MONEY IRAs

Why Roth IRA Tax Tricks Won’t Rescue Your Retirement

magician balancing an egg on a paper fan
George Karger—Getty Images/Time & Life Picture Collection

It's a myth that a Roth IRA is a sure way to add wealth. Saving more will make a bigger difference.

Roth IRAs are in fashion. Many people seem to believe that the Roth’s tax-free nature somehow generates more wealth in the end than other retirement savings options. But Roth IRAs have no magical capabilities.

A simple example of putting $5,000 to work in two types of IRAs—Roth and Traditional—shows there is no difference in the ending values of the two accounts, assuming your tax rate is unchanged between the initial contribution and withdrawal.

If your tax rate does change, the story is different. If your rate goes down, a Traditional IRA does better. And if your rate goes up, then the Roth does better. So neither IRA is a slam-dunk for tax savings: It all depends on whether your tax rate changes, and in which direction.

RMDs May Be No Big Deal

Roths are also touted for their ability to sidestep required minimum distributions. RMDs are the government’s way of making sure you pay taxes on Traditional IRAs. They are calculated as your IRA account balance divided by a “distribution period” corresponding to your life expectancy. You must begin RMDs at age 70 1/2, and include those withdrawals as part of your taxable income.

RMDs can be a nuisance to those with significant savings, and the dwindling few who receive pensions, because they can generate unnecessary taxable income. That is money you don’t need for living expenses, which will be taxed anyway. Even worse, in some scenarios, RMDs plus Social Security can force you into a higher tax bracket.

But RMDs may be a moot point. Many of today’s retirees are tapping their portfolios well before 70½ or relying on Social Security. And for many pre-retirees, the problem won’t be having to take out more than they need—it’s not having enough retirement savings in the first place! The government’s RMD rules won’t force much, if any, “extra” income on them.

Because of the threat of RMDs pushing you into a higher tax bracket, the conventional advice is that you should “top-off” your tax bracket in low-income years of early retirement by doing a Roth Conversion. That means transferring money from your Traditional IRA to a Roth, and paying income tax on the converted amount. You would be choosing to pay taxes now, in hopes that will save you on higher taxes in the future.

Consider the Margin for Error

But conventional rules of thumb can be inaccurate. You have to run your own numbers and, even then, the accuracy of the answers will be limited by your ability to predict your income far into the future. RMDs and Roth conversions lead to some very complex financial scenarios.

Analyzing my own situation using the best retirement calculators shows only modest levels of RMDs into our 90s, with our current 10% to 15% tax bracket unchanged. In theory, I could generate about 2% to 3% more wealth in the end if I did Roth conversions, as long as I paid the conversion tax from non-IRA assets. If I paid the tax from IRA funds, there would be no value in doing a conversion.

However, that 2% to 3% gain is well within the margin of error for retirement calculations. Who knows if I would ever see it? But, in doing Roth conversions, I would see additional complexity and paperwork in my financial life starting right now. Given that, I’m foregoing Roth conversions for the time being.

Roth conversions are unlikely to save you from high taxation of retirement assets. That’s because the total amount you can convert is limited by the number of years you spend in a lower tax bracket and your “headroom” to the next higher bracket.

Still, there are scenarios where Roths can save you money, particularly for those in higher tax brackets. And Roths can be useful to tax diversify your savings. To clarify the issues in your situation, use one or more of my recommended high-fidelity retirement calculators to run your own numbers.

And before you invest too much time in Roth tax tricks, make sure your overall retirement savings rate is on track: that will have a much bigger impact on your long-term financial success!

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

Read next: Which Wins for Retirement Savings: Roth IRA or Roth 401(k)?

MONEY early retirement

5 Ways to Know If You’re on Track to Retire Early

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David Madison/Getty

More than any numerical calculation, your financial behaviors are a reliable indicator for early retirement.

Interested in retiring early? How do you know if you’re on track? The usual answer is a financial formula: A given amount of savings, plus some investment return, equals a certain lifestyle, for a certain number of years. It’s simple math. Or is it?

In fact, it’s extremely difficult to predict your financial trajectory far into the future. Numbers can be deceiving. How about a different approach? These five career and financial behaviors may be the best indicator for whether you’re on track to retire early.

Do you love your work?
It might seem ironic to begin a discussion of early retirement with whether or not you like your job. After all, isn’t the point of retirement to stop working? Yet, in my experience, the only way to create the value needed to acquire the assets to retire early is to be great at what you do. And it’s hard to be great at something if you don’t love it. How else will you be motivated to put in the hours required for learning, practice, and mastery? Even in retirement, you may not want to stop being productive. But you’ll have the opportunity to do it in your own way, on your own schedule.

