EarlyRetire Pro Help Contents

Press F1 to get context-sensitive help for any active control on any screen.

Overview
Getting Started
New Changes in This Release
Frequently Asked Questions
Tax Effects and Assumptions
Distribution Algorithm
Glossary

Annual Savings Contributions
Assets at Retirement Age
Beginning Status
Calc Buttons
Client/Consultant Detail
Deduct Taxes from Savings
Distribution Start Age
Financial Events
Graph
Import/Export Assets
Inflation
Interview
Leftover Assets at Death
Life Expectancy
Loan Calculator / 72(t) Calculator
Net Retirement Income
Optimization Settings
Other Taxable Income
Plan Report
Portfolio Designer
Preserve/Consume Assets
Probability Analysis (Monte Carlo Simulation)
Retirement Age
Return On Investment (ROI)
Social Security Wizard
Start Distributions at Retirement
Tax Rates

 

 


EarlyRetire Pro Overview

EarlyRetire Pro is a tool for examining the long-term effects of financial decisions, discovering new options, and developing a tailored plan for financial independence. By modeling your current status and experimenting with financial choices and tactics, you can look into the future and discover ways to increase the value of your assets, explore the conditions in which you can retire, and determine the best way to accumulate and use your assets before and after retirement.

What's special about EarlyRetire Pro? There are many financial planners available that translate financial data you enter into a yearly plan. Generally, such planners require you know in advance how you intend to save and withdraw assets over your lifetime, and provide limited ability to evaluate alternatives. The EarlyRetire advantage is your ability to creatively experiment and optimize your financial plan using a highly flexible adjustment/recalculation process and a powerful algorithm that can be tailored to suit individual circumstances and explore tax-saving ideas. EarlyRetire allows you to quickly compare options and test ideas that will stretch your assets further. EarlyRetire's philosophy is that you control your destiny, and can make your dreams come true by using creative thinking and computer power.

Be aware that EarlyRetire Pro is only a calculator that mathematically projects the results of hypothetical inputs provided by you. It cannot predict future economic conditions, investment results, tax laws, entitlement changes, etc., and can in no way guarantee the success of any plan it is used to generate. Also realize that EarlyRetire involves a high degree of complexity which may be subject to both program and user error. EarlyRetire's results are not the same as advice. You should consult with a professional advisor for specific financial, tax, or investment advice.

The EarlyRetire Model

EarlyRetire models your financial future on a timeline starting with the present, at your current age with your current assets. It assumes you will invest those assets and make annual savings contributions to them until you reach "Retirement Age" (unless you start as already retired). At that point or at some point afterwards, you will begin drawing a retirement income, all or part of which will come from distributions of your invested assets, until you die. Both before and after you retire, your assets will grow depending on the way you invest them (your Return On Investment, or "ROI"), as well as the way they are taxed. There may also be other asset inflows and outflows along the way, including social security, pension income, college expenses, etc.

Figure 1 shows the relationship of these variables and how they fit together in EarlyRetire's model. The variables can be manipulated on EarlyRetire's main window, the Planner, shown in Figure 2. The red and blue colors in Figure 1 indicate how the variables are divided into the Planner's two main sections, Pre-Retirement and Post-Retirement, which EarlyRetire can analyze independently or together.

Figure 1. How the Planner variables fit into the EarlyRetire model:

You normally begin taking distributions from your retirement assets at your Retirement Age, however you can delay taking distributions by setting a separate Distribution Start Age. This gives you a period of “semi-retirement” during which you neither contribute nor withdraw retirement assets.

Variables for planning Pre-retirement and Post-retirement are contained within two separate sections on the Planner. If you're already retired, you can deactivate and close the Pre-retirement section. Note "Advanced Features" are enabled.

Figure 2. The Planner:

Each variable is dependent on all the others. If you change one variable, another must change to compensate. For example, reducing your retirement age will require you either live on less income, earn a higher post-retirement ROI, or accumulate more savings before retirement--requiring either greater annual savings contributions or a greater pre-retirement ROI, etc. One of these will need to be recalculated (by pressing its Calc button). EarlyRetire allows you to instantly recalculate the variable of your choice. Start by entering the known quantities, then experiment with the unknowns until the final picture is both desirable and realistic.

When you first enter information on the Planner or whenever you edit a variable on the Planner, the red message Choose a variable to recalculate is displayed at top, indicating that the variables displayed do not "add up" to the specified retirement goals. You must thus select a variable on the screen to be recalculated by EarlyRetire. When you click on the Calc button of your selected variable, EarlyRetire will use all the other variables to calculate the field you selected, after which it will display a green Plan Complete message, indicating that all numbers now fit together mathematically and represent a workable plan.

Each time you change a variable, the plan is altered and another variable must be recalculated to make it complete again. EarlyRetire employs a sophisticated algorithm that re-optimizes the withdrawal of retirement assets (to maximize your retirement income) every time it recalculates any variable.

Example:
After entering your current status and desired retirement income, you press the Calc button next to Return on Investments (ROI). EarlyRetire calculates you would need to earn a 35% ROI to achieve your retirement goals, a value you feel is unrealistic. You specified a retirement age of 55 but would be willing to retire later. You can do one of several things: If you want to see what ROI would be required if you retire at 60, increase the Retirement Age to 60, and recalculate the ROI. Or since you're flexible with your retirement age, you could set the ROI to a value you feel is realistic (e.g. 7%) and press the Calc button next to Retirement Age. That will show you when you can retire with a 7% ROI. If you don't want to extend your retirement age, you could recalculate another variable, like your Taxable Savings Contribution. EarlyRetire gives you complete flexibility.

Each time you calculate a variable, you can generate a Plan Report (with Graph and charts) that details how the plan would be implemented. A "Sample Plan" is provided in your EarlyRetire folder for you to practice and experiment with.

EarlyRetire does not make specific investment recommendations but does provide a Portfolio Designer to help you experiment with asset allocations and see the effect they would have on your ROI and probability of success.

It is strongly advised that you review Tax Effects and Assumptions and Distribution Algorithm in order to understand how EarlyRetire applies IRS rules to your assets. It is especially important that you properly categorize your current assets and contributions when you enter them. There is also a Glossary to help explain terms used in this text.

 


Getting Started

It is highly recommended you read the Overview before proceeding.

