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In the midst of all the controversy surrounding the appointment of Justice Brett Kavanaugh to the Supreme Court, another controversy had emerged – this time in the world of personal finance. There is a growing movement called FIRE "(financial independence, retire early), a movement of young people who wish to achieve financial independence and retire from their stressful job very early in their thirties or forties. To do this, they significantly reduce their living expenses and perhaps get parallel concerts to supplement their incomes. The goal is to exchange material status and luxury for more time and freedom.
When Suze Orman, personal finance editor and former moderator Suze Orman's show, was asked about this trend, she tore it up and said, "I hate it. I hate that. I hate that. I hate that. And calling it "the biggest financial mistake you'll ever make of your life". She compared a person who earned $ 80 a year to an early retiree with the same income of $ 80,000 in investments. the worker can have disability and health insurance provided by his employer. Orman also discussed the $ 2 million spent on his mother's retirement home care and the tax burden. She concluded that a person would need $ 5 to $ 10 million to retire earlier and that age 70 should be the new retirement age.
So, is the dream of an early retirement (or even retirement before age 70) dead? I would not be so pessimistic. Let's look at each of the challenges faced by Orman's anticipated retirees and how they can be overcome:
Disability. This is an area where pre-retirement has a considerable advantage. If they become disabled, they will always receive the same $ 80,000 from their nest egg. However, it has been estimated that less than 40% of people between the ages of 20 and 30 have even taken out long-term disability insurance. Even for those who do, it usually reaches 50 to 70% of their income, usually after a waiting period of a few months. .
Health insurance. If a pre-retiree manages to minimize his taxable income (he will talk about it later), he will be able to benefit from higher subsidies for health insurance under the Affordable Care Act. For example, a 35-year-old non-smoker with a taxable income of $ 20,000 would pay about $ 79 a month for a medium-level "medium" plan with a ceiling of $ 2,450. Medical cost sharing can be another option.
Long-term care. With regard to the $ 2 million in costs associated with retirement home care, few Americans could pay these bills, no matter when they retire (let alone the private and island private plan mentioned by Orman). One solution is to purchase long-term care insurance. In particular, if you take out a policy under a state partnership program and you use all the insurance coverage, you can keep an amount of assets equal to the one you have subscribed and Medicaid will take over the rest of the bill. In this way, you only need the insurance to protect your assets.
The taxes. Orman herself discusses one of the best ways to protect herself from taxes: Roth accounts. Contributions in a Roth IRA may be withdrawn without tax or penalty at any time and for any reason whatsoever. Earnings are potentially subject to tax and a penalty of 10% if they are withdrawn before the age of 59 ½, but contributions are always paid first. As long as the account has been open for at least 5 years, the winnings can then be withdrawn after 59 ½ years without any taxes or penalties. (There are also Roth 401k plans that can be integrated with a Roth IRA when you leave your employer.)
What about all the money you accumulate in pre-tax accounts? Normally, this money is subject to taxes and possibly a penalty of 10% when you withdraw it before the age of 59 ½. However, you can avoid the penalty by converting money into a Roth IRA. You must pay taxes when you convert, but after 5 years, the amount you convert can be withdrawn without tax and without penalty. (All gains after the conversion can be withdrawn from the tax and the penalty after 59 ½ years.)
Another strategy is to contribute as much as possible to a health savings account (if it is eligible), then to avoid exploiting it to cover the costs of health care. Just be sure to keep your receipts, because you will be able to withdraw at any time the money you spent on eligible health care expenses at any time, without taxes or penalties. Of course, you can also use it without tax and without penalty for eligible retirement health care costs, including long term care insurance premiums.
There is good news for money that is not immune to a retirement account. As long as you keep investing for more than a year, you will pay a lower long-term capital gains rate on capital gains and dividends. For a married couple filing jointly in 2018, this tax rate is 0% if their taxable income is equal to or less than $ 77,200. Do not forget that the "taxable income" does not include tax-free money from Roth accounts nor at least $ 24,000 in standard deductions for the spouses' marriage declaration. You can also use the losses to offset your taxable earnings.
It's the federal tax, but what about the state? You can reduce or even avoid income taxes by retiring to a state where taxes are low or zero, such as in Florida, Texas or Nevada. Some states do not tax pension income if you are lucky enough to have it.
All this put together, and a single retiree in a state like Florida would pay only $ 800 a year in federal taxes on taxable income of up to $ 20,000. (This amount of $ 20,000 could consist entirely of conversions to Roth IRA with current expenses paid with Roth money tax-free and / or dividends and capital gains at a tax rate long-term capital gains of 0%.) This is an insignificant barrier to early retirement.