Do you value your time more than things?
Another prerequisite for early financial independence is valuing your free time more than owning things. Many modern professionals could retire in their 50’s if they saved more of their income rather than spending it. But temptations abound, and the instant gratification of another purchase is easier to taste than freedom a decade hence.

Ask yourself whether the things in your life are worth the years of labor you trade for them. Expensive houses, cars, and vacations are big-ticket items that can drain away earnings. Taking on debt to pay for them compounds the problem. We all need some luxuries. But requiring the best in everything is a financial burden. Valuing your time more than things will keep you from that trap.

Are you saving at least 30% of your salary?
There are few absolutes in the early retirement equation. High earnings are nice. A frugal lifestyle is helpful. But, when you really dig into the math, what matters most is your savings rate—the amount of your earnings, as a percent, that you save instead of consuming. That single number captures all the relevant factors for financial independence: how much you make, spend, and invest. It’s the single most important numerical factor in whether you can retire early, and it’s independent of your salary.

If you save at the often-recommended rate of only 10%, it will be about 40 years before you can retire. But accelerating that process is possible. It all depends on your resources and motivation. I saved approximately one-third of my salary, plus bonuses, during the peak earning years. That allowed me to retire at age 50 If you’re able to save 50% of your earnings, you could retire in less than 15 years!

How do you achieve those high savings rates? Increase your earnings by self-improvement. Cultivate a healthy, low-cost lifestyle with free fun and a few carefully chosen luxuries. Max out retirement savings and get company matches.

Do you track your financial “vitals”?
Every early retiree that I know got there in part because they quantify and track things. Rocket science is not required: If you can make a list of numbers and add them, you have most of the math skills needed for early retirement. Here are three vital financial signs to watch:

  • Monthly expenses reflect your lifestyle back to you: Are your daily spending decisions taking you towards financial freedom, or further away?
  • Quarterly net worth tracks your progress to financial independence: Are you growing your assets, or digging yourself into debt?
  • Annual portfolio return measures your investing skill: Are you matching the broad market return? (That’s good enough for early retirement.) If not, try a low-cost, passive indexing approach.

Do you have a potentially profitable passion?
Here’s a secret about early retirement: Like much of life, it’s risky. If you need a perfectly predictable, secure existence, then keep your job. But most early retirees aren’t leaving their career to lie on the beach or play golf full time. Most of them are setting off to pursue other passions. And many of those pursuits have income potential. Whether it’s blogging, guiding, or volunteering at a nonprofit, anybody with extensive experience, who is serving others, will generate value. Oftentimes that winds up paying, which reduces the risk of early retirement.

More than any calculation, your financial behaviors are a reliable indicator for early retirement. I’ve just reviewed five important ones. With these behaviors in place, relax and enjoy the ride. Find happiness every day in meaningful work and prudent living. That will lead to financial freedom, on a schedule that is right for you.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

For more help calculating your needs in retirement:
The One Retirement Question You Must Get Right
How to Figure Out Your Real Cost of Living in Retirement
4 Secrets of Financial Freedom

MONEY retirement planning

How to Balance Spending and Safety in Retirement

piggy banks shot in an aerial view with "+" and "-" slots on top of them
Roberto A. Sanchez—Getty Images

Every retirement withdrawal method has its pros and cons. Understanding the differences will help you tap your assets in the way that's best for you.

You’ve saved for years. You’ve built a sizable nest egg. And, finally, you’ve retired. Now, how do you withdraw from your savings so your money lasts as long as you do? Is there a technique, a procedure, a product that will keep you safe?

Unfortunately, there is no perfect answer to this question. Every available solution has its strengths and its weaknesses. Only by understanding the possible approaches, then mixing them together into a personal solution, will you be able to move forward with an enjoyable retirement that balances both spending and safety.

Let’s start with one of the simplest and most popular withdrawal approaches: spending a fixed amount from your portfolio annually. Typically this is adjusted for inflation, so the nominal amount grows over time but sustains the same lifestyle from year to year. If the amount you start with, in year one of your retirement, is 4% of your portfolio, then this is the classic 4% rule.

The advantages of this withdrawal method are that it is relatively simple to implement, and it has been researched extensively. Statistics for the survival probabilities of your portfolio, given a certain time span and asset allocation, are readily available. This strategy seems reliable—you know exactly how much you can spend each year. Until your money runs out. Studies based on historical data show your savings might last for 30 years. But history may not repeat. And fixed withdrawals are inflexible; what if your spending needs change from year to year?