When creating a new plan, you'll first be prompted to enter your birthdate. If the plan will be for a couple, enter the birthdate of the partner who will have the most assets in his or her name at retirement (typically the higher earner).  Next, the Interview will appear. The Interview provides an informative guide to walk you through the process of obtaining and entering the data you'll need. At the end of the Interview, press Finish and all your information will be pasted into the appropriate fields on the Planner.

Once the Interview has disappeared and your variables are on the Planner, check them over to make sure your current asset values, tax rate settings and social security values are correct. Values such as these that are unlikely to change should be verified before proceeding, along with setting an inflation value you're comfortable with.

Next, you should ask yourself if there will be any special Financial Events in your life you haven't yet included. These are things like making a large payment, sending kids to college, buying a second home, getting a reverse mortgage, making a future Roth conversion, receiving an inheritance, etc. You can't be expected to think of everything in advance, but do your best, and you can always make changes later. Financial Events are added by pressing the Add button above the Financial Events list, and can be changed (or deleted) by double-clicking their name in the list. You can also temporarily deactivate Events in the list by unchecking them... a great way to experiment with alternative ideas.

Once you've got the initial data entered, now comes the fun part! The Planner will be displaying the red message, Choose a variable to recalculate. You can choose any variable that has a Calc button next to it. Whichever one you choose will be recalculated and the Planner will then display the green message Plan complete. That doesn't mean the plan is to your liking; it's simply one that will mathematically work. It's likely that the variable you just recalculated now shows a value that is unacceptable to you, like an ROI of 43%, or a Retirement Age of 73, or a Net Retirement Income of $17,000. Now you must experiment with other variables to see what compromises you are willing to make. EarlyRetire makes this easy by letting you adjust and/or recalculate any applicable variable. As you experiment, you'll gain an understanding of what choices truly make a difference, and you'll probably be surprised by what is possible in your life.

When you have a plan that is doable and satisfies your goals (or is close), click the View button. The Plan Report shows in great detail what specifically you'll have to do in future years to execute the plan. Pay particular attention to the Savings and Distribution Schedules. If you click on a row in either of these schedules, an annual detail appears in the lower section of the report window that shows specifically what you'll need to do in any given year. You can see from this report how EarlyRetire has determined the most efficient way to utilize your assets in retirement, which gives you better understanding with which you can go back and refine things even more. Remember to save your plan(s). A plan will evolve over time, and you'll want to revisit it as things change and you get new ideas.

How to optimize your plan: Suppose you've determined via the Planner when you can retire, how much you'll have in retirement, etc. You may be able to improve this plan. One place to experiment is the Optimization Settings. By making adjustments that control 72(t) plans, borrowing, tax-bracket leveling, Reality Retirement Planning, etc., you can continue to fine tune. Make adjustments to the Optimization Settings, "Apply" them, and then recalculate a variable on the Planner. Other places to experiment are your Financial Events and Annual Savings Contributions to determine which asset categories are most efficient for contributing to or withdrawing from. Check tax rules for certain events; for instance, you can use tax-deferred assets before you're 59½ for your kids' college expenses. Optimization is a key part of the planning process, so use your imagination and explore!

See Frequently Asked Questions for more tips.

Press F1 to get context-sensitive help for any active control on any screen.

For technical support, you can email questions to ersupport@hamiltonsoftware.com.

 

 


New Changes in This Release

Major changes in Version 2018:

Major changes in Versions 2015 thru 2017:

Major changes in Versions 2006 (first Pro version) thru 2014:



Frequently Asked Questions

I changed a variable on the Planner, then pressed the Calc button next to it. The value simply changed back to what it was. What am I doing wrong?

What does it mean when I get the message "EarlyRetire was unable to calculate this variable to a reasonable value..."?

What does it mean when I get a message that my assets will become negative and my plan requires borrowing?

Why does the report show that I am "borrowing" money from an asset category to pay for a Financial Event rather than just increasing the distribution from another asset category?

What interest rate does EarlyRetire apply when it borrows?

Why does my plan borrow in the final year(s) when it doesn't need to?

How do I use the “Subsidized Healthcare Premium” Financial Event to model the tax credit I can get through the Affordable Care Act?

Why do I sometimes get different recalculation answers from the same variable settings or the same answer for different variable settings, depending on which variable I recalculate?

How should I include my home as an asset?

How can I model a reverse mortgage?

Why does my $10,000 Financial Event appear on the Report Savings Schedule as $9,700?

Why isn't my Financial Event value, which I entered in Actual Dollars, exactly the same value on the Report?

How can I avoid the 10% early withdrawal penalty?

Why isn't EarlyRetire using 72(t) when it looks like it should?

When I have the "Preserve Assets" setting on, I expect my assets to remain constant over the distribution period, but the graph shows them fluctuating. Why?

My Taxable Assets are zero, yet they appear to be generating growth income...?

How does EarlyRetire apply penalties for early withdrawal from tax-deferred savings or failure to take Required Minimum Distributions (RMDs)?

If your question is not answered in this Help file, you can email it to nesupport@hamiltonsoftware.com.

I changed a variable on the Planner, then pressed the Calc button next to it. The value simply changed back to what it was. What am I doing wrong?

The variables on the Planner all fit together mathematically, and the Planner can calculate any one variable if it knows all the rest. That means you can set any of the variables to any values you want, but then you have to pick one variable to be recalculated to make everything add up correctly. When you press a Calc button, you are asking the Planner to calculate the variable next to the Calc button you pressed. What you usually want to do after you have changed one or more variables is to calculate a different variable from the one(s) you changed. For example, suppose you want to see how reducing your retirement age will affect your post-retirement income. To do this, you would change the Retirement Age value and then press the Calc button next to Net Retirement Income. The idea is to set the variables which you are least flexible with and have EarlyRetire calculate one(s) you are most flexible with.

What does it mean when I get the message "EarlyRetire was unable to calculate this variable to a reasonable value..."?

Some variable combinations produce unreasonable or unrealistic results; for example trying to turn one dollar into a million dollars in two years would require an ROI in the thousands, or producing a $50,000 retirement income from a $100/year savings contribution would result in a retirement age that exceeds your life expectancy. When you get this message, take a close look at all of your variable settings and make sure they make sense. Sometimes you might get the message "EarlyRetire was unable to calculate this variable to an exact value and had to adjust your Net Retirement Income". This simply means that accuracy limitations of the selected variable calculation required that another variable be adjusted slightly to compensate.

