This is the fourth post in a series called Saving With Purpose: Living a More Intentional Financial Life. In this series, I plan to highlight a number of specific savings goals my family has identified we would like to achieve over the next few decades.

In the last series post we discussed ways to reach early retirement through a combination of taxable investments and retirement contributions that may be withdrawn before traditional retirement age. This post picks up where the other left off; we’ve now reached that golden age of 59 1/2 and may begin withdrawing from our traditional retirement plans.

Should we invest in both a Roth IRA and a 401(k)? Should I count on social security income, and if so, should we elect to receive early payments? What alternative investments can we make to fund retirement?

Forget Everything You Thought You Knew About Retirement

Our strategy for retirement is different from the more traditional idea of working somewhere 40 years, retiring, and drawing social security for the next two or three decades (hopefully). Our plans for retirement have been influenced by a shift in some of the long-held financial beliefs.

Things like a guaranteed 8% return in the markets may be soon be a distant memory. Sure, some years will be good and some bad, just as it always has. However, I suspect there will be more volatility and negative financial news than anyone my age remembers. So our plans have been molded by life experiences, the political climate, and even larger economic trends that have developed in our lifetimes. Our investments will be more conservative, and we will always lean to being “cash heavy,” because we value preparedness over the chance of hitting it big.

Maximize Roth IRA Contributions

Each year, my wife and I will contribute the maximum amount to a Roth IRA. I’m a big fan of the Roth IRA, for several reasons. First, the earnings in a Roth IRA grow tax free, and since you are using after-tax dollars, contributions can be withdrawn at any time, for any reason (making the Roth sort of a 2nd pseudo-emergency fund).

The Roth IRA also has no mandatory distribution age, meaning if you hit 59 1/2 and don’t want to tap your Roth IRA balance, you don’t have to. Traditional IRAs require distributions at age 70 1/2, meaning you could be forced to reduce the amount you leave to heirs thanks to mandatory distributions.

With about 27 years until we reach that 59 1/2 years-old threshold, my wife and I could save a large amount in our Roth IRAs, assuming we don’t tap contributions early to fund early retirement (something I mentioned as possibility in the last series post). Assuming a 6% average return on our $10,000 yearly investment, we would have nearly $700,000 in Roth IRA savings in 27 years.

Maximize 401(k) Contributions

In Adam’s recent post asking whether or not he should save for retirement or pay off debt, it seemed the consensus in the comments was Adam should contribute through his employer’s match, but use any remaining funds to reduce his debts. I agree; there is nothing like “free” money in the form of matching contributions.

However, there is a larger question here. After becoming debt free, should one continue to increase 401(k) contributions to the maximum yearly amount (currently $16,500), or should they invest that money elsewhere in a more diversified mix of asset classes (paid-for real estate, business ventures, etc.)? I don’t believe there is a right or wrong answer here. but it seems to me that if all you can afford to do is stretch to max out your 401(k), you may do better to spread that money around a bit. On the flip side, if you can afford to save above and beyond the yearly maximum, then you should first fund all tax-advantaged accounts, such as a 401(k).

What did we decide? After much deliberation, we decided to slash a few budget items and go after the max 401(k) contributions, recognizing we may not be able to do this every year going forward. Fortunately, we are now debt free, and through my blogging pursuits, we have what amounts to a second income. I recognize this does not work for everyone, and it certainly didn’t work for us until just recently. In fact, I haven’t even contributed to a 401(k) in the last few years while we whittled away debts and built emergency savings.

If we could find a way to continue maxing out 401(k) contributions until retirement age, we would have $1.1 million, assuming a 6% return. Add in Roth IRA contributions and growth, and we’re approaching $2 million. Of course, as I mentioned in my last post, this is not likely to happen because I want to move away from full-time employment in the next 12-15 years. If we kept up our goal of maxing 401(k) for just 15 years, we could still build a 401(k) nest egg of just over $400,000, and another $250,000 in Roth IRAs. Not bad at all.

Will We Receive a Return On Our Investment In Social Security?