Instead, you could withdraw a fixed percentage of your portfolio annually, say 5%. This is often called an “endowment” approach. The advantage of this is that it automatically builds some flexibility into your withdrawals based on market performance. If the market goes up, your fixed percentage will be a larger sum. If the market goes down, it will be smaller. Even better, you will never run out of money! Because you are withdrawing only a percent of your portfolio, it can never be wiped out. But it could get very small! And your available income will fluctuate, perhaps dramatically, from year to year.

Another approach to variable withdrawals is to base the amount on your life expectancy. (One source for this data is the IRS RMD tables.) Each year you could withdraw the inverse of your life expectancy in years. So if your life expectancy is 30 years, you’d withdraw 1/30, or about 3.3%, in the current year. You will never run out of money, but, again, there is no guarantee exactly how much money you’ll have in your final years. It’s possible you’ll wind up with smaller withdrawals in early retirement and larger withdrawals later, when you aren’t as able to enjoy them.

What if you want more certainty? Annuities appear to solve most of the problems with fixed or variable withdrawals. With an annuity, you give an insurance company some or all of your assets, and, in exchange, they pay you a monthly amount for life. Assuming the company stays solvent, this eliminates the possibility of outliving your assets.

Annuities are good for consistent income. But that’s also their chief drawback: they’re inflexible. If you die early, you will leave a lot of money on the table. If you have an emergency and need a lump sum, you probably can’t get it. Finally, many annuities are not adjusted for inflation. Those that are tend to be very expensive. And inflation can be a large variable over long time spans.

What about income for early retirement? It’s unwise to draw down your assets in the beginning years, when there are decades of uncertainty looming ahead. The goal should be to preserve net worth until you are farther down the road. If your assets are large enough, or the markets are strong enough, you can live off the annual interest, dividends, and growth. If not, you may need to work part-time, supplementing your investment income.

Every retirement withdrawal technique has drawbacks. Some require active management. Some can run out of money. Some don’t maintain your lifestyle. Some can’t handle emergency expenses or preserve principal for heirs. Some may be eroded by inflation.

That’s why I believe most of us are going to construct a flexible, “hybrid” system for living off our assets in retirement. We’ll pick and choose from the available options, combining the benefits, while trying to minimize the liabilities and preserve our flexibility.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

For more help calculating your needs in retirement:
The One Retirement Question You Must Get Right
How to Figure Out Your Real Cost of Living in Retirement
4 Secrets of Financial Freedom

MONEY early retirement

Get These 3 Variables Right and Retire Earlier

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Chris Clor/Getty Images

Most people overestimate what they'll need to live comfortably in retirement. The more realistic you are, the sooner you might be able to kick back.

How do you know if you can retire? Despite all the attention given to your retirement “number”—your total savings—there are several other important variables that go into the retirement equation. If you want an accurate estimate for when you could retire, you must choose reasonable values for each one of them. Get these numbers wrong, either too optimistic or too pessimistic, and it could throw off your retirement calculations by years.

In my experience, people tend to be overly pessimistic about their retirement variables. Maybe it’s all the “bad” news about retirement. Or maybe it’s an abundance of caution around this critical life decision. But if you can be realistic about these numbers without being reckless, you can potentially accelerate your retirement and the freedom it brings.

Even if you have a financial adviser, it’s a good idea to become familiar with the key retirement variables yourself. Yes, some math is required, but it’s pretty simple. And there are easy-to-use retirement calculators that can handle the details for you. So let’s take a look at these important retirement parameters.

1. Living expenses. It’s common to assume that your retirement living expenses will be a fixed percent of your pre-retirement income. But if your lifestyle is unique in any way, especially if you’re a diligent saver, these income-based estimates can be wildly inaccurate. The best way to know your expenses is to actually track them yourself. One expert says you can retire on less than 60% of your working income, which is consistent with my personal experience.

And the news about expenses gets better: The typical retirement calculation automatically increases your living expenses every year by the rate of inflation. That sounds reasonable at first glance. Yet research shows that most people’s expenses decline as they age. Studies show decreases from 16% to as much as 40% over the stages of retirement. Even with higher health-care costs, you simply can’t consume as much at 80 as you did at 60.

2. Inflation rate. Inflation remains a critical retirement variable, because it can influence your fixed living expenses and the real returns on your investments. Many fear higher inflation in the future. Pundits have been expecting it for more than a decade. Although conditions might favor higher inflation down the road, nobody knows for sure when or how it will arrive. In my opinion, trying to plan for extreme inflation is not sensible. And many retirees, myself included, experience a personal inflation rate that is below the government’s official rate, proving that you have some control over how inflation impacts your life.