What does it mean when I get a message that my assets will become negative and my plan requires borrowing?

By default, EarlyRetire's algorithm may borrow money (accrue a negative asset balance) in your distribution years for any of several reasons...

- EarlyRetire calculates your Net Retirement Income as a constant, inflation-adjusted income so that you receive the same annual amount for the entire period you receive it. If your assets increase considerably during your retirement (usually due to a Financial Event), EarlyRetire will effectively borrow from your later assets in order to provide a steady income in earlier years.

- EarlyRetire tries to even out your tax-deferred distributions over your lifetime so you stay in the lowest tax bracket. It may accumulate a temporary deficit in your taxable assets (simulating a loan) in order to accomplish this.

- You may have a Financial Event that withdraws more money from an asset category than you have in that category. If the money is never paid back by a future Financial Event, the deficit is retained indefinitely in that category and EarlyRetire accumulates a surplus in one of the other categories to compensate. This situation is not necessarily realistic (for instance, you may not be able to actually borrow money from within a tax-deferred account). You can correct this situation by rearranging your Financial Events or by making them "generic".

When your assets become negative, you have effectively taken out a loan to pay your income, and will pay the loan back with assets you acquire in later years. When this happens, your ROI for the applicable period becomes the default interest rate you are charged for the assets you borrow. You can change this interest rate in the Optimization Settings. The Report shows both the annual and cumulative deficit as "Amount Borrowed" (and you will usually see a negative asset balance in an asset category). Loan balances are shown on the graph as negative asset balances which usually return to zero before or at the end of the graph.

EarlyRetire borrows in these cases by default because it assumes you will probably be able to borrow against your assets (e.g. a home equity line of credit), and EarlyRetire pays the loan back (with interest) using your own assets. If this is not desirable to you, there are several ways to reduce or eliminate borrowing in your plan. First, turn off the Borrowing Level and Force Borrowing toggles in the Optimization Settings. If you turn these toggles off and still have undesired borrowing, you need to re-examine your Financial Events to ensure you are not withdrawing more than you have in an asset category. Making your Financial Events "generic" where possible will likely eliminate any remaining borrowing.

Why does the report show that I am "borrowing" money from an asset category to pay for a Financial Event rather than just increasing the distribution from another asset category?

You specified you wanted to pay for the event using a specific asset category and you don't have enough money in that category to cover the event. What EarlyRetire does is report to you what your plan will do to that asset category; it doesn't assume how you intend to handle that situation. If it is your intent to draw the money from any available source without borrowing, you should make the event "generic". Generic events are withdrawn from assets in the order described in the distribution algorithm.

If you turn down the Borrowing Level in the Optimization Settings, EarlyRetire will try to eliminate borrowing by using money from other asset categories. In many cases, this will eliminate the borrowing. If not, the deficit is retained indefinitely in that category and EarlyRetire accumulates a surplus in one of the other categories to compensate. If you click on the final year in the report, you'll notice that it retained enough assets in the other categories to cover your "loan". So you were effectively borrowing from yourself the whole time.

What interest rate does EarlyRetire apply when it borrows?

By default, EarlyRetire uses your ROI (either pre-retirement or post-retirement depending on the applicable period) as the interest rate charged on negative asset balances. You can set this interest rate yourself (the "Interest Rate charged on borrowed funds") in the Algorithm Settings.

Why does my plan borrow in the final year(s) when it doesn't need to?

EarlyRetire tries to spread your tax-deferred assets over your lifetime to exploit your standard deduction and personal exemptions in every year to minimize your overall taxes. If your last year's distribution does not include enough tax-deferred to exploit these exempt amounts, the plan will borrow money the prior year so that enough tax-deferred will be left to exploit the exemption and pay off the loan in the last year. You can control this in the Optimization Settings either by reducing the Borrowing Level or by setting Tax-Deferred Withdrawals to No More than Required.

How do I use the “Subsidized Healthcare Premium” Financial Event to model the tax credit I can get through the Affordable Care Act?

First, create a Financial Event using the Event Wizard and select “Subsidized Healthcare Premium”. It will ask you for a premium amount.

The amount of the tax credit is based on the premium for the second lowest cost silver plan (SLCSP) in the exchange and area where you’re eligible to purchase coverage. If you choose a different plan, you’ll still receive the tax credit, but you will pay (or save) the difference in cost between your plan and the SLCSP.

Therefore, to accurately determine your subsidized premium, find the SLCSP in your exchange and enter that annual premium as the amount for the “Subsidized Healthcare Premium” Event. If you are already retired and using a different plan, create a second “Health Insurance” Event specifying the annual difference in cost of the two premiums.

EarlyRetire will adjust the premium of the first Event based on your taxable income each year. The lower your income, the lower the premium will be. Use options in the Optimization Settings to try lowering your income in earlier years, such as Defer taxable income until age 65, to see what the effects will be. Your actual projected premium costs for each year can be seen in the Report.

Why do I sometimes get different recalculation answers from the same variable settings or the same answer for different variable settings, depending on which variable I recalculate?

If you’re using self-calculating Financial Events (Medicare Premiums or Subsidized Healthcare Premiums), there are sometimes multiple values for key variables that will produce the same outcome over time. That’s because a higher taxable income will cause a higher premium to be charged in these Financial Events, which negates the effect of the higher income. For instance, a 3.7% ROI might produce the same Net Annual Income as a 4% ROI because the increase in earnings will go towards higher Medicare premiums. You may see ambiguous results because there are multiple paths from point A to point B.

How should I include my home as an asset?

If you simply list your home's value as a tax-free asset, EarlyRetire will utilize it to produce retirement income as it would any other asset. If you are consuming your assets over your lifetime, your home will be gradually consumed. Generally, it's not realistic to include your home this way, but there are ways to utilize its equity in retirement. In the earlier years of retirement, it's very handy to borrow against your home equity in order to reduce income taxes, and this is one area where EarlyRetire's Borrowing feature can be of great help. In your later years, you may pull equity out of your home and buy a smaller home, or you may use a reverse mortgage to use its equity to pay for living expenses. Either of these cases can best be modeled by a Financial Event, as well as other possibilities (moving to a retirement home, selling to your children, etc).

How can I model a reverse mortgage?