In a word, no. I don’t believe we will. Put another way; don’t count on it. I personally believe social security as we know it today will not exist in another 15-20 years. It can’t, mathematically, as soon there will be many more people receiving benefits than paying in. That sort of upside down pyramid doesn’t work – just ask anyone associated with a failed Ponzi scheme.

Now, I am not as radically anti-social security as some. I just like the idea of controlling my own investment dollar, because I’m confident I can earn more than the U.S. government can. Enough of that, I’m not out to make a political statement. I am simply trying to reinforce the idea that people in their 20’s and 30’s should not expect to be able to live on social security in retirement.

If we do receive some form of payment from social security, just consider it a bonus, but certainly don’t count on it for financial survival. If the program is still solvent when I reach the age eligible to receive early payments, I’ll likely sign up. After all, nothing is guaranteed – neither my health or the continued viability of the program. Unfortunately, several people close to me paid in their whole lives and never received any benefits, or received very limited benefits through disability before dying young.

Alternative Investments for Retirement

In addition to the traditional types of investments I’ve listed here (and in earlier series posts), we are also interested in things like paid-for real estate. Specifically, we’d like to pay off our own home well before contemplating an early retirement. I have always thought living mortgage-debt free must be the ultimate in financial freedom.

Just imagine no credit card debt, no car payments, and no mortgage payments. Imagine the options available to someone in that position. Imagine the freedom they must feel with the only income requirement to earn enough to cover basic living expenses, and save for future ones. That’s it.

In addition to real estate, I will always have a side hustle or two going, and in the future may elect to invest more money to grow a current hustle, or develop a new one, without introducing too much risk into our lives. I started Frugal Dad over two years ago on less than $50, so it might be tough start something even more frugal!

In the final post in this series, we’ll look at one last topic: giving. Yes, part of our saving strategy is to give a lot away. I’ll share a few ideas I have on the subject, and as usual, try to put some specific numbers to our giving goals going forward.

That’s a question that a lot of people ask while in debt. Dave Ramsey, possibly the most popular debt counselor, recommends that you stop ALL retirement saving while eliminating debt. He argues that it gives you a huge advantage because you have a lot more money for your debt snowball.

I am a little more liberal when it comes to this rule. I think that it should be based on some other factors as well. For example, our current pile of debt is so large that we will be missing out on 5+ years of retirement saving (the amount of time it’s going to take us to pay off this debt). When you add compound interest into the equation, it means that we would be missing out on a lot more money. Let me give you our situation as an example:

I currently work for the Government and am offered a 5% match for money I put into the Thrift Savings Plan (fancy government word for 401k). That means that for every dollar I put into the plan, they match me 100% up to a 5% of my income. That’s a guaranteed 100% return on my money and I can invest it in any of their funds. However, if I didn’t contribute to the plan, I would miss out on that free money. Plus, I would miss out on 5+ years of compound interest.

Now, I am going to put some numbers to the scenario. Let’s say I start putting 5% of my income (plus the match) into the plan starting today (age 25). By the time I reach age 70, I will have almost $2.5 million in the account assuming an 8% return. Now, if I wait 6 years (best case scenario for debt repayment) and start investing the same amount per year, I will only have $1.7 million in the account. Still not bad, but almost $800,000 less than if I would have started at 25. Here is a graph of this example:

So, as you can see, starting to save for retirement 6 years from now instead of today will cost me about $800,000 in retirement savings by age 70. Am I really going to pay that much more in interest by not stopping my contributions? I don’t think so!

So, I guess the question is, when should you stop contributing to retirement in order to clean up your debts? Should you do it if you can get the debts paid off in 2 years or less? 4 years or less? What is the magic number?

All I can say is, I am not missing out on almost $800,000 in retirement growth to save MAYBE a couple thousand in interest charges.

What are your thoughts on the subject? Can you think of any reasons why I should be STOPPING my contributions?

Did you know contributions to a Roth IRA may be withdrawn at any time, without penalty? It’s one of the lesser-known Roth IRA withdrawal rules. It is also one that I do not plan to take advantage of, but knowing it is there makes maxing out Roth IRA contributions a little easier. Here’s why.

