Exciting News: We’re Lowering Our FIRE Number!

After taking a fresh look at our future retirement budget, we’re lowering our Financial Independence (“FI” or “FIRE”) Number to $1,000,000!

When we initially determined our FIRE Number last year, we estimated that our annual spending in retirement would be around $50,000 per year. This gave us a FIRE Number of $1,250,000 using a 4% withdrawal rate, which is the goal we’ve been working towards up to this point.

However, watching the housing market explode in our area, and thinking through what we actually want to do once we’re both retired, caused me to take another look at the plans.

It’s totally normal to revisit your FIRE Number from time to time. I recommend revisiting your target annually, or as circumstances change, to make sure the number continues to represent your spending levels and support the lifestyle you want to live in retirement.

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Our FIRE Plan

Our plans for after Mr. RFL joins me in early retirement haven’t actually changed since we first calculated our FIRE number. Rather, the housing market’s recent boom led us to take another look and reconsider the effect our plans will have on our budget. We were missing something before.

When rerunning our budget, we came up with an annual cash requirement of around $54,000 based on our current living situation.

Although this budget suggests that our FIRE Number of $1,250,000 might actually be a little too low, it includes mortgage payments (principal and interest) for our current home in the amount of $16,000 per year. While I don’t consider principal payments to be “expenses” per se, I have included them in our future cash outflows, since we no longer plan to pay off the mortgage before early retirement.

Here’s the thing. We have no intention of staying in this home once we are both retired.

Our home is in a great location, which has been perfect for Mr. RFL’s commute and raising a child. It’s even been fun, though stressful, to fix up. But it’s too big for our family. We both agree that we’d prefer to downsize and move somewhere cheaper once work is no longer a factor.

If we don’t need to commute to an office job, then we can live wherever we want to! It opens up so many options for great real estate at a better price. We’d still want to be somewhere with decent schools since we have a young child. That said, there are so many more affordable places to live that would meet our criteria.

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Home Equity & Calculating Your FIRE Number

Many people believe that you should exclude home equity from your FIRE calculations. In fact, I was one of these people up until a month ago. On the surface, this makes sense, because you will always need somewhere to live.

But what if you own a $2 million dollar mansion and want to retire to a considerably cheaper mountain cabin? Or, what if you want to sell your expensive house and slow travel or rent?

The reality is that some circumstances support the inclusion of at least a portion of your home equity in the decision-making process.

If you only have a small amount of equity in your home, then it’s easiest to just ignore it. It’s probably not going to impact your path to FI.

However, if you own a significant amount of equity in your home, and your plans for retirement involve selling and either renting or moving somewhere more affordable, then it makes no sense to completely exclude it in the calculations.

This is our situation.  

Using Home Equity to Reduce Our FIRE Number

Since we plan to sell our current home after retirement, we’ll have access to the equity we’ve built up in the home.

The market currently estimates that our home is worth between $800,000 and $1,000,000. As a reminder, we bought this home for a bargain price. It needed a lot of work and we’ve spent the last two years renovating it. We still have a little bit more to do but expect to deplete our Renovation SINK fund and complete the renovation by the end of the 2021.

Our current investment in the home, including purchase commitments, is about $730,000. So even at the low end of the estimates, we’ll walk away with a profit.

But what’s more important, is how much equity we’ve built up in the home. This is the money we’d be left with if we sold it.

We only have $194,000 remaining on the mortgage balance. If we sold on the lower end of this range, we’d walk away with between $550,000 – $600,000 in equity after selling costs.

Our FIRE plan is to use the equity we receive from the sale of our home as the maximum amount we spend on our next home. With a budget of $550,000+, there are plenty of wonderful homes in the places we’re considering that would be within the budget. With our new interest in renovating and the DIY skills we’ve picked up during our home renovation, we could buy and even cheaper home and fix it up over time.

To Mortgage or Pay Cash?

Whether or not we choose to mortgage our next home will depend on the interest rates, the home we select and our financial situation at the time.

The decision won’t impact our FIRE Number, since one scenario results in having lower expenses (no mortgage payments) and the other results in having a higher base of investments that spins off more passive income and supports a larger annual expense.

For the purposes of our planning, and demonstration herein, we’ll assume that we buy the next house in cash. It’s cleaner that way.

We’re also assuming that we buy a new home which costs the same as the amount of equity we pull out of our current home. In reality, we may buy something cheaper, in which case, we’d just invest the extra and have more cushion.

FIRE Budget & Calculating Our FI Number

Here’s a look at our revised FIRE budget:

As you can see above, removing the mortgage payments and slightly reducing associated housing costs for our plans, results in an expected annual expense of $36,500. Using the 4% Rule of Thumb results in a required investment portfolio just over $900,000.

Because there is always a margin of error in estimates, we decided to round this up to $1,000,000 when updating our FIRE Number.

What’s the Expected Withdrawal Rate?

In early 2022, we expect approximately $550,000 of our investments to be in retirement accounts, with the rest of the $1,000,000 in cash or taxable brokerage accounts.

To be transparent, there is little to no chance that Mr. RFL will be ready to retire at that point in time. But financial independence is all about having the freedom of choice! And it’s because of that, we’re crunching the numbers as if he’ll retire once we cross a million-dollars in investments.

Using these assumptions, and an expected dividend/interest rate of 2%, we expect our investment portfolio to generate approximately $20,000 of passive income each year. Approximately $9,000 of this amount will be generated by our taxable accounts and used to offset our expenses each year.  

After that, we’d need to cover the remaining $27,500 in expected annual expenses through other sources of income or by selling off a portion of our investment portfolio. If we assume no other income, this translates to a withdrawal rate of only 2.8%, which is considered pretty conservative in most circles.

As a reminder, we also both have pensions and will receive annuity payments beginning at age 62 in the amount of ~$10,000/year. We may even receive some social security income (if it’s still around). Although we don’t factor these income streams into our plans, they do provide additional buffer in later years.

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How We Estimated the Retirement Budget

I’ve been tracking our expenses and budgeting for years. By now, I’ve got a pretty firm grasp on how much we spend and how easily we could adjust that spending without feeling deprived.

The FIRE budget was primarily created from our current spending estimates, while adjusting for any factors that will change in the future (i.e. selling our home and going from two cars to one).

Some of the line items are complete estimates, but I’ve tried to provide a reasonable one for now.

For example, medical insurance and costs are the biggest unknown. With the current subsidies offered under the Affordable Care Act, it’s nice to know that obtaining affordable health insurance in early retirement is an option. My previous budget for this line item was much higher, but I’ve since lowered it to take advantage of the subsidies. Legislation could always change in the future, but seeing how little Root of Good pays for his family has helped me get comfortable with my current estimate.

Additionally, multiple lines in the budget are purely discretionary, such as the $5,000 travel and entertainment budget. If the market were to suffer another recession or if we were to incur some unexpected expenses, we could always scale back on discretionary spending to offset these costs or keep our withdrawal rate low.

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We’re So Close!

There are still a lot of unknowns but it looks like $1,000,000 will be more than enough to fund our future! We’re so close to the finish line… it’s starting to get exciting!