3. Tax rate. Taxes are one of the most feared and loathed factors in retirement. Yet in my experience as a middle-income retiree, taxes aren’t as big a deal as they are made out to be by those with an agenda for your money (or your vote). In the lower tax brackets, income taxes are just another expense, and not a particularly large one. When calculating taxes for retirement, be especially careful to distinguish between effective and marginal tax rates. Your effective tax rate is your total tax divided by your income. Your marginal rate is the amount of tax you pay on your last dollar of income. That’s a function of your tax bracket and is nearly always much higher than your effective rate.

Most retirement calculators use an effective rate, but that isn’t always clear. If you mistakenly enter a marginal rate into a retirement calculator, you will grossly overestimate your tax liability and underestimate your available retirement income. For example, my marginal tax rate in my peak earning years was 28%; now that I’m retired, my effective tax rate has been around 6%. Big difference!

So there is room for optimism on some key retirement variables. But retirement planning is an exercise in reality, and the reality of the stock and bond markets right now is more negative than positive. Investment returns are one retirement variable where you cannot afford to be overly optimistic, or you could run out of money in your later years. Many experts point to current low interest rates and high market valuations as indicators that we must plan for lower returns going forward. How much should you scale back your expectations? That’s anybody’s guess, but I’m seeing estimates of from 2%-4% below the long term averages for stock returns.

Retirement analysis can be difficult and perplexing. A good retirement calculator can condense all the variables into a single view of your financial trajectory. For the most accurate picture, choose realistic values. Don’t lengthen your journey to retirement with excessive assumptions for living expenses, inflation, or tax rates. But don’t get overly confident about investment returns, either. A realistic analysis will increase your odds of working and saving the right amount, before you make the leap to retirement.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

Read next: Retirement Calculators Are Wrong But You Need One Anyway

MONEY retirement planning

Retirement Calculators Are Wrong—But You Need One Anyway

child's hand moving an abacus
Cliff Parnell—Getty Images

To get the most from retirement calculators, it helps to understand their limitations.

Everyone knows it’s impossible to predict the future, but we seem to forget that truth when it comes to our personal finances. We save too little and hope there will be no emergency expenses. We look to financial advisers or media pundits to pick the most profitable stocks. And we think there is some magic formula or equation that will compute exactly when we can afford to retire.

But there just isn’t a precise answer to the question of whether or not you have enough money to retire. And that’s because retirement calculators aren’t evaluating a simple mathematical equation. Rather, they’re attempting to model the future. And that’s a very tough assignment.

You may have perfect knowledge of your personal situation: how much you’ll make, how much you’ll need to spend, how long your good health will last. But the world won’t stand still for you. How much will stocks and bonds return in the years ahead? What will inflation run? How will tax rates change? No person or tool can predict the trajectory of the economy, the markets, and government policy decades into the future.

When I used a simple retirement scenario to compare prominent free retirement calculators, I found a difference of nearly a factor of two in the final portfolio size between the most pessimistic and optimistic outcomes. That’s right, the answers varied by nearly 100%!

Given slight changes in input, even the same calculator can report vastly different results, ranging from going broke to dying a multimillionaire. So we can’t approach retirement calculators with a “pass/fail” mindset. All a retirement calculator really provides is an opinion as to how long your assets would last, given current conditions and a certain set of guesses about the future.

Can you get more accuracy by choosing a “better” calculator? It depends on what you need. A more powerful calculator can guide you on tax moves, claiming Social Security, and sequencing retirement withdrawals. But don’t bother searching for a calculator that is somehow inherently better at predicting your future wealth. The major variables of market returns, inflation rate, and life expectancy will always preclude a perfect answer to that question.

Still, a retirement calculator can be invaluable for making one of the most important decisions of your life. So even if it’s impossible to find the one that will perfectly predict the future, how should you go about choosing one that’s good enough?

For starters, understand the calculator’s pedigree: Where is it coming from and why? Who is the individual or company behind it? Will they be available to support their tool now, and later? Beware calculators geared to computing your insurance or investment needs if the people behind it are standing ready to sell you those same products. You can also sidestep tools designed for professional advisers or researchers; there are plenty of other easy-to-use general-purpose retirement calculators available.

Next, consider the “fidelity” of the calculator, or how closely it can simulate reality. This will impact how much data it collects from you and how much time you need to spend on inputs. If you’re younger and just need a rough check on whether you’re saving enough, a quick, easy-to-use, low-fidelity calculator will be adequate. But if you’re older and want to analyze specific financial events in your future, or fine-tune a tax, income, or withdrawal strategy, you’ll need to choose a higher-fidelity calculator and invest more of your time.

The single most important variable in a retirement calculation is usually the real rate of return: how much your investments will grow above inflation. Broadly speaking, there are three methods for modeling return rates: average return, random Monte Carlo, and historical sequence. Experts argue over which is best, but most of the rest of us aren’t in a position to choose sides. My suggestion: Pick a calculator, or calculators, that cover all three approaches, then compare the results for yourself.