Create a Financial Event using the Financial Event Wizard, and select Reverse Mortgage Income as the event type. The Wizard provides a link to a website that allows you to calculate the proceeds from a reverse mortgage depending on your age and the value of your home. The calculator uses your birthdate to calculate your age, so if you want to start your reverse mortgage at a future age, you'll need to adjust the birthdate you enter on the calculator as though you were that age today. Use the current value of your home since the event will be represented in today's dollars. The event models a reverse mortgage paid as an annuity for the rest of your life.

Why does my $10,000 Financial Event appear on the Report Savings Schedule as $9,700?

Amounts shown in the Savings Schedule are after-tax. EarlyRetire cannot calculate your income tax during the pre-distribution period because it doesn't know your income or deductions, so it simply applies estimated tax rates (federal and state) directly to all applicable cash flows. In the Distribution Schedule, EarlyRetire calculates your income taxes, so income and event amounts are shown before taxes and taxes are shown separately.

Why isn't my Financial Event value, which I entered in Actual Dollars, exactly the same value on the Report?

Amounts entered in actual (future) dollars can sometimes contain minor rounding errors when displayed on the Report. The errors are due to partial-year adjustments made when the event begins mid-year, and have an insignificant effect on your overall results.

How can I avoid the 10% early withdrawal penalty?

There are several things to check... By default, EarlyRetire distributes enough tax-deferred income to take advantage of your standard deduction and personal exemption, even when you are under 59½. You can change this default setting in the Optimization Settings so such distributions will not be taken in years when a penalty would apply. To guarantee no early-withdrawal penalties, you can turn on the "Force borrowing to avoid early-withdrawal penalties" toggle in the Optimization Settings (but be aware that this may cause borrowing to occur), and make sure you have not created a Financial Event that forces a non-qualified distribution which is "Subject to Penalty". As an alternative to forcing borrowing, turn on the "Allow Flexible Borrowing" setting.

To allow EarlyRetire to automatically calculate a 72(t) SEPP plan, turn on the "Allow 72(t)" setting (in Optimization Settings). You can also create your own 72(t) Plan as a Financial Event.

You may also be able to add a Roth Conversion Ladder to your plan.

Why isn't EarlyRetire using 72(t) when it looks like it should?

There are several possible reasons...

- You may not have enough tax-deferred assets to cover the required 72(t) period at the parameters you specified (amortization interest rate, annuity factor, or life expectancy calculation). For instance, if your amortization rate is 7% but your ROI is only 5%, you will consume your tax-deferred assets faster than they grow, and you may run out before the end of the 72(t) period.

- You may have a Financial Event that withdraws more tax-deferred assets in one year of your 72(t) period than your 72(t) plan would allow you to withdraw. In this case, try reducing the "Amount of tax-deferred to use for 72(t)" in the Optimization Settings. By reducing the amount of assets dedicated to 72(t), the Financial Event may be able to be funded by your other tax-deferred assets. Or try using another asset category to fund the Financial Event.

- You may have a Financial Event that specifies a Roth conversion during your 72(t) period. Since rollovers of distributions from a 72(t) account are prohibited (a Roth conversion is considered a rollover), EarlyRetire will exclude the year in which that event occurs from consideration for 72(t) if the amount of the conversion is great enough that it would require assets needed for the 72(t).

When I have the "Preserve Assets" setting on, I expect my assets to remain constant over the distribution period, but the graph shows them fluctuating. Why?

You have one or more Financial Events that start or end during the distribution period (social security may be one of these). Since EarlyRetire makes sure your Net Retirement Income does not fluctuate, your assets may have to fluctuate to accommodate changes caused by events. When you elect to preserve your assets, EarlyRetire calculates your income so that you will have the same assets when you die that you do at your Distribution Start Age. If you have no financial event changes during that period, your inflation-adjusted assets will remain constant and the graph will be a straight line.

My Taxable Assets are zero, yet they appear to be generating growth income...?

When excess tax-deferred funds are withdrawn to satisfy a required distribution, the excess is deposited in the taxable category. If that money is withdrawn later in the same year (e.g. to pay taxes), it effectively passes through the taxable category, generating taxable growth income. The pass-through amount is not shown since its net effect is zero; only the growth income is shown as attributed to the taxable category.

You can also have positive growth on a negative balance if your loan interest rate is less than inflation.

How does EarlyRetire apply penalties for early withdrawal from tax-deferred savings or failure to take Required Minimum Distributions (RMDs)?

If your Distribution Start Age is above 70½, a pre-tax penalty equal to 50% of your RMD is charged to your tax-deferred assets each year you are over 70½ until your Distribution Start Age (since withdrawing the amount reduces the penalty, the amount subtracted is actually one third your RMD). See Distribution Algorithm for a description of how and when penalties are applied after your Distribution Start Age.

 

 


Tax Effects and Assumptions

It is necessary to make assumptions and simplifications in tax calculations for obvious reasons; tax rules are complicated and involve a large number of personal variables, and no one can predict what changes Congress may make to them in the future. EarlyRetire's approach is as follows:

Prior to your Distribution Start Age, the federal and state Tax Rate values are applied to taxable investment income as simple multipliers without regard for tax bracket structure, deductions or other income. You should therefore set these values to the tax rate you expect to pay on your unsheltered investment earnings. 

After your Distribution Start Age, EarlyRetire calculates your federal income tax each year by applying the downloaded current-year tax schedule, standard deduction, and number of personal exemptions applicable for single, joint (married filing jointly), or head-of-household filers (these numbers are adjusted for inflation each year to simulate anticipated adjustments in the tax schedules). It assumes that all post-retirement income is accounted for in the available EarlyRetire variables and Financial Events, that you will have no special deductions and no other dependents besides you, your spouse (if joint), and any additional dependents you have specified in Optimization Settings. This scenario may not exactly fit your circumstances, but it enables EarlyRetire to model the taxation of your assets to an accuracy reasonable for long-term planning. Pick the filing status that best fits your situation and use Optimization Settings to fine tune.

EarlyRetire uses three taxation categories to model the tax effects of asset and savings choices: Taxable, Tax-Deferred, and Tax-Free. This distinction is important to accurately model the growth and availability of your retirement funds, and allows you to compare options which may have important consequences with respect to your investment planning. The taxable status of the three investment types determines how taxation will be applied to both your current assets and savings through three taxable stages: contribution (the year in which you add an annual savings contribution), growth/earnings (each year in which an asset increases by the applicable ROI), and distribution (the year in which assets are paid out as retirement income). The program taxes the three categories as follows:

                     Contributions     Earnings     Distributions (withdrawals)
                          Taxed*          Taxed*           Taxed
                     ------------------------------------------------------------
Taxable                Yes              Yes                No
Tax-Deferred          No                No               Yes
Tax-Free              Yes                No                No

*Taxation of contributions and earnings is applied only if the Deduct Taxes from Savings setting is on.

