Unfortunately, $5 million is barely enough to retire early with a family in a large city. It might sound ridiculous to you. But I assure you that thanks to inflation and a drop in interest rates, retiring early is now tougher than ever before.
Half the United States population living in expensive coastal cities and other high-cost areas of the country. Yet, there is somehow disbelief and even outrage a family might need multiple millions, let alone $5 million dollars, in order to retire early comfortably.
I recognize the attractiveness of lower cost areas, hence why I’ve aggressively invested in the heartland of America. Migration to the heartland is a multi-decade trend I want to be a part of. The global pandemic has really accelerated the work from home trend as well. There is clearly a “fanning out” of America.
However, I hope more folks can also recognize some of the reasons why half the United States population lives in higher cost areas as well. Some of the reasons include: higher pay, more job opportunities, greater diversity, sometimes better weather, amazing food selection, and family to name a few.
An Average Retirement Life With $5 Million
In my after-tax investment amounts by age for a comfortable retirement, I included a more aggressive after-tax investment chart for those who want to retire in an expensive city like San Francisco, New York, Los Angeles, Washington DC, Boston, San Diego, Seattle, Miami, or now Denver.
Again, not everybody wants to or can relocate to Des Moines and leave their friends and family behind. As a refresher, let’s review the high cost of living retirement chart.
If you retire at 40 with $2,500,000 in after-tax investments, you’ll only be able to generate $100,000 a year in gross income or $75,000 in after-tax income based on a 4% rate of return.
Is this enough? Not according to the Department of Housing and Urban Development, which considers $100,000 a year “low income” for a family of three living in San Francisco, for example.
Yes, you could potentially earn a higher rate of return than 4%, but when you’re counting on only your investments to support a family, it’s better to have a more conservative portfolio.
Private grade schools and private universities give financial aid to families who make $100,000 a year or less per child. Why is that? Because they agree with the Department of Housing and Urban Development.
Living Off $5 Million In Retirement
Based on simple math, $5,000,000 in after-tax investments at a 4% annual return will generate $200,000 a year in gross income. The reality is, getting a 4% yield today is much more difficult with the 10-year bond yield at ~1.65%. A more conservative yield or appropriate withdrawal rate is 3%. But let’s go with 4% anyway.
To give you an idea of what $200,000 a year in passive income can cover, let’s profile Jerry, a Financial Samurai reader’s budget. Jerry is 45 years old, has a 8-month-old daughter and a non-working spouse named Linda, 38. They’ve lived in Los Angeles for the past 20 years.
Both have decided to retire early in order to spend as much time as possible with their daughter. After both negotiated severance packages equal to $100,000 for Jerry and $60,000 for Linda, they have a combined net worth of roughly $6,300,000 if you include the $600,000 in equity they have in their primary residence, and $700,000 in their combined pre-tax retirement accounts.
Their goal is to never go back to full-time work again and perhaps do some part-time consulting once their daughter goes to kindergarten in five years. Neither parent is doing any sort of side hustling at the moment, contrary to most early retirees I know, including myself.
I’ve cross-referenced all the numbers based on my family’s own household expenses over the past year since we have a 18-month-old toddler and also live in California. All the expense line-items are realistic, if not a little conservative.
Please review J&L’s expenses below.
Retirement Income Analysis
One of the biggest benefits of earning passive investment income versus job income is a lower federal marginal income tax rate.
J&L’s $200,000 in investment income is taxed at a 10% effective federal long term capital gains rate (15% marginal) versus 21% effective (25% marginal) if it had been earned through employment.
After paying an effective 7% (9.3% marginal) in California state income tax, Jerry and Linda’s effective federal + state effective tax rate is only ~17% versus ~27% if they were W2 employees. Further, they don’t have to pay the 6.2% FICA tax on the first $128,700 in income per person either.
Due to the State And Local Tax (SALT) deduction being capped at $10,000, they’re losing out on at least $3,000 in tax refunds they would have received before Trump’s Tax Reform Act was passed. It is unclear how much the $25,100 standard deduction (2021) will offset HCOL homeowners until taxes are done.
Because Jerry and Linda want to be completely present parents, they’ve promised not to do any activity to generate money at least before their daughter goes to pre-school. They’re burnt out anyway. As a result, they must be disciplined and stick to their budget if they want to remain retired.
Retirement Budget Analysis
Kids Are Expensive (~$36,000/year)
The 10 hours a week of childcare assistance is extremely important so J&L can keep their sanity. Sometimes they use that time to go on dates, other times they use those hours to have “me time” to get away from each other. Being stay at home parents 24/7 is no joke. But it’s getting a little easier every month as their daughter sleeps a little better through the night.
J&L take their daughter to swim class twice a week and gym class once a week. Drowning is one of the leading causes of accidental deaths for children under 5.
On the other days, they go to the local science museum, where they have an annual family membership for $150. They also go to the zoo, where have a $150 annual family membership.
Despite being able to each contribute $15,000 a year to their daughter’s 529 plan, they can really only afford to contribute $11,000 each if they want to maintain their lifestyle.