Fortunately, cost doesn’t need to be a factor when you’re selecting a retirement calculator. There are free offerings in all the major categories. But you may be able to winnow the field by platform. The easiest and friendliest calculators are generally web-based. But if you aren’t comfortable with sending your financial data across the Internet, there are good options that will run locally on your desktop, laptop, or tablet instead.

Finally, when you’re ready to choose a retirement calculator, check out my list of The Best Retirement Calculators. Out of a field of more than 75 tools, I’ve hand-picked solid choices in each category. You can sort and search by most of the parameters I’ve discussed above, plus other features. And there are links to each of the calculators, so you can try them out personally.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

For more help calculating your needs in retirement:
The One Retirement Question You Must Get Right
How to Figure Out Your Real Cost of Living in Retirement
4 Secrets of Financial Freedom

MONEY early retirement

How Managing ‘Lifestyle Inflation’ Can Help You Retire Early

141117_RET_LivingExpenses
Getty

Before you sign up for that seemingly cheap financial commitment, calculate how much it will really cost you. It's a lot more than you think.

What, exactly, is a “lifestyle”? We’re all chasing a better one, but what does that mean on a day-to-day basis? Well, in financial terms, your lifestyle is reflected most clearly in your recurring expenses: the financial obligations that you commit to each month and that seem necessary to support your way of living.

We’re talking here about essentials like housing, groceries, transportation, insurance, utilities, and taxes. And we’re also talking about a variety of discretionary expenses such as entertainment, memberships, subscriptions, maintenance plans, and personal services.

Look at the list above: Can you cut back in any of these areas without affecting the quality of your life? Whether your goal is building wealth, retiring early, or just making your dollars go farther, controlling your living expenses will pay huge dividends.

Recurring expenses are especially important—and insidious—for a number of reasons. For starters, these expenses are often automatic. They hit your bank account like clockwork every month while your attention is elsewhere. Unless you track your expenses or balance your account, you may not even notice them. But each one costs you, and unless you take action, they will go on forever.

Businesses love recurring charges, which represent steady income at very low cost. So companies are skilled at making these expenses easy for you to add on impulse—often requiring a simple consent or web form—but hard to stop unless you pick up the phone or send a written cancellation. Even the most ethical companies have little incentive to help you minimize your monthly charges. Their policies and procedures are necessarily oriented to persuading you to tack on new ones. So it’s up to you to be vigilant.

Relying on the Rule of 300

Recurring expenses may seem small or insignificant, but, from the perspective of retirement or financial independence, they are all substantial. Why? Because of what I call the Rule of 300: “The amount of money you must save to meet a monthly expense in retirement is approximately 300 times that expense.”

Where does that factor of 300 come from? It stems, simply, from two multipliers. The first, 12, is easy to understand: To convert a monthly expense to an annual one, you must multiply by the 12 months in a year. The second multiplier comes from the well-known “4% rule” for withdrawal from retirement savings. (That rule is under attack as possibly too optimistic, but that only makes the need to control recurring expenses even stronger.) The 4% rule is another way of saying you need to save 25 times your annual expenses to retire safely. So 25 is the second multiplier. Combine these two multipliers, 12 times 25, and you get my “Rule of 300” for the amount you must save to cover a monthly expense in retirement.

For example: Say you commit to a seemingly insignificant $30-per-month membership. A dollar a day sounds cheap, and you think you’ll enjoy the convenience. But, once you stop working, you’ll need to have saved $30 times 300—or $9,000—to pay for that membership from your investments! Yes, believe it or not, a mere “dollar a day” expense actually represents about $9,000 in required retirement savings. How long will it take you to save that much? And is it worth it?

Don’t get me wrong. It’s really important to enjoy life. I’m a big fan of occasional splurges, fun treats along the road to financial independence. I’d be the last one to deny the simple joy of an occasional latte, the delight of opening a new book, the excitement of an evening on the town. But these are all one-time expenses: They don’t inflate your lifestyle. And you can easily reduce or eliminate them, if needed. No phone calls, negotiations, or transaction costs required.

Recurring expenses, even small ones, deserve serious consideration before you sign on the bottom line. I set a very high bar for committing to any new recurring expenses and recommend you do the same. Before you decide that a regular financial commitment sounds “cheap,” multiply it by 300, then picture how much work it will take for you to save that number.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. This column appears monthly.

More from Darrow Kirkpatrick:
The Single Most Important Thing You Can Do to Achieve Financial Success
The One Retirement Question You Must Get Right
How to Figure Out Your Real Cost of Living in Retirement

 

MONEY early retirement

The Most Important Move to Make If You Want to Retire Early

Small birdhouse
Michael Blann—Getty Images

Housing is the most dangerous expense for those seeking financial freedom. Here's what you can do to control those costs.