Dividends being cut. FIRE's income is based not only on dividends, but also on the 4% rule from studies showing that you can historically safely withdraw 4% of the initial value of a diversified portfolio and increase this amount according to inflation each year. Although the rule is not guaranteed in the future, it has survived many periods of poor market performance, dividend reductions and high inflation. (Some even argue that 4% underestimate the amount of income that retirees can safely withdraw.) Early retirees do not want to forget that studies were based on 30-year periods. A withdrawal rate of 3% may therefore be better suited to a longer period. longer retirement.
Lose the composition. Orman warns that pre-retirees will lose years of funding when they stop working and contribute to their retirement accounts. But it neglects to point out the additional benefits they could derive from savings from such a high percentage of their income and from early investment in their careers. In reality, it is one of the most important financial benefits of FIRE.
Need $ 5 to $ 10 million to retire earlier. Using the 4% rule, that would give about $ 200 to $ 400,000 in retirement income. I do not know why Orman thinks pre-retirees will need so much income, but as you can see in this article, it should not be used to cover insurance and taxes. When you consider the fact that you do not have to save for retirement, that you have a mortgage paid and other debts, that you may go to a region where the cost of living is lower. (in the US or abroad) and you have more time to cook than to eat. It's not hard to see how you can retire with a much lower income than you have now while maintaining a similar standard of living.
70 years as the new normal age of retirement. For all the above reasons, you should not have to work before age 70 if you do not need to do it. But I would go further and say that retiring at age 70 is in itself a huge risk because, as Orman herself said, "something can go wrong". At present, only half of US workers under the age of 50 work until age 63, and less than one-third work after age 65, mainly because of health problems or the need to work. take care of family members. If Orman is right regarding the replacement of jobs by the AI, many people may be forced to leave the job market even sooner. In this case, it is financial independence and early retirement that may have to become the new norm.
All that being said, FIRE is not for everyone. This requires a high savings rate (often between 50 and 80% of income), which many people can not or do not want to hire. Those who wish to pursue FIRE should leave aside their qualified and impartial financial planning advisor in order to fully understand all the implications regarding insurance, taxes and investment. Suze Orman has served us all well, highlighting some of the dangers that might come with playing with FIRE.
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In the midst of all the controversy surrounding the appointment of Justice Brett Kavanaugh to the Supreme Court, another controversy had emerged – this time in the world of personal finance. There is a growing movement called FIRE "(financial independence, retire early), a movement of young people who wish to achieve financial independence and retire from their stressful job very early in their thirties or forties. To do this, they significantly reduce their living expenses and perhaps get parallel concerts to supplement their incomes. The goal is to exchange material status and luxury for more time and freedom.
When Suze Orman, personal finance editor and former moderator Suze Orman's show, was asked about this trend, she tore it up and said, "I hate it. I hate that. I hate that. I hate that. And calling it "the biggest financial mistake you'll ever make of your life". She compared a person who earned $ 80 a year to an early retiree with the same income of $ 80,000 in investments. the worker can have disability and health insurance provided by his employer. Orman also discussed the $ 2 million spent on his mother's retirement home care and the tax burden. She concluded that a person would need $ 5 to $ 10 million to retire earlier and that age 70 should be the new retirement age.
So, is the dream of an early retirement (or even retirement before age 70) dead? I would not be so pessimistic. Let's look at each of the challenges faced by Orman's anticipated retirees and how they can be overcome:
Disability. This is an area where pre-retirement has a considerable advantage. If they become disabled, they will always receive the same $ 80,000 from their nest egg. However, it has been estimated that less than 40% of people between the ages of 20 and 30 have even taken out long-term disability insurance. Even for those who do, it usually reaches 50 to 70% of their income, usually after a waiting period of a few months. .
Health insurance. If a pre-retiree manages to minimize his taxable income (he will talk about it later), he will be able to benefit from higher subsidies for health insurance under the Affordable Care Act. For example, a 35-year-old non-smoker with a taxable income of $ 20,000 would pay about $ 79 a month for a medium-level "medium" plan with a ceiling of $ 2,450. Medical cost sharing can be another option.
Long-term care. With regard to the $ 2 million in costs associated with retirement home care, few Americans could pay these bills, no matter when they retire (let alone the private and island private plan mentioned by Orman). One solution is to purchase long-term care insurance. In particular, if you take out a policy under a state partnership program and you use all the insurance coverage, you can keep an amount of assets equal to the one you have subscribed and Medicaid will take over the rest of the bill. In this way, you only need the insurance to protect your assets.