Taxable:
These are assets which produce annual taxable income. They include ordinary interest-earning or dividend-paying investments (bank accounts, stocks, bonds, mutual funds, etc.) not contained within a qualified tax-deferred investment plan (but do not include municipal bonds in this category). Distributions (withdrawals) from this category are not taxed. Note: Since some long-term growth investments will be taxed mostly upon their sale, it may in some cases be more appropriate to designate such investments as tax-deferred, even if they are not in a tax-deferred account.

Tax-Deferred:
These are assets which produce no taxable income until they are withdrawn to pay for living expenses. This category normally refers to qualified tax-deferred plans designated by the IRS such as IRAs, Keoghs, 401(k), 403(b), and other employer-sponsored plans to which you or your employer contributes on your behalf. Contributions to tax-deferred assets are usually deductible, and EarlyRetire treats all tax-deferred contributions as deductible. Distributions are always taxed, and distributions taken before you are 59½ are usually penalized an additional 10%.

Tax-Free:
These are assets which will never produce a tax liability. Roth IRAs and municipal bonds go here, as well as your equity in your home (you probably don't want to include your home as an asset however, unless you plan to use its value to provide retirement income). There are special rules concerning the taxable status of Roth distributions; the earnings on Roth assets are usually taxable and subject to a 10% penalty if withdrawn before you are 59½. EarlyRetire treats whole life insurance equity the same as Roth earnings.

These categories are simplifications of complicated tax laws, and do not fully account for all the tax effects of all types of assets. The idea is to find the category which best fits each of your investments. Consult your tax advisor for guidance if you're not sure what category to place an asset in. The Interview provides a guide to help you place your assets in the best categories.

See the Distribution Algorithm description for an explanation of how the different asset categories affect your income after retirement---how they are taxed, penalized, and most efficiently distributed.

Required Minimum Distribution Calculation:
EarlyRetire calculates your RMD for each year using the life expectancy table (single person to age 70, uniform beyond age 70) to divide the value of your tax-deferred assets (tax deferred assets / (life expectancy - age)). Since your tax-deferred assets may contain those of both you and your spouse, there may be in actuality, two separate RMDs applicable to you. If your ages are different, the RMD will begin when the older partner reaches age 70 and be calculated based on an estimate of the older partner's portion of the tax-deferred assets. When both partners are 70, the RMD will be calculated based on the total of the remaining tax-deferred assets. There are a number of factors that can make EarlyRetire's estimated RMD inaccurate, and it should not be relied upon for anything other than high-level planning. Hire a tax advisor to determine what RMD laws apply to you and what your RMD(s) should really be.

Warning:
EarlyRetire warns you but does not prevent you from specifying IRA contributions when you are over 70½, or contributing more than the IRS-specified annual limits to IRAs or 401(k)s.

A note about ROIs:
Return on Investment (ROI) values are treated as constants throughout calculation periods. This implies that your asset allocation and market conditions remain constant, even though this is unlikely to be the case in reality. EarlyRetire does allow separate ROIs to be used for pre- and post-retirement. You can use the Portfolio Designer to design separate pre- and post-retirement portfolios and estimate average ROIs for those periods. The Probability feature uses Monte Carlo simulation to simulate fluctuating ROIs for testing purposes.

 

 


Distribution Algorithm and Applied Tax Rules

The distribution period is the post-retirement period during which assets are distributed (withdrawn) to pay living expenses. Differing tax treatment of the three asset types and the IRS rules pertaining to distributions are critical considerations to making effective use of your assets after retirement. EarlyRetire attempts to maximize the value of your distributions by minimizing taxes and penalties over the long term. While EarlyRetire's strategy is fairly detailed and will be advantageous and/or informative for most people, please bear in mind that this one-size-fits-all approach may not necessarily be ideal for your individual circumstances. The algorithm can be extensively tailored via the Optimization Settings, and there may be other ways to improve your strategy depending on your circumstances.

Be aware that it may be necessary to incur tax-related penalties in order to maintain a constant Net Retirement Income or to maximize income in the long run. Also remember that EarlyRetire's simulation of tax laws is generalized; you should consult a tax professional during your retirement years rather than rely entirely on EarlyRetire's calculations.

To obtain your after-tax Net Retirement Income, EarlyRetire uses the following rules (those marked with asterisk can be adjusted using Optimization Settings):

- Financial Event amounts, Social Security, and Other Taxable Income are added to or withdrawn from assets at the beginning of each year. Distributions are then withdrawn to provide retirement income and income tax required for the year, and the remaining assets are adjusted for earnings growth and inflation. Taxes are then withdrawn at the end of each year.

- Enough tax-deferred assets are normally withdrawn to take advantage of your personal tax exemption and standard deduction (which essentially makes this portion of your income tax- free). If you are under 59½, there will be a 10% penalty on these withdrawals, but it is usually beneficial to take them anyway.*

Over age 59½:

- Distributions are withdrawn from assets in the following order: taxable first, tax-deferred second, and tax-free last, with the following exceptions...

- Tax-deferred assets are withdrawn first to meet any Required Minimum Distribution (RMD) requirements (an RMD is required if you are over 70½). RMD is recalculated each year based on recalculated life expectancy (see RMD in Tax Effects and Assumptions). If the RMD exceeds the amount needed to provide your Net Retirement Income and income tax for the year, the excess RMD withdrawn is added to your taxable assets.

- EarlyRetire will try to conserve enough tax-deferred assets throughout the distribution period to exploit your personal tax exemption and standard deduction in every year of your retirement.* This practice minimizes taxes paid over the long term.

- If tax Auto-Leveling* is active, EarlyRetire will try to spread distribution of tax-deferred assets throughout the distribution period in order to minimize exposure in the higher brackets.

- If "Defer taxable income until age 65"* is active, the general order of withdrawal is: taxable first, tax-free second, and tax-deferred last (up to age 65).