Looking to achieve financial independence and retire sooner? A top priority should be to control expenses—especially your major living expenses like housing, food, transportation, health care, and recreation. We’ll focus on the rest of these spending categories in future columns, but for now let’s take a look at housing—the single largest expense for many, and one that can all too easily sabotage your journey to financial freedom.

Housing-related decisions will impact your financial independence by years, if not decades. Homes are a downright dangerous expense variable, because price tags are high, leverage (borrowing) is usually required, and various financial “experts” with their own agendas are usually involved. And houses expose our vanities, tempting us to spend for the approval of others, instead of in our own best interests. Losses of tens of thousands of dollars are routine in real estate, and can completely derail your savings plan.

Even when you don’t suffer an outright loss, changing homes is expensive. I moved around in my 20’s, had few possessions, and rented, so the cost of relocating was minimal. Then I married, we bought our first house, and had a child. Our next move was punishing: We were forced to sell our house at a steep loss, and, because of all our new stuff, we had to hire professional movers for the first time. When we finally bought a house again, we stayed put for nearly 17 years. In retrospect, that long time in one place was an enormous help in growing our assets and retiring early.

How much does it cost to change homes? By the time you add up the costs of selling, relocating, buying again, and settling in, you can easily spend $20,000, or more. According to Zillow, closing costs to a home buyer run from 2% to 5% of the purchase price. The seller doesn’t have mortgage-related costs but is likely paying a realtor commission as high as 6% or 7%. Then there are moving costs, and the inevitable shakedown costs with any new home: painting, carpets and curtains, repairs, supplies and furnishings, and basic improvements to suit your lifestyle.

In short, changing homes is frightfully expensive, and will probably eat up most of the average family’s potential savings for several years running.

Of course there are scenarios like career moves, where you don’t have the luxury of staying in place. But anytime the choice to move is yours, stop and consider the expenses. The worst possible choice would be an optional move into a larger house that you don’t really need. You are taking on a big one-time expense, plus a bigger ongoing mortgage and maintenance obligation. If more space is truly necessary, consider instead modifying your current home: When our son reached the later teen years, we renovated a larger downstairs room so he could have more space.

Once you’re in your home, be smart about home improvement projects, especially those you can’t do cheaply yourself. Trying to create the “perfect” home is an uphill battle, at best. Borrowing to improve your home is an especially bad idea, in my opinion. You can spend vast sums of money without measurably improving your quality of life. And old assumptions about getting that money back when you sell are outdated. For 2014, Remodeling Magazine reports that the average cost-value ratio for 35 representative home improvement projects stood at just about 66%. In other words, you don’t make money when you sell: rather, you only get about two-thirds of your money back! Financially speaking, that’s a lousy investment.

Lastly, while there are situations where it makes sense, on paper, to hold a mortgage, for those truly dedicated to financial independence, the disadvantages of debt often outweigh the benefits. In general, pay off your mortgage as soon as possible. Using extra income to pay down a mortgage loan can be a solid investment in today’s low-return environment. We paid off our mortgage years before retiring, and the peace of mind was invaluable. Now, in retirement, we rent instead of own. It’s a flexible, economical, and low-hassle lifestyle.

In short, maintaining a home will be one of your largest life expenses. Pay careful attention to your housing decisions if you’re serious about financial freedom!

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. This column appears monthly.

More from Darrow Kirkpatrick:

The Single Most Important Thing You Can Do to Achieve Financial Success

The One Retirement Question You Must Get Right

How to Figure Out Your Real Cost of Living in Retirement

Read next: 3 Little Mistakes That Can Sink Your Retirement

MONEY retirement planning

The One Retirement Question You Must Get Right

Man slamming his head into chalkboard of theorems in frustration
Getty Images

Figuring out how big a nest egg you need is a huge financial planning challenge. Here are some helpful tips from an expert who retired at 50.

How much money do you need to retire? This is one of the most difficult questions in all of financial planning. Countless words are written, endless fees are charged, and plenty of sleep is lost, just trying to answer it!

But I’ll tell you a secret—a truth that none in financial services and few in the financial media will admit. We don’t know how much you need to retire! Beyond some broad ranges that have worked in the past, it’s practically impossible to calculate the precise amount of money needed to carry you through a retirement lasting decades or more into the future.

Why? Because, in addition to predicting a host of smaller factors, computing how much you need to retire requires pinning down two huge and essentially unknowable variables: the length of your life, and the real return on your investments. (That’s the actual return, after inflation.)