They don’t believe making their daughter a 529 millionaire is a particularly wise move given the possible lack of motivation so much money might cause. Although, sending their daughter to public school in order to have the option to make her a millionaire sounds brilliant.
J&L will start their daughter off in public school to save money and see how she does. If they find she needs a smaller environment with a different style to thrive, then they will consider paying for private grade school.
Their #1 goal is give their daughter a wonderful foundation so she can be a strong and independent woman.
Having a gross monthly property cost of around $4,794 for a single family home in West LA is reasonable believe it or not. J&L live in a modest 1,600 sqft, 3 bedroom, 2 bathroom home at the edge of Santa Monica.
Their house is assessed at around $1.3M, or $400,000 below the median priced home in the area since they are further inland.
J&L have been thinking about upgrading to a remodeled house closer to 2,500 sqft. But such a house in their neighborhood would cost around $2M. They read my Buy Utility, Rent Luxury strategy for real estate investors.
As a result, they have decided to keep costs low and earn a higher rental yield in other parts of the country through real estate crowdfunding and aristocrat dividend stocks instead.
Healthcare Premiums ($1,650/month for a platinum plan)
According to the Kaiser Family Foundation, the average annual premium for employer-based family coverage is $19,616 or $1,635 a month. You can see the breakdown of what the average employer and worker pay in the chart below.
Given J&L no longer have jobs, they bear the entire cost of health insurance. With an 8-month-old daughter, they’ve decided not to mess around and maintain a gold health insurance plan.
Their daughter not only sees a pediatrician every three months, but also an ophthalmologist every three months. She has ocular albinism and strabismus (intermittent exotropia like Da Vinci).
They need to make sure their daughter’s prescription is correct to help her eyes align properly during development. After about age five, the neural pathways that go from the brain to the eyes tend to hardwire.
Health insurance is clearly one of the largest and most necessary expenses early retirees must consider. You could get Affordable Care Act subsidies if your household income is below a certain threshold. However, J&L need the income to live and don’t want to draw down principal so early.
For reference, my family of four is paying $2,250/month for a Gold Plan in 2021. I expect our health insurance rate to go up at least 5% a year, forever.
J&L value their time more than anything. As a result, they are happy to pay $5 for food delivery and save 1-2 hours cooking in order to spend more time with their daughter. Los Angeles does have some of the best food variety in the country. They also want to eat healthy, which costs more.
Finally, J&L supplement their grocery shopping with Amazon Prime about once a month as well. They still prefer doing their own grocery shopping because they’re better at picking out fruit than the delivery guys.
If there’s one thing we’ve learned during the global pandemic, it’s that overweight/obese people are more susceptible to the virus. Therefore, spending more money on quality food is worthwhile.
Another thing worthwhile is getting affordable term-life insurance to protect your loved ones and dependents. Check out PolicyGenius for the best life insurance rates. There is no obligation and it is free to check.
If there’s one thing we’ve all learned during the pandemic, it’s the importance and appreciation of life.
With PolicyGenius, my wife was able to double her life insurance coverage and pay less. All these years, she thought she was getting best rate with USAA. However, life insurance rates are so opaque. PolicyGenius helps shine a light on the best rates.
J&L hardly ever buy new clothing for themselves. They have no need since they don’t have to look good in front of anybody for work. If they need to look fancy, they’ll wear their old work clothes that still fit 10+ years later because they have maintained their same sizes.
J&L feel their $330 sports club expense is well worth it. Los Angeles has a huge fitness culture. The club provides a physical and social outlet three times a week. They’ve made many friends from the club. Without their health, their wealth is meaningless.
Finally, they’ve decided to stay local for the first two to three years of their daughter’s life. They have so much of Los Angeles, Newport Beach, Big Bear, and San Diego left to explore as a family. Besides, they agree with me that extensive travel before the age of three is a waste of time since their daughter won’t remember a thing when she’s older.
Budget Adjustments If Necessary
J&L could cut their expenses by contributing less to their daughter’s 529 plan. They could order less food delivery. If they spend less money on childcare, they’d free up an extra $5,000 – $10,000 a year. But they’re not sure the additional savings would outweigh the decline in their lifestyle.
They could move to a lower cost area of the country, but they’d rather stay warm all year round, rather than face brutal Midwest winters.
Further, as a Latino (Jerry) and Asian (Linda) family with a mixed-race daughter, they prefer the diversity of LA that can only be matched by even more expensive places like New York City or San Francisco.
This feeling of comfort is underestimated by the majority. Diversity is one of the reasons why people are migrating to California from the heartland. See: Main Financial Blindspots On The Road To Financial Independence
Instead, it seems better to just continue sticking to their budget. Then earn supplemental income if they need more money or want to spend more money.
Jerry worked in management consulting for 23 years and Linda worked in digital marketing for 15 years. Prior to retiring, Jerry was earning a base salary of $300,000 + $100,000 – $200,000 in bonus. Linda was earning a $180,000 base salary + $50,000 in stock compensation.