Let’s say you are still working to build a fully-funded emergency fund, but only have one month of expenses. You manage to scrape up a few thousand dollars to save near the end of the year (a bonus, an inheritance, whatever), and would like to open a Roth IRA. If you are like I was, the thought of locking that money away in a retirement account terrified me. What if I have a big emergency two months after I open my Roth, and before my emergency fund is fully funded?

Never fear. If you do have a big emergency soon after contributing to your Roth you can simply withdraw your contributions without penalty. The rules here are different from other tax-deferred retirement savings plans because the money you invest in a Roth has already been taxed. However, the earnings in your Roth IRA have not been taxed, and therefore must be left untouched, unless you meet one of a few exceptions for withdrawing earnings tax and penalty free. Here’s the language from the IRS.gov website, Publication 590, related to making early withdrawals of your contributions from a Roth IRA:

Are Distributions Taxable?

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s).

So there you have it; straight from the horses mouth. Withdrawals of regular contributions made to your Roth IRA are not counted towards your gross income. Does knowing you can withdraw Roth IRA contributions early without penalty make you more likely to max out your Roth IRA contribution for the current tax year? It did for us. For the first time in our married lives we maxed out my Roth IRA contribution (currently $5,000), as well as my wife’s spousal IRA (another $5,000).

In the event of an emergency larger than our emergency fund could handle, that $10,000 would be available to us (assuming the market doesn’t tank again). And that is something to consider. I would not suggest using a Roth IRA as your only source of emergency funds, because chances are your investments inside the Roth are exposed to more risk than traditional emergency fund savings.

However, Roth IRA funds could certain supplement your emergency savings, or some other savings goal, such as parking money to be used for a down payment on a first home (by the way, this is one of the qualifying events for which you can withdraw Roth IRA earnings tax free, assuming the account is over five years old).

With compound interest being such a close personal finance ally, the sooner you start investing in retirement funds, the better. Remember, you cannot go back and invest in a Roth IRA for previous tax years. It’s now or never. So go ahead and set aside some money in a Roth, and try your best not to withdraw those contributions. But remember Roth IRA withdrawal rules allow withdrawal of contributions, penalty free, if you absolutely need them.

The first step in retirement planning is to estimate how much money you need to retire. This is actually a fairly straightforward task because there are simple mathematical formulas and easy-to-use online retirement calculators designed to help you. The process is well understood and the tools are easily accessible on the internet.

What is less well known, however, is how these calculators work and the inherent problems involved in using them correctly. In other words, it is easy to create a retirement estimate but surprisingly difficult to do it accurately.

The reason it is difficult to create an accurate estimate for the money you need to retire is because the accuracy is dependent on the assumptions you use. Many people fuss over whether to use elaborate models like Monte Carlo or simple rules-of-thumb like the 4% rule, but that is missing the forest for the trees.

Huge differences in your retirement planning estimates occur when you vary the assumptions used for spending, income, inflation, and other required inputs. The unspoken truth about retirement planning is the validity of the assumptions used to determine how much you need to retire will make or break your financial security.

The Inherent Problem With Making Retirement Assumptions

Below are the six common assumptions required by nearly all retirement calculators to determine how much money you need to retire:

1. Annual spending budget
2. Estimated inflation rate
3. Expected lifespan
4. Annual income from sources other than savings
5. Estimated return on investment
6. Expected retirement date

As you read through this list of assumptions you probably realized something – they can’t possibly be answered accurately. Think about it. All but one requires you to predict the future—something no one can do reliably without a crystal ball. In fact, only one question can be answered with confidence because it is the only one you have any control over (number 6 in case you haven’t guessed).

Amazingly, conventional retirement planning requires you to provide assumptions that are impossible to estimate accurately in order to determine how much money you need to retire. It is insanity. If you vary these required assumptions within a reasonable range of probable outcomes you will find the estimate for your retirement savings can vary by two to three times the original amount.