If you misjudge your life expectancy by even a few years, you could potentially die broke, or with tens of thousands of unspent dollars on the table. If you misgauge your real rate of return by just 1% (and the pros miss it by more than that, all the time), the error in a half-million dollar portfolio over a 30-year retirement will be about $175,000—one-third of the starting value, and a lot of money to go missing!

So there can be no precise answer to this question. And, yet, you must answer it, in some fashion, if you don’t want to go on working forever. So where do you begin?

As I’ve written before, knowing your expenses is an essential first step to retirement planning. You simply must know what it costs you to live each month, in order to get any sense for what you must save to retire.

From that monthly expense number you can subtract any guaranteed, inflation-adjusted income that you are certain to receive in retirement: Social Security for many of us, pensions for a fortunate few, and annuities for those who buy them.

Your remaining expenses must be funded from your investment portfolio. The traditional approach has been the 4% Rule, which states that you can withdraw 4% of your portfolio in the first year, then adjust that withdrawal amount for inflation each year, without fear of running out over the course of a 30-year retirement. However, some experts say this rule is too optimistic for the current difficult economic times, with low interest rates and high market valuations. On the other hand, if you retire in better economic times, or if you choose to annuitize your assets, the rule might be too conservative. (You can find online tools that will let you see the impact of using different economic assumptions—I mention three of the best retirement calculators in this article.)

Boiling down all the research papers, case studies, and opinions that I have read on this topic—and I read about it nearly every day—I can tell you this: The safe withdrawal rates from your retirement savings probably range from about 5% on the optimistic side to about 3% on the conservative side.

That means, for example, if your living expenses not covered by guaranteed inflation-adjusted income were $3,000 a month in retirement, then you would need between $720,000 in savings on the optimistic side, to $1.2 million on the conservative side, to provide for your lifestyle over a several-decade retirement.

Thus if your savings were in that range you could consider retiring. But there is more to it than that, especially for an early retiree. You would also need to factor in the risk that you would run low, and your ability to do something about it. That risk would be a function of the economic environment you retire into, and the longevity factors in your family. The ability to do something about it would be a function of your age and health at retirement, your professional skills, and your lifestyle flexibility.

In the end, there is no simple answer to the question “Do I have enough to retire?” But, there is a range of possibilities, based on historical data and your own risks and capabilities. And, even after you’ve made the retirement decision, you still need to assess and drive your retirement, especially in the early years. So, once you’ve started on the retirement journey, don’t fall asleep at the wheel!

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. This column appears monthly.

MONEY early retirement

How to Figure Out Your Real Cost of Living in Retirement

Your retirement savings “number” gets a lot of press. But your expense number is even more important, especially if you retire early.

Many financial advisors say you’ll need some fixed percent of your previous income in retirement—often 80% is considered “reasonable.” But that’s nonsense. What it costs you to live in retirement, or before, is not a function of how much you make! There are millionaires who live like college students, and college students who live like millionaires—for a while anyway, on credit.

Where are you on the lifestyle spectrum? To get serious about retirement planning, you’ve got to have an accurate picture of your monthly living expenses. You need to know your bare minimum or fixed expenses, your average or normal expenses, and your ideal expenses—allowing for some luxuries.

Spending is a personal area, so everyone’s pattern will be different. But on average the first phase of retirement is when you’re likely to spend the most, since you’re finally free to travel, dine out and enjoy other leisure activities. Among older Americans, average annual expenditures peaked at about $61,000 for those in the 45-54 year age range, according to the latest data from the Consumer Expenditures Survey. By ages 55-64, spending dipped to $56,000, and down again to $46,000 between ages 65 to 74. At 75 years and older, average spending was only $34,000, though health care expenses may spike up for many.

We are in our mid-50’s and live a modest but comfortable lifestyle, which currently costs us about $4,500 a month, in addition to housing. We rent a smaller, two-bedroom house (about $1,500 monthly), and share a single gas-efficient car ($370 a month, including gas, insurance and repairs). But we eat well, own some nice things, and have plenty of fun—mostly free or cheap outdoor activities. And our living expenses run about 25% above the national average for our age.

This past year we moved to our ideal retirement location. So we’ve had to spend a bit more than usual due to the relocation. But these have generally been one-time home or personal expenses—not recurring expenses that would inflate our lifestyle forever more.

Health care costs remain a concern, since we are too young for Medicare. Fortunately, I was able to get coverage through my wife’s retirement health plan, thanks to her former career as a public school teacher; we pay $1,100 a month on average for premiums, co-pays, deductibles and the like. That’s one of our larger expenses, but it is manageable, for now. (For more on our spending in early retirement, see my blog here.)