Every $10,000 of supplemental income earned equates to $250,000 in after-tax capital earning a 4% rate of return. J&L could easily consult part-time for a combined 10 hours a week at $100/hour. He would earn $52,000 a year if one of the following concerns come true.
J&L’s financial concerns in early retirement include:
1) What if they want and have another child? They will need to reallocate or earn at least another $20,000 a year for basic expenses, college savings, and childcare help.
2) What if the stock market and real estate market roll over? Their $5 million after-tax portfolio could easily shrink by 10% – 20%. This would leav them with passive income of only $160,000 – $180,000. That’s not enough to fund their existing lifestyle with one daughter.
3) What if their daughter has future unknown medical issues? Nobody really tells new parents this, but it may take years before you know all the issues that need addressing. For example, autism usually only starts showing signs between 18 – 36 months old.
4) What if one or all of their parents get sick and need to move in with them? All parents are still alive, but not all have long-term care insurance. Housing one or two parents will require extra funds.
Can Always Go Back To Work
Worst case, either Jerry or Linda can go back to work full-time, or they can start eating into their after-tax retirement principal until their daughter goes to kindergarten.
Again, please be aware the vast majority of people who espouse FIRE are working hard to make extra income or have a working spouse.
Even though my wife and I are also stay-at-home parents, I continue to publish 2-3X a week on Financial Samurai partly because I enjoy writing, partly out of habit for the past 10 years, but also because this site makes a healthy amount of revenue.
While J&L have settled on $5 million in after-tax investments to raise their family, we’re shooting for more just in case our boy doesn’t win the SF public school lottery. My fingers and mind still work, so I might as well keep going until they don’t.
Different Strokes For Different Folks
Despite detailing the numbers and providing context around J&L’s financial situation, I’m sure there will continue to be disbelievers that $5 million or more in after-tax investments is what’s required to live a comfortable, but not extravagant lifestyle in a high cost location.
It’s also become a national pastime to hate the rich, no matter how hard or long they studied in school, no matter how many hours they’ve worked a day, no matter how many risks they’ve taken to provide a better life for their family, and no matter how much in taxes they pay.
Like how more international travel and the mastery of a second language can help to create more harmony, hopefully, this article can help lead to more understanding by those who do not.
$5 million is a lot of money. But the composition of a $5 million net worth matters as well. If the $5 million is all tied up in your primary residence, then you certainly won’t have enough capital to generate enough passive income for retirement.
If you want to retire early with a couple kids, please shoot to have at least $5 million in invested capital. This is excludes your primary residence. Interest rates are at rock bottom levels. Returns might not be as good as they have been.
If you can’t get to $5 million before retiring with kids, then at last find ways to generate supplemental retirement income. Find something you will enjoy doing that makes some extra money. This way, you can cover the gap and do something meaningful in retirement.
Recommendations For Retiring Early
1) Stay on top of your finances like a hawk.
Track your finances for free with Personal Capital. Run your numbers through their Retirement Planner. Check your investments for excessive fees. Make sure your net worth is properly allocated.
You can do all this for free with Personal Capital. Don’t be one of the millions of Americans winging it on their road to financial freedom.
2) Refinance your home before retiring.
If you have a mortgage, definitely refinance before retiring. Once you lose your steady W2 paycheck, you become dead to banks. You will need at least two years of 1099 income to be considered for a refinance.
Take advantage of all-time low interest rates by refinancing with Credible. Credible is an online mortgage marketplace where qualified lenders compete for your business. You will receive free, no-obligation mortgage quotes in minutes. I refinanced to a 2.25% 7/1 ARM with no fees and couldn’t be happier!
3) Invest in real estate to benefit from inflation.
It’s hard to become a millionaire simply by saving your income. Income growth has simply not caught up to housing costs, college education costs, and health care costs. See the inflation chart above again as evidence. Therefore, in order to benefit from such rising costs, you should invest in real estate.
My favorite way to invest in real estate is through real estate crowdfunding. I’ve invested $810,000 in real estate across the heartland of America. It’s great to take advantage of faster growth, lower valuations, and potentially higher returns. Once I became a dad in 2017, I wanted to dramatically simplify my life.
My favorite real estate crowdfunding platform is Fundrise. They are one of the largest and oldest platforms having bee found in 2012. Fundrise smartly created private real estate funds to earn income 100% passively. For most people, investing in a diversified eREIT from Fundrise is the smart way to go. Fundrise is free to sign up and explore. .
If you are an accredited investor, take a look at CrowdStreet. CrowdStreet enables you to invest in individual commercial real estate deals mostly in 18-hour cities. 18-hour cities are faster growing cities with lower valuations. If you have a lot of capital, you can build your own select real estate fund with CrowdStreet.
Due to the rise of the work from home trend thanks to technology and the pandemic, there will likely be a multi-decade trend to lower cost areas of the country. CrowdStreet is also free to sign up and explore.
Everybody I know with $5 millionaire or more in net worth invest in real estate. I’ve personally invested $810,000 in real estate crowdfunding to diversify ad earn income 100% passively.