Why $5 Million Is Barely Enough To Retire Early With A Family

Why $5 Million Is Barely Enough To Retire Early With A Family

When toddlers close their eyes, they think others can’t see them. But I wouldn’t expect grown adults to think the same.

Despite half the United States population living in expensive coastal cities and other high-cost areas of the country, 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. But I hope more folks can also recognize some of the reasons why people live in higher cost areas as well: 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.

To give you an idea of what $200,000 a year in passive income can cover, let’s profile Jerry, a ONIG Financial Blog 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.

Budget for family of three retiring early off $5 million

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. This painful realization will be felt by millions of HCOL homeowners in 2021 when they do their 2021 taxes. It is unclear how much the $24,000 standard deduction 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 as well as the zoo, where they also 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.

Property ($4,794/month)

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 and 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.

Santa Monica house for $1.4 Million is very average looking

Not living large in Santa Monica, CA for $1.395M

Healthcare Premiums ($1,650/month for a platinum plan)

According to the Kaiser Family Foundation, the average annual premium for employer-based family coverage in 2021 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.

Average healthcare premiums  2021

Average healthcare premiums nearly $20,000 for a family

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 because 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, but J&L need the income to live and don’t want to draw down principal so early.

Food ($1,800/month)

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.

Obesity chart

J&L spend more for healthier foods b/c they don’t want to die young

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.

Non-essential Expenses

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.

Ryan Gosling has strabismus & that's OK

Ryan Gosling has strabismus & that’s OK

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, ordering less food delivery, and spending less money on childcare to 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.

Population distribution of where Americans live

Half the population lives in the more expensive blue zones

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.

Instead, it seems better to just continue sticking to their budget, and 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 and 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%, leaving them with passive income of only $160,000 – $180,000, 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.

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 ONIG Financial Blog 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.

Unfortunately, with interest rates and the stock market plummeting in 2021, $5 million is looking very shaky now for retirement.

Recommendation: 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. Don’t be one of the millions of Americans winging it on their road to financial freedom.

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