If you’re willing to live in a cheaper area, buy used, and eat simpler, you can probably live on much less than we do. On the other hand, if manicured retirement communities, luxury vehicles, and international travel are your idea of retirement living, you could need quite a bit more. In most surveys of consumer expenses, the biggest items are housing and transportation. So, if you want to optimize your retirement lifestyle, start with your home and vehicle.

Without a complete understanding of how much it costs you to live, your retirement planning can’t get off the ground. The best way to determine your expenses is to actually keep track of them for at least a year, as you approach retirement. You can record expenses using dedicated tools like Quicken on the desktop or Mint on the web, or you can use an electronic spreadsheet or paper journal.

As an engineer, tracking expenses was second nature to me. But what if you aren’t the detail-oriented type? You could estimate your expenses based on those government averages above, but in the long run you’ll need more accuracy to be confident about your own situation.

One approach is to sit down with your checking and credit card statements, and use them to estimate a monthly or annual amount for each important budget category. You can start with this short list: housing, transportation, food, health care, entertainment, and personal expenses. Just don’t forget those less-frequent items such as home and auto repairs, vacations, and property taxes!

Your retirement savings “number” gets a lot of press. But even more important than that is your expense number. Understanding your expenses is a critical stepping stone to building wealth and retiring comfortably. If you still don’t know where your money goes, why not get started today?

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. This column appears monthly.

MONEY early retirement

4 Secrets of Financial Freedom

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Feng Yu—Alamy

You can shorten the path to early retirement if you start with the right strategies.

Ever since I retired at age 50, I’m often asked how I managed to reach financial security. Looking back, I see that the key factors fall into four categories—family support, career choice, money management, and personal habits and attitudes. Here’s how you can use these building blocks to reach your goals.

Start from a Strong Foundation
Some of us were fortunate to start out in families that instilled integrity, prudence, and hard work. If that’s your experience, you can be grateful. But, if not, then it’s still within your power to cultivate those qualities now. Not only will that create the conditions for your own financial success, but it will benefit everyone around you as well.

Throughout you will need patience. Typically the personal and financial decisions that will pay off in the long run require sacrificing a little today. Patience helps you live with the reality that true rewards usually require some short-term discomfort.

Choose a Career Wisely
Your choice of career is one of the most important decisions you’ll ever make. You need to love your work if you want to be great and prosper from it. So pay attention not only to your gifts, but to what makes you enthusiastic about getting up in the morning. Then, find a career path that plays to those strengths.

If you’re just starting out, and it suits you, a high-paying career in a technical or professional field will clearly advance your cause. Competence in math or technology can be a first-class ticket to building wealth. But, if that’s not possible, at least be aware of the financial implications of your college education and early career choices. A graduate in an esoteric major with five digits of student debt starts out life doubly handicapped. You can pursue your passions, integrate them with a professional track, and stay out of significant debt—but only if you make informed choices.

If you’re already in a career, look for mentors and other professional relationships that complement your skills and personality. Having been on both sides of the equation now, I can tell you that older, more experienced people generally enjoy counseling a talented and enthusiastic newcomer. It’s a relationship that pays dividends on both sides. So be open to wisdom when it’s offered. You don’t have to take every piece of advice, but it can be your starting point.

Learn to Manage Money
You might start out with a great family foundation. You might have a high-paying career that you love. But unless you live on less than you make, it won’t put you any closer to financial freedom. In fact, if you develop expensive tastes in houses and cars, and need to look as affluent as your neighbor, you could wind up worse off financially—no matter how much you make. You can start heading in the right direction by simply tracking your expenses, as well as learning about saving and budgeting. Identify the few areas where money spent truly pays off in better quality of life for your core interests. Spend there, and cut back everywhere else.

Next, find a mentor to help you become a confident investor. You need to master any fear of stocks, so you can profit from them in the long run. Offset the risk of stocks by allocating into other asset classes as well. Start small and carefully, but do start. Learn and abide by a few bedrock investing principles: diversification, patience, simplicity, low expenses. Track your net worth and your overall portfolio return each year, so you know what direction you’re going, and why.

Related: Find the right mix of stocks and bonds

Once your career and finances are on track, you can explore more entrepreneurial paths for wealth building—perhaps by owning a small business or real estate. These can leverage your time and money, getting you to financial independence years earlier. They can be fun and rewarding too!

Keep Your Perspective
Even with all these potent ingredients for success, be sure to take life one day at a time. Again, cultivate patience. You’ll need it for the long stretches.

Remember the goal—financial independence —but don’t obsess on it. Don’t sacrifice the present for the future; it won’t turn out as planned anyway. Make time for your loved ones and meaningful activities, even if you must work longer in the end. As great as it is to achieve financial freedom and retire early, you don’t want to arrive there having missed out on life along the way.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. This column appears monthly.

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