Under age 59½:

- Since Roth IRA earnings withdrawn before age 59½ are taxed as income and penalized an additional 10% (this rule only applies to Roth earnings, not your Roth contributions), Roth earnings are not withdrawn before you are 59½ unless all your other assets are depleted. Roth earnings are calculated using the proportions of your initial Roth assets and annual Roth contribution (specified in the Interview). If you did not specify any Roth assets, all your tax-free assets are treated as non-Roth. If you specified Roth assets but did not specify "Roth contributions made to date", all your Roth assets are treated as Roth earnings. Whole life insurance is also treated like Roth because of similar restrictions. Roth conversions are treated as Roth earnings until the 5-year wait period has elapsed (except they are never taxed when withdrawn), then they are treated as tax-free.

- You can take penalty-free withdrawals from a 401(k) (or other employer-sponsored plan) before you're 59½ if you retire after age 55. If you have specified 401(k) funds to use early and you meet the qualifying criteria, EarlyRetire will use them between ages 55 and 59½ before it uses your tax-free assets.

- Distributions are therefore withdrawn from assets in the following order: taxable first, qualified 401(k) second, tax-free (except Roth earnings) third, tax-deferred fourth, and Roth earnings last, with the following exceptions...

- If you run out of taxable and qualified 401(k) assets before you reach 59½, EarlyRetire will try to use your tax-deferred assets penalty-free before it uses your tax-free assets.* The 10% early withdraw penalty can be avoided by using the 72(t) rule (aka "SEPP" or "annuity rule"), wherein a prescribed distribution amount becomes the exact required distribution for each year. EarlyRetire will use the 72(t) method when your available taxable assets are consumed* and only if you have sufficient tax-deferred assets throughout the 72(t) period to make the required distributions. There are several variations on the use of 72(t) which can be tailored in the Optimization Settings.

- If you don't have sufficient assets to use the 72(t) method, EarlyRetire will distribute your non-Roth tax-free assets first, and will apply a 10% penalty to all tax-deferred assets and Roth earnings distributed before you are 59½.

- If "Defer taxable income until age 65"* is active, the general order of withdrawal is: taxable first, tax-free (except Roth earnings) second, qualified 401(k) third, tax-deferred fourth, and Roth earnings last.

*You can control these features by adjusting the Optimization Settings.

 

 


Optimization Settings

Report Formatting

Align schedules to calendar years specifies how the Report is generated. When this toggle is on, both the Savings and Distribution schedules in the Report will be aligned with the calendar year (each full year in the report is aligned to a calendar year, which means the first and last year in each schedule may be a partial year). If the toggle is off, the Savings schedule begins at the current (plan) date and the Distribution schedule begins at Distribution Start Age, and each schedule progresses in one-year increments from those dates. The Mo and Day fields allow you to specify the beginning of the calendar year to use when the toggle is on.


Tax Leveling

Tax Leveling is a strategy to minimize the taxes you pay over your lifetime by keeping your highest tax bracket as low as possible. You can control this to some extent manually by selecting a minimum tax bracket as follows:

While over 59½, always withdraw tax-deferred thru at least: It is generally good to exploit the standard deduction and personal exemption to withdraw tax-deferred assets tax-free. If you have little income other than your asset distributions, you can usually take a distribution each year from your tax-deferred assets (normally taxable income) without paying any tax on it. If you have a lot of money it can also be beneficial to force withdrawals up to higher tax brackets in order to keep your tax brackets level. It is more efficient to pay taxes in one or two brackets over your lifetime than to pay little or no tax in some years and in very high brackets during others. When one of these toggles is set, EarlyRetire attempts to hold tax-deferred assets so it can exploit the selected bracket in every year of retirement, thus "leveling" (and minimizing) your total taxes.

The Automatic Leveling feature changes the way your assets are distributed after age 59½ so as to maintain consistent income tax liability from year to year. Leveling taxes eases making estimated payments and can lower your overall tax liability by keeping you in a single bracket over your lifetime. There are two options for auto leveling: Smooth (even payments), and Defer (postponing higher tax liability to later in life). Both methods attempt to keep you in a single bracket throughout your lifetime, but you may find one benefits your bottom line or simply suits you more than the other. Note that Financial Events can disrupt tax leveling, so the results may not be perfect.

Allow these tax-deferred withdrawals while under 59½: This toggle permits the algorithm to make tax-deferred withdrawals as required for tax leveling when you are under 59½. Such withdrawals before age 59½ will be subject to a 10% early withdrawal penalty. For most people, it is still best to take the early distributions and pay the penalty because of the tax savings, but this may not be the case for everyone.

Convert excess Tax-Deferred distributions to Roth IRA: Tax-deferred distributions in excess of what is needed for your required annual income may be taken to take advantage of the exempt amount or specified tax bracket as described above. EarlyRetire will normally add such excess amounts to your taxable assets, but if you turn on this toggle, it will add these amounts to your tax-free assets, simulating a Roth conversion. This is advantageous in most circumstances, but remember that implementing this plan requires you to actually make Roth conversions in the years specified. Note: EarlyRetire will not convert amounts withdrawn to satisfy an RMD or 72(t) withdrawal, and treats any annual conversions it does make according to Roth Conversion restrictions.

Defer taxes on Leftover Assets until death: If you have Leftover Assets at Death, this toggle will attempt to leave only tax-deferred assets to your estate in order to minimize your tax liability while you're alive. If the toggle is off, your assets will be consumed in the order that maximizes their total value, which may leave most of your tax-free assets to your estate, and require you to pay more taxes (thus reducing your spendable income) while you're alive. Turning on the toggle will give you a higher income from your assets, but leaves the tax liability to your heirs.

Defer taxable Income until age 65: Under the Affordable Care Act, you can qualify for subsidized health insurance up to age 65 if your taxable income is under a certain amount. The amount of the subsidy you receive increases as your income decreases, and can result in a substantial savings on your healthcare costs. When this toggle is on, EarlyRetire uses taxable and tax-free distributions first to pay living expenses while you and your spouse are under 65, deferring tax liability until later years. Note that other settings in this section take priority over this one so you can adjust the amount of deferral. Use this setting in conjunction with the "Subsidized Healthcare Premium" Financial Event to explore the effects of this strategy.


