item retirees wished that they had passed onto their younger selves).
That spending muscle needs to be exercised too. It is not a careless or reckless type of spending but measured thought out and weighed against the saving side of the equation. I have always felt learning to spend AND save at the same time was important to knowing yourself best and understanding what makes you tick and what brings you joy.
And you do not have to be rich to practice this. Doing it in your twenty’s will help you develop a healthy relationship with the two. It will help you use debt appropriately (it is not always a bad thing) and it will help you better prepare for the ISE phase.
The conventional wisdom is that as you age your investments need to become less risky – and I agree with that. Investing is NOT roulette where you put it all on one number and hope it comes up a winner. It isn’t based on winning the lottery either to put you over the top of your goal.
But your assets will not deliver for you if you simply put them all in a bond fund for the next 30 years when in the post work phase. You will need to remain in the broader market for some of your assets for most of your retirement to beat inflation.
Remember my 1989 goal of $2.5 million that nearly thirty years later was really $5 million in purchasing power. If you want to spend money and enjoy life in retirement you will likely need to continue to grow your assets as you spend them.
As a result in retirement you have to become a more active investor than you may have been while fund managers were managing your 401K or index funds. That is why I believe during the ESI phase you have to boost your financial literacy and understand how to invest. To understand the impact of taxes, to understand how you will pay yourself and from which sources and in what order. In the ISE phase it is your most important job.
So now that you are retired and you want to spend money and enjoy it, how do you plan to pay yourself and how often? Again our habits are hard to break and I believe that in the ISE phase you should pay your self just like you were earning a bimonthly paycheck. If you want to pay yourself $80,000 a year, then pay yourself $3,334 twice a month. You should still have an emergency fund of cash equal to a half years expenses so if you need an extra $10,000 this month for a trip you do not have to alter your withdrawal plan (or liquidate assets), or negate a critical tax threshold (more on this later).
So now where does that money come from? You should have at least three asset pools (taxable account / savings, 401k / IRA, and home equity). You may also have a Roth and if you are one of those rare workers today even a pension. Even more rare you may have passive income from a rental real estate portfolio. But for this discussion we will focus on the first four listed here.
But before I outline an example of how those sources of funds are going to be used I would like to point out that Barron’s recently published an article on the four types of spenders in retirement: typical spenders, home spenders, health spenders and discretionary spenders.
You can find the article to understand all the types but what I am proposing in the ISE phase is that you consider your plan to deliver for you a discretionary spenders profile. The researchers categorize this as those people who spend 25% or more of their retirement income on discretionary items like entertainment, gifts and charity. They cite that only 13% of people between 55 and 64 are in this category, but that increases to 18% after 64 (either when most people retire or the early retirees realize they can shift from typical to discretionary).
My point is why wait?
Sources of Funds
How you mix and combine withdrawals from these sources may be unique to your plan based on your balances (and what percentage of your nest egg each one occupies).
If you retire early and roll over your employer sponsored 401K plan to your IRA for example, that money is often looked at as off limits because early withdrawals are subject to penalties. If you are 45 how do you wait 15 years?
However this isn’t entirely true. There is a section of the IRS tax code that lets you withdraw from an IRA penalty free. I suggest researching the 72(t) option of Substantially Equal Periodic Payments.
This strategy can help preserve balances in taxable accounts and Roth accounts if most of your assets are in your IRA. With the new laws on how non spouse beneficiaries have to spend IRA funds (no longer over their lives but now over or at the end of a 10 year period), the stretch IRA is no longer as attractive. It will bring the Roth conversion strategy and the 72(t) strategy into play for early retirees in my opinion.
Taxable accounts can provide tax free income in the form of capital gains if you happen to keep your gains and AGI under the cap where rates kick in. These are funds you should think about as drawing on strategically before you get to the RMD phase of retirement. This is a great way to help reduce your effective tax rate.
Home equity is a source of funds and for most completely tax free. Many people will downsize at some point in their life (and some day we will even though we just upsized) and when they do that can provide years of tax free cash. This depends on how you downsize of course but with mortgage rates as low as they are taking on or keeping housing debt in retirement on the retirement home, could leave cash in the bank from the equity of the sale of the previous residence.
This can be a very effective way to pay yourself tax-free, conserve investable assets and lower your income taxes. Remember you can finance a house, you can finance an education, but you cannot finance retirement. It’s the same idea as a reverse mortgage but on much better terms.
Roth withdrawals are tax free (if you have followed the rules) but after tax contributions can be withdrawn at any time so there is no need to believe that the magic age of 59.5 means these cannot be a factor in how you pay your self before that age. However this is the last account you should tap.
IRA withdrawals are fully taxable (assuming there are no non deductible assets in the account). For example purposes below we will assume that is the case for planning purposes.
The bottom line is how will you pay yourself, how will you consume your assets and how will you minimize taxes. All are critical to how much you have to spend to enjoy! So the goal of enjoying your money is linked to a great extent on how you manage the issue of funding your spending, investing your assets and the taxes you pay. You need a very well thought out ISE plan (and as I mentioned I think this issue is WAY under represented in the FIRE movement).