The taxes. Orman herself discusses one of the best ways to protect herself from taxes: Roth accounts. Contributions in a Roth IRA may be withdrawn without tax or penalty at any time and for any reason whatsoever. Earnings are potentially subject to tax and a penalty of 10% if they are withdrawn before the age of 59 ½, but contributions are always paid first. As long as the account has been open for at least 5 years, the winnings can then be withdrawn after 59 ½ years without any taxes or penalties. (There are also Roth 401k plans that can be integrated with a Roth IRA when you leave your employer.)
What about all the money you accumulate in pre-tax accounts? Normally, this money is subject to taxes and possibly a penalty of 10% when you withdraw it before the age of 59 ½. However, you can avoid the penalty by converting money into a Roth IRA. You must pay taxes when you convert, but after 5 years, the amount you convert can be withdrawn without tax and without penalty. (All gains after the conversion can be withdrawn from the tax and the penalty after 59 ½ years.)
Another strategy is to contribute as much as possible to a health savings account (if it is eligible), then to avoid exploiting it to cover the costs of health care. Just be sure to keep your receipts, because you will be able to withdraw at any time the money you spent on eligible health care expenses at any time, without taxes or penalties. Of course, you can also use it without tax and without penalty for eligible retirement health care costs, including long term care insurance premiums.
There is good news for money that is not immune to a retirement account. As long as you keep investing for more than a year, you will pay a lower long-term capital gains rate on capital gains and dividends. For a married couple filing jointly in 2018, this tax rate is 0% if their taxable income is equal to or less than $ 77,200. Do not forget that the "taxable income" does not include tax-free money from Roth accounts nor at least $ 24,000 in standard deductions for the spouses' marriage declaration. You can also use the losses to offset your taxable earnings.
It's the federal tax, but what about the state? You can reduce or even avoid income taxes by retiring to a state where taxes are low or zero, such as in Florida, Texas or Nevada. Some states do not tax pension income if you are lucky enough to have it.
All this put together, and a single retiree in a state like Florida would pay only $ 800 a year in federal taxes on taxable income of up to $ 20,000. (This amount of $ 20,000 could consist entirely of conversions to Roth IRA with current expenses paid with Roth money tax-free and / or dividends and capital gains at a tax rate long-term capital gains of 0%.) This is an insignificant barrier to early retirement.
Dividends being cut. FIRE's income is based not only on dividends, but also on the 4% rule from studies showing that you can historically safely withdraw 4% of the initial value of a diversified portfolio and increase this amount according to inflation each year. Although the rule is not guaranteed in the future, it has survived many periods of poor market performance, dividend reductions and high inflation. (Some even argue that 4% underestimate the amount of income that retirees can safely withdraw.) Early retirees do not want to forget that studies were based on 30-year periods. A withdrawal rate of 3% may therefore be better suited to a longer period. longer retirement.
Lose the composition. Orman warns that pre-retirees will lose years of funding when they stop working and contribute to their retirement accounts. But it neglects to point out the additional benefits they could derive from savings from such a high percentage of their income and from early investment in their careers. In reality, it is one of the most important financial benefits of FIRE.
Need $ 5 to $ 10 million to retire earlier. Using the 4% rule, that would give about $ 200 to $ 400,000 in retirement income. I do not know why Orman thinks pre-retirees will need so much income, but as you can see in this article, it should not be used to cover insurance and taxes. When you take into account the fact of not having to save for retirement, having a mortgage paid and other debts, maybe moving to an area where the cost of living is lower (in the US or abroad) and to have more time to cook rather than eat It's not hard to see how you can retire with a significantly lower income than that you now have while maintaining a similar standard of living.
70 years as the new normal age of retirement. For all the above reasons, you should not have to work before age 70 if you do not need to do it. But I would go further and say that retiring at age 70 is in itself a huge risk because, as Orman herself said, "something can go wrong". At present, only half of US workers under the age of 50 work until age 63, and less than one-third work after age 65, mainly because of health problems or the need to work. take care of family members. If Orman is right regarding the replacement of jobs by the AI, many people may be forced to leave the job market even sooner. In this case, it is financial independence and early retirement that may have to become the new norm.
All that being said, FIRE is not for everyone. This requires a high savings rate (often between 50 and 80% of income), which many people can not or do not want to hire. Those who wish to pursue FIRE should leave aside their qualified and impartial financial planning advisor in order to fully understand all the implications regarding insurance, taxes and investment. Suze Orman has served us all well, highlighting some of the dangers that might come with playing with FIRE.