In other words, one set of assumptions might result in $750,000 of retirement savings needed, and an equally plausible set of assumptions might estimate $2,250,000 in required savings. The difference is huge, and yet both set of assumptions are equally likely to be true. The whole process can leave you wondering what is the real retirement number and how can you ever retire in confidence?

Below we will look at each of the assumptions necessary to accurately answer the question, “How much do I need to retire?” so that you can better understand the issues involved.

How To Estimate A Spending Budget For Retirement

Most traditional retirement planning models assume you will need 75% to 85% of your working income in order to maintain your standard of living after you retire. The idea is that you will save on work-related costs like commuting and a professional wardrobe, as well as the expense of raising children. The formulas also generally assume that your home will be paid for and you will enter a lower tax bracket.

The truth is every individual has a unique set of circumstances that affect retirement spending. Today’s retirees lead longer and more active lives driving up the total cost of living in retirement. The expenses of hobbies, leisure activities and travel can easily offset any decrease in work-related expenses.

Your health care expenses are also likely to increase as you age, not to mention the price of long term care if you don’t have insurance to cover that. If you still have a mortgage on your house or a child in college, your expenses during your first few years of retirement may be equal to or greater than before.

The reality is you must plan a personalized retirement budget that reflects your unique plans for retirement. Some will spend more than their current income during retirement, and some will spend less. The research on retirement spending indicates a wide variance in retirement spending patterns with most people reducing spending as they get older. Any way you look at it, the 75-85% rule-of-thumb is a dangerous assumption that is best ignored.

Reasonable Assumptions For Inflation During Retirement

Most retirement calculators assume a modest 3% inflation rate. This is based on recent history (the last 20 years or so) and implies that your spending in nominal dollars will roughly double every 24 years.

The problem is if inflation increases to 6% (not a far-fetched possibility) then your spending will double every 12 years instead. That obviously makes a very big difference in how much you need to save for retirement. Rather than watching your expenses double once or maybe twice during retirement you could see them double 3 or 4 times which would drastically affect what you could afford to spend.

Historically, inflation has fluctuated from negative numbers to double-digits during wartimes and has shown prolonged periods of higher rates than the commonly assumed 3%. Given current conditions with high government debt and deficits combined with entitlement funding problems, many credible economists predict increased inflation over the next 20 years.

So how much will you assume for inflation when calculating how much money you need to retire? A percentage point or two can make a dramatic difference. I suggest using a range of assumptions varying from 3% on the low side up to 6% on the high side depending on how conservative you want to be in your retirement planning.

How To Estimate Life Expectancy

Isn’t it amazing that retirement planning requires you to estimate your life expectancy? Talk about an impossible task.

Sure, you can estimate your lifespan based on family history and your current health and medical conditions, but no one can possibly know how long they will live with any confidence. There is zero actuarial validity to estimating a single lifespan. You are no more likely to live until age 80 than you are to die tomorrow. For any one person life expectancy is random. It is only a valid statistical concept when large numbers are involved – not individuals.

Yet life expectancy has a major impact on figuring how much to save for retirement. The reason is because funding 20 years of retirement is dramatically different from 40 years or more. In the first scenario you can spend principal and the effects of inflation are reasonably manageable, but in the second scenario you not only can’t spend principal but you must also develop a perpetual income stream that grows faster than inflation. In short, different life expectancies imply dramatically different retirement savings requirements.

The conservative solution is to assume the best and plan on a very long life – longer than the actuarial tables estimate. If you come up short the worst that will happen (besides dying early) is you leave a nice legacy behind. If you live a full, long life you will need every penny. Many complain that a long life expectancy pushes retirement savings goals out of reach, but the truth is roughly half those people will outlive the averages and require the greater savings anyway.

Estimating Income From Social Security, Pensions And Annuities?

While Social Security will not likely disappear altogether, the inflation adjusted value of benefits will almost certainly decrease – especially for those retiring behind the Baby Boomers. You can check your annual wage and earnings statement from the Social Security Administration to get an idea of how much you’ll receive when you retire. The younger you are today the greater the risk that the inflation adjusted value of your benefits will be less than currently estimated.