Over in the Millionaire Mentor section I plan to discuss in greater detail the topic of order of withdrawals and how you pay yourself a “salary” after you stop working for that paycheck and enter the ISE phase. How to draw down is critical and will vary depending on your account balances but for now we will use real numbers and give an example that reflects how a $2,500,000 asset balance can be drawn down in the ISE phase of your ESI-ISE plan.
Example: Retirement at age 50 for a married couple
- Home equity of $350,000 ($100,000 mortgage balance at 4.5% 12 years left)
- Taxable account balance of $750,000 ($100,000 cash, $650,000 in securities with a $450,000 cost basis)
- IRA balance of $1,250,000
- Roth IRA $150,000
- Basic Needs $7,000 a month ($84,000 a year)
- Discretionary addition: $16,000
- Desired income of $100,000 a year
- Cost of healthcare (average based on the Kaiser Family Foundation web page for 2 adults aged 50, silver plan is $1,260 per month / $15,120 a year)
- If you pay yourself $100,000 in taxable income from any combination of your taxable assets you will not qualify for any subsidy. In order to qualify for an $8,435 tax credit (which could cover almost 100% of your federal tax liability) your Modified Adjusted Gross Income would have to be $68,000 or less. Remember the ACA subsidy is a cliff. Go over the 400% of the FPL (even by $1 and the subsidy evaporates). This example will be optimized to receive that subsidy 9 out of 10 years.
- None – taking the standard deduction
Rates of return:
- Equities 7%
- Bonds 1% (fed tax exempt)
- Cash 0%
- Inflation 2.5%
- Dividend rate 2%
Age 50 to 55 IRA, Roth and Taxable accounts 100% invested in equities. 56 to 60 75% equities 25% bonds (except the Roth which remains at 100% equities)
- Downsize to smaller home with value of $250,000 (put $50,000 down to avoid pmi and take a 30 year mortgage at 3%, invest $200,000 into equities in your taxable account and $100,000 into bonds to pad your initial cash balance)
- 72(t) the IRA for 10 years @ $40,000 per year
- Target is for $100,000 per year cash adjusted for inflation @ 2.5%
- Qualify for the ACA Subsidy 9 of 10 years (the subsidy effectively pays your federal tax bill)
- Use cash, dividends, and targeted sales in the taxable account to approach but not exceed the MAGI limits for the ACA and to make up the balance between the $40,000 72(t) amount and the total cash target for each year.
In year 6 when the taxable account is rebalanced there is a large capital gain of $75,000 but based on income the capital gains taxes will be approximately 11% of that gain. In all other years there are essentially no capital gains taxes paid based on AGI.
Downsizing lowered the property taxes and mortgage payment in terms of net cash outflows compared to pre retirement costs
At the end of 10 years the balances will approximate:
- Home equity of $135,000 ($150,000 mortgage balance at 3% 20 years left)
- Taxable account balance of $1,015,000 ($90,000 cash, $965,000 in securities with a $650,000 cost basis)
- IRA balance of $1,760,000
- Roth IRA $295,000
Here are the specifics laid out by year if you are interested in seeing them.
Total cash amount withdrawn over 10 years to spend on essentials and discretionary items comes to $1,128,000.
Net worth went from $2,400,000 to $3,205,000.
At age 60 the IRA can be accessed for any amount necessary and so can the Roth. However with 5 more years before Medicare starts the plan may be worth following so the ACA subsidy continues to be paid.
At Age 65 there are a few different strategies to potentially implement that will shift money from the IRA to the Roth as well as when to claim Social Security. It is quite likely if you continued to apply the strategy from age 60 to 65 that at age 65 your net worth would exceed $4,000,000 – or more.
Additionally I generally believe that there should be three years of cash on hand after age 55 and before that anywhere from one to one and a half. Any more than that leaves too many assets on the sidelines.
One last thought (and I expect some push back on the strategy and I am glad to make the spreadsheet available) is that this strategy and this income amount could be accomplished with a net worth of much less than where we started at $2,400,000. This is NOT the simple 4% rule applied. It was based on understanding the role of taxes, which assets to draw down, which assets to invest aggressively and how to use cash on hand and the taxable account to keep taxable income low while having the government subsidize your medical costs.
For example, if the target cash needs were $180,000 a year the ACA subsidy would not have been an option and therefore a different asset utilization would likely apply to put the annual cash needs in place. This is why there is no single answer and why individuals need to expand their investment and tax knowledge in the ISE phase.
Please remember money is a tool for living and life should be about finding joy in your life and giving it to others. No one wants to be the richest person in the cemetery or known for leaving it all to someone else to enjoy. In this scenario this couple would still leave a great legacy.
You Earned it, you Saved it, you Invested it. So continue to Invest it, Spend it and certainly Enjoy it.
The ESI-ISE extended plan can lead you to a great deal of freedom to truly enjoy what you have worked so hard for.