Additional Dependents/Tax Rate Adjustment

Additional Dependents/Deductions: This allows you to add one or more personal exemptions to your tax deduction between a specified start and end date. This can be used to add children or other dependents still living with you after you retire (since EarlyRetire only calculates taxes during your distribution years, additional dependents will have no effect on pre-retirement calculations). It can also be used to account for other deductions such as blindness, charitable gifts, etc.

Adjust post-retirement tax rates: After your Distribution Start Age, EarlyRetire calculates your federal income tax using the current-year tax schedules adjusted for inflation each year, and your state income tax using the State Tax Rate value specified on the Planner. Since the tax rates themselves are often adjusted by Congress, you may feel the current-year rates are lower or higher than what you expect over the long term. You can use this field to add a percentage adjustment (for instance, a positive 10% adjustment will increase all federal tax rates applied during your post-retirement years by 10%). This adjustment is only applied to federal rates and only during distribution years; you control the state rate by the State Tax Rate, and the pre-retirement federal rate by the Federal Tax Rate values on the Planner.

Use AMT (alternative minimum tax): EarlyRetire will automatically determine whether you are subject to AMT and apply this method when it calculates your federal income tax each year (this normally only affects high incomes in the over $200,000 range). Since EarlyRetire's income tax calculation is based on a number of simplified assumptions, you can prevent the AMT method from being applied, if you know you will not be subject to it, by turning this toggle off.


Reality Retirement Planning (RRP)

Reality Retirement Planning assumes that a household's real spending will voluntarily decrease incrementally throughout retirement as indicated by the U.S. Bureau of Labor's Consumer Expenditure Survey, and adjusts spending estimates accordingly. The survey suggests you can spend more in early retirement because you will spend less in later years. When this switch is on, EarlyRetire decreases Net Retirement Income by 3% per year between ages 55 and 75 (a conservative simplification of trends reflected in the Consumer Expenditure Surveys). This results in a larger Net Retirement Income at Distribution Start Age, but a smaller income (in today's dollars) after age 75.

You can also specify a minimum for the Net Retirement Income to prevent it from falling below an anticipated minimum requirement (which will have the effect of reducing the additional income in earlier years). You can also adjust the rate at which Net Retirement Income is reduced each year between ages 55 and 75. The default for this rate is 3%, as determined by the U.S. Bureau of Labor's survey.


Early IRA Withdrawals Using 72(t) (SEPP)

Allow 72(t) to be used will allow or prevent EarlyRetire from using the 72(t), or SEPP (Substantially Equal Periodic Payments), method to distribute IRA assets without penalty when you are under 59½. Using the 72(t) method can be very advantageous, but rules must be followed carefully. During the 72(t) period you cannot contribute to the IRA, and the prescribed distribution amount must be strictly adhered to or the IRS will charge retroactive "recapture" penalties (for instance, if you have an unexpected financial need in a 72(t) year which requires you to withdraw more than the prescribed amount, you will be subject to the recapture penalty). When Allow 72(t) to be used is on, EarlyRetire will use the 72(t) method after your available taxable assets are consumed and only if it determines you will have sufficient tax-deferred assets throughout the 72(t) period to avoid the recapture penalty.

Encourage/Accelerate 72(t): You can increase the likelihood you'll be able to use 72(t) by having more assets available to combine with 72(t) distributions. This toggle forces the algorithm to try to use 72(t) immediately, before you have consumed any assets. This will make the 72(t) period longer, exposing you to more risk, but can save you money in some circumstances. Note that it does not guarantee you will be able to use 72(t); you may simply not have enough assets in the right amounts to use 72(t) at all.

Don't start 72(t) until: You can set a minimum age at which EarlyRetire will consider using 72(t). It may be wise to postpone starting a 72(t) plan if you don't need one, because of the inherent risks and yearly requirements.

72(t) Method: The IRS allows three methods for determining the required 72(t) distribution: Minimum Distribution (using the standard RMD calculation), Amortization (amortizing your tax-deferred assets over your life expectancy using a specified interest rate), and Annuity Factor which amortizes your tax-deferred assets using an appropriate annuity factor from an annuity table. The Minimum Distribution method is the least risky because you cannot run out of tax-deferred assets, but it produces a distribution amount that may be too low to make 72(t) possible for you, and the amount must be recalculated each year. Amortization and Annuity give you more flexibility since you can choose the interest rate or annuity factor you use, and give you a higher annual payment that doesn't change. But if the market takes a dip, your IRA could run out before the end of the 72(t) period. The interest rate you choose cannot exceed 120% of the "Mid Term Applicable Federal Rate" which the IRS publishes monthly. The annuity factor can be obtained from a standard annuity table for a reasonable life expectancy and interest rate (subject to IRS rules), or you can use EarlyRetire's 72t Calculator to estimate an annuity factor based on the IRS mortality table and an interest rate subject to the aforementioned restriction. You should always consult a tax professional to fully understand the rules before initiating a 72(t) distribution plan.

Apply one-time conversion of 72(t) method allows you to specify whether to convert your method from Annuity or Amortization to Minimum Distribution during the 72(t) term, which the IRS allows you to do only once. Converting to the Minimum Distribution method will reduce subsequent withdrawal amounts for the remainder of the term, which may be advantageous depending on your situation. The selection list enables you to force a conversion at a certain age or allow EarlyRetire to automatically determine when you will have sufficient after-tax assets to convert safely.

Amount of tax-deferred to use for 72(t): You don't have to use all your tax-deferred assets in a 72(t) plan; in fact, a 72(t) plan must apply to one or more specified IRA account(s). You can therefore designate any portion of your tax-deferred assets for 72(t) use. EarlyRetire lets you designate by amount, by percentage, or by individual asset. The Optimize button calculates the amount which will result in the lowest tax burden over your lifetime (therefore producing the highest income). EarlyRetire assumes you will arrange your IRA assets appropriately in order to implement the 72(t) plan it recommends (once you have separated from your employer, you can transfer 401(k) assets to an IRA). The 72(t) Calculator can help you determine any of these parameters. Note that if you have a spouse of different age, the 72(t) feature is not applicable to your spouse's assets and they should not be included in this amount.

Warning: You should not use this feature to model an existing 72(t) plan once you're beyond age 55. Since a 72(t) plan must run at least 5 years, any 72(t) plan EarlyRetire creates after age 55 will run beyond age 59½. If you have an actual 72(t) plan and are over 55, you should model your plan using a Financial Event and disable this setting.