Pensions, particularly private ones, are also proving to be less reliable than they once were. Fewer companies are offering pensions in the first place, but even those with longstanding traditions of fat pension benefits are backing out of those obligations – just ask airline employees.

Sure, there are protections in place to ensure you don’t completely lose out on what was promised to you, but underfunding is a serious problem with the recent market declines. Should your company default on its pension plan you could be left with a reduced payout. If your pension is frozen, you will still be entitled to benefits already earned, but you will stop accruing additional benefits.

In other words, Social Security and pension income may not be as dependable as you thought placing a greater burden on your retirement savings.

What Will Be My Investment Return During Retirement?

Most traditional retirement planning formulas assume long-term historical returns from a traditional stock/bond portfolio of 7% to 10%, decreasing to 4% to 5% after retirement as you shift away from equities and toward fixed income.

The problem with these estimates is they are derived from super-long data periods irrelevant to most retirees. What retirees care about are 15-20 year periods – not 100 year market history – and the surprising reality is how variable the returns can be over 15-20 year time spans. Negative to flat returns are entirely possible but are wholly unexpected when using traditional retirement assumptions – just witness the last 10 years for the U.S. stock averages.

This is incredibly important because even small changes in return on investment can dramatically alter your retirement security. It is not realistic to blindly assume long-term historical returns when your investment time horizon is significantly shorter than the data assumes.

When Can I Retire?

Finally, a question you can answer accurately. You choose your retirement date and you are in full control of when that occurs. If you are somewhat flexible in deciding when to retire, you can significantly reduce the amount of money needed to fund your golden years. Working just a few more years allows you to continue building your portfolio while at the same time putting off drawing down your savings. If retiring is not optional, however, due to medical or other reasons, plugging this known figure into your retirement calculator will send you on your way to determining how much you need to save.

In Summary

The key point to notice from this discussion is retirement planning is not nearly as simple as the financial calculators would lead you to believe. Sure, it is easy to create an estimate when saving for retirement, but creating an accurate estimate is an entirely different matter.

The fact is you need to make six different assumptions when calculating your retirement number; yet, only one of the assumptions can be estimated with any certainty. The rest require you to predict the future which is unknowable and impossible to do. Even the experts can’t do it – and neither can you or your financial planner. If you believe otherwise you are just deceiving yourself.

This is a big problem because the answers you assume to these questions will dramatically affect how much money you need to save so that you can retire with financial security. A small change in just one answer can vastly alter the resulting retirement savings requirement. In fact, I highly recommend you test this using your favorite retirement calculator and prove it to yourself. Don’t take my word for it.

Start varying the three most important and difficult assumptions – return on investment, life expectancy, and inflation – and you will be amazed at the dramatic impact it has on how much money you need to retire. Now, imagine if your estimates are off on all five of the variables—your retirement savings could be wildly off target forcing you to work longer, cut back on your lifestyle, or worse, run out of money before you run out of retirement.

What you will see when you complete this exercise is the traditional approach to estimating how much money you need to retire makes you completely dependent on how well your assumptions reflect your future retirement reality. In other words, you have to be able to forecast 20-40 years into the future. This makes the apparent scientific precision of retirement calculators far less scientific.

Financial planners occasionally squabble over whether or not to invest in a 401(k) or open a Roth IRA.  Most agree that passing up matching funds in a 401(k) plan makes little sense, so it’s probably best to start there.

After taking advantage of those matching funds by investing through the company match, it most advisers recommend investors turn to the Roth IRA to take advantage of tax free growth opportunities.  After that, you are on your own, and left with a lot of questions.  Do I return to the 401(k) plan and max out my annual contribution there?  Do I invest in company stock?  Do I park anything left over in cash, or single stocks?  Let’s take it one step at a time.

Invest In 401(k) Through Matching Funds

Let’s assume your company offers to match the first 3% of your annual salary if you contribute to the plan.  If you earn $50,000 a year, and agree to participate at a 3% contribution, your annual contribution amount will be $1,500.  Your employer will kick in another $1,500, bringing your total contribution each year to $3,000.  That $1,500 contribution from your employer is almost like free money (nothing is completely free – you will owe taxes on it when you withdraw it down the line).

Max Out Roth IRA Contribution For You and Spouse

If you are living frugal, and haven’t buried yourself in house and car payments, you can probably afford to kick in another few thousand dollars each year to saving for retirement. Assuming you are eligible to contribute to a Roth IRA, it probably makes sense to turn your investment dollars above your employer’s 401(k) match here.

Contributions to a Roth IRA won’t help with your taxes in the year they are made, but earnings grow tax free over the life of the investment.  If your $5,000 contribution this year turns into $40,000 by retirement, you get to keep all $35,000 growth tax free, assuming you withdraw after reaching retirement age, or for a narrow list of specified qualified withdrawals.

Another beauty of Roth IRAs investments is that Roth IRA withdrawal rules allow for the withdrawal of contributions without penalty, at any time.  So theoretically, you could park money in a Roth IRA to grow for three or four years, and then only withdraw contributions, leaving the earnings untouched and continuing to grow.

Max Out 401(k) Contributions or Taxable Investing

At this point you’ve invested in a 401(k) through the company match, and maxed out contributions to a Roth IRA for you and your spouse (if married).  If you still have money to invest for retirement you have a choice:  return to your 401(k) plan and invest up to your annual maximum contribution, or invest in non-retirement, taxable accounts.

The path you ultimately take here depends on your goals for the future, and your overall financial picture. Personally, I would begin to invest in low-cost, low-turnover, taxable investment vehicles such as a broad index fund.  I have plans to “retire” early from full-time employment, and to do so will need access to savings prior to the IRS-defined retirement age (currently 59 1/2). If I planned to work well past the currently defined retirement age, I would probably plow more money back into the 401(k) plan to lower my taxable income and defer those taxes to retirement.

If you do decide to invest in taxable accounts go with a low-cost brokerage such as Vanguard or Fidelity.  These brokerages are widely recognized as two of brokerages with the lowest expense ratios in the industry.  Inside those brokerages, look for mutual funds with low turnover.

Remember, each time an investment inside a mutual fund is sold or exchanged, or “turns over,” it is a taxable event.  Those taxes will be distributed to mutual fund owners at the end of the year, and can create quite a tax hit, even if your overall mutual fund performance is down.

If I had to pick one fund to invest in it would the Vanguard Total Stock Market Index fund, which owns a little piece of every stock listed.  As you can imagine, there is not a lot of buying and selling happening here, which minimizes your tax hit.  It is also about as diversified as one could get within the domestic equities market (the Total International Stock Index fund is the international investment equivalent).

Additional Resources:

• 2009 401k And IRA Contribution Limits
• Roth IRA Investment Account Basics
• Retirement Saving After 401(k) and IRA
• Find the best stocks to buy in today’s few hot industries
  

My daydreams about retirement have evolved over the years.  When I was younger I thought retirement meant spending most of the day on the fairways and the afternoons at the 19th hole. Or maybe trolling the waters of a big lake in a nice fishing boat sharing stories with an also-retired friend.  So saving for retirement was centered around these same activities.

Photo courtesy of danperry.com

When I got a little older my dreams graduated to a grand retirement played out in an expensive condo on the beach, or a million-dollar cabin in the mountains.  After I got a job, got married, and had two kids I quickly realized this idea of a luxurious retirement was not very realistic. My early ideas were shaped more by the movies than the real world.

Now that I’m a “thirty-something” (and old enough to remember the television show by the same name), my dreams for retirement are more centered around spending time with family. I’d like to do a little traveling (nothing glamorous, and mostly domestic), and spend some time working with young people by either coaching or teaching, or some combination. While my retirement plans are still a little vague, I am certain that I do not want to still be working in the corporate world in my old age.

To make my dream of financial independence a reality, I need to put a number on it, and devise a plan to hit that number in a reasonable amount of time.  Lots of theories out there on how to calculate your “number,” and depending on the formula used there is some fluctuation in the amount required. However, this is a case where being in the same ballpark is close enough for me, so I don’t overly concern myself with the math.

The 4% Rule

To demonstrate the 4% rule I’ll use a fictitious 30 year-old worker named Dan.  Dan works as a software engineer by day, and builds decks and fences on the weekends.  He earns $80,000 a year for his combined efforts. Ideally, Dan would like to reach financial independence at 50 years-old and spend his time modifying homes for those with disabilities – things like building wheelchair ramps, widening doorways, and similar accessibility features.  The service would represent a combination of his love for carpentry and a call to service Dan has wanted to fulfill his entire life.  What kind of nest egg would Dan need to pull this off?

The rule of 4% uses a couple assumptions, some of which are hard to justify in our current market conditions. In a typical market, it is not unreasonable to expect a 10%-12% annual return on a portfolio of stock market investments. That means you can safely withdraw 4% of your portfolio each year and not reduce your principal balance, even after accounting for inflation.

Anything earned above the 4% withdrawal and the rate of inflation grows your balance even higher (with the idea that you may have to increase withdrawals later to cover increased medical costs, insurance premiums, etc. as you get older).

To figure out the number required to maintain your current style of living, divide your current income by a factor of 0.04. In Dan’s case, maintaining an $80,000 yearly income would require a $2 million nest egg. But Dan is a frugal guy, and he and his wife plan to pay off the mortgage early – in their early 40’s. They buy older, used cars and trucks with cash, and have managed to pay off credit cards they ran up in their twenties.  They could easily live on $50,000 a year.

Running the formula again reveals Dan would only need $1.25 million to become financially independent.  He could withdraw a guaranteed $50,000 a year, or in years where his new business earned money he may not have to touch the nest egg at all.

Is 4% Too Much To Expect?

As I mentioned, the 4% formula uses some long-held assumptions about investments that may or may not be true in the coming decade.  I personally look for things to turn around in the next two years, but that doesn’t mean we’ll see a repeat of the “irrational exuberance” of the last 90s in the market. I think going forward investors will slowly have their confidence restored, but because it will take some time we can probably expect lower rates of return than in previous periods.

I also expect inflation to rise at a faster pace in the next few years.  Actually, I expect currency deflation to occur, but the net result is the same – future dollars will be worth much less than they are today.  The rise in inflation, coupled with lower expected yields from the market, mean it might be asking too much to expect to withdraw 4% from your nest egg without lowering your principal.

So What’s My Number?

My lifestyle lines up pretty well with Dan in that I hope to be living completely debt free by 50 – no credit cards, no car loans, and no mortgage.  If I can get to that point, my lifestyle needs will be fairly basic, and we could live very comfortably on $40,000-$50,000 per year (in fact, we could probably live on much less, but I’m being conservative here).

Reducing my expected withdrawal rate to 2-3% means I would need between $1.5 million and $2 million to live comfortably on $40,000-$50,000 a year.  I’ll split the difference and make my goal for financial independence $1.75 million.  Looks like I’ll need a few more side hustles.

Short post today as I’m home sick with a nasty bug.  Since I find myself at home on a workday, it reminded me of a great post I read at Bible Money Matters just yesterday on the subject of retirement.  Pete specifically asks, “Do You Ever Plan To Fully Retire?”

It’s an interesting question for a couple reasons.  “Retirement” means different things to different people, and that idea can change over time.  When I was a kid, retirement meant sitting on a lake fishing several hours a day, and basically being able to do whatever you wanted, whenever you wanted.  I suppose that is still true, to a certain extent.

Today my definition of “retirement” is centered more around continuing to find ways to contribute to causes you believe in, regardless of compensation.  In other words, I look forward to “retiring” from working for money so that I can begin working for something I believe in.  Not that I don’t believe in the mission associated with my current job, but let’s face it, most of us are not lucky enough to be able to wake up every single morning totally inspired by our 8-5 jobs.

At this point I’d like to turn things over to readers, and offer up the following question for discussion in the comments below.  What does retirement mean to you?