Early 401(k) Withdrawals

The IRS allows you to take early penalty-free withdrawals (before age 59½) from a 401(k) (or other employer-sponsored retirement plan) when you separate from your job, if you quit in or after the year you turn 55. In order to take advantage of this penalty exception, two conditions must be met: 1) You must quit your job no earlier than the year you turn 55, and 2) you must take the withdrawals from a qualified employer-sponsored retirement plan (e.g. 401(k), 403(b), 457(b)). IRAs are NOT included in this rule. Not all company plans permit such withdrawals, however, so check with your plan administrator to be sure your plan permits these withdrawals before turning on this feature. Turning on this feature allows you to select a 401(k) account or specify the estimated value of your 401(k) at age 55. EarlyRetire will then use the 401(k) funds to provide retirement distributions as described in the Distribution Algorithm. Note that if you have a spouse of different age, the Early 401(k) feature is not applicable to your spouse's assets and they should not be included in this amount.


Borrowing

Level of Borrowing: These options determine the degree to which EarlyRetire can accrue temporary deficits within asset categories when it is advantageous to reducing taxes. Such deficits occur when Financial Events (or other forms of income) cause fluctuations in an asset category. For instance, an inheritance occurring in 2020 will pay back a taxable asset deficit accrued in the years leading up to 2020, and borrowing from the inheritance in advance could avoid additional withdrawals from tax-deferred assets which may place you in a higher tax bracket or incur penalties. The borrowing level is maximized by default because allowing EarlyRetire to borrow in these instances usually benefits your bottom line. You will probably have a house or other assets in retirement you can borrow against at a lower interest rate than the taxes you would pay (and ROI you would lose) if you used assets from another category (see Interest Rate below). If this is not the case, reducing the borrowing level will increasingly force EarlyRetire to use whatever assets are available whenever necessary. It does not guarantee that all borrowing will be eliminated, however, because you may have Financial Events that necessitate borrowing. If you set the minimum level and still have undesired borrowing, you need to re-examine your Financial Events.

Force borrowing to avoid early-withdrawal penalties: When this toggle is on, EarlyRetire will not withdraw tax-deferred savings or Roth earnings to pay living expenses while you are under 59½ (unless specified within a Financial Event or to satisfy a specified tax bracket). If you don't have enough assets in other categories to pay your living expenses, a negative balance will accrue in the Taxable category until you reach 59½ (or replenish Taxable assets from another source). This negative balance simulates taking a loan to pay living expenses, which can often be better than paying taxes and penalties on early withdrawals.

Interest Rate charged on borrowed funds: When a negative balance accrues in an asset category, you are effectively borrowing money in that category. EarlyRetire resolves all such "loans" before you die by accumulating an offsetting surplus in another category or paying back the loan with a future Financial Event. This borrowing can often be implemented in reality through use of a home equity loan or other type of loan. The interest rate EarlyRetire applies to such loans is your ROI by default, but this field allows you to set an interest rate that more closely matches what you expect to actually pay on such a loan. This rate applies to both post- retirement and pre-retirement periods.

 

 


Glossary

401(k), 403(b), 457(b)  Employer-provided savings plans which are tax-deferred; contributions and earnings are not taxable, but distributions (withdrawals) are. Normally, distributions cannot be taken before you are 59½ or you must pay a 10% penalty. There is an annual limit on contributions to such plans ($18,500 in 2018 or $24,500 if over 50), which is adjusted by the IRS each year. Plan balances can be converted to traditional IRAs when you retire or change jobs. Note that these plans may also accept "after-tax" contributions, which are not tax- deferred but produce tax-deferred earnings. EarlyRetire treats all 401(k) assets as tax- deferred, so if you intend to separate these amounts after retirement, you should categorize the after-tax amounts in EarlyRetire as tax-free.

529 Plan/Prepaid Tuition Plan  State-sponsored savings plans for college expenses in which savings grow tax-free and qualified distributions (withdrawals) are tax-free. Earnings on non- qualified distributions (not used for college expenses) are subject to both taxes and 10% penalty, and there are other restrictions which vary from state to state. EarlyRetire treats such accounts as unrestricted tax-free savings on the assumption they will be properly used for qualified college expenses.

72(t), SEPP (Substantially Equal Periodic Payments) Rule, Annuity Rule  Terms referring to the tax law which allows penalty-free distributions from a tax-deferred IRA account prior to age 59½. A prescribed distribution amount (figured using one of three methods defined by the IRS) becomes the exact required distribution for each year. The 72(t) period goes into effect at the time you begin using tax-deferred assets and remains in effect until you are 59½ or five years have passed, whichever is the longer period. During the 72(t) period you cannot contribute to the IRA, and the exact amount of the prescribed distribution must be withdrawn each year. If you violate the rules in any year the IRS will charge retroactive "recapture" penalties (the 10% early withdraw penalty will be assessed on all prior distributions). Since you can have multiple IRA accounts, you can have multiple 72(t) plans. You should seek professional assistance if you implement a 72(t) plan.

Affordable Care Act (aka Obamacare)  The health care law that mandates individual or employer-provided health care coverage for every American starting in 2014 and provides federal subsidies (tax credits) for individuals and families with taxable incomes under 400% of the federal poverty level. To qualify for the tax credit, you must obtain health insurance via your state or federal "Health Insurance Marketplace" (exchange), apply for the credit, and meet income requirements. The amount of the tax credit increases with lower income. EarlyRetire provides features to help you analyze and maximize this credit.

Distribution  As used in the context of this program, a distribution is a post-retirement withdrawal from your assets. A distribution may or may not be a taxable event, depending on the type of asset category and your age at the time of the distribution.

Education IRA/ESA/Coverdell Plan  IRA accounts for college expenses in which savings grow tax-free and qualified distributions (withdrawals) are tax-free. Earnings on non-qualified distributions (not used for college expenses) are subject to both taxes and 10% penalty. These accounts are geared towards minors, owned by the recipient, and impose additional restrictions on age and contribution limits. They should not normally be included in retirement assets, but if they are, EarlyRetire treats these the same as Roth IRAs.

HSA/MSA (Health Savings Account or Medical Savings Account)  An account used in conjunction with high-deductible health insurance plans which allows annual tax-deductible contributions up to $6,900 per family in 2018 ($7,900 if over 55). Withdrawals used for medical expenses or Medicare premiums are tax-free. EarlyRetire treats these accounts as both tax-deductible and tax-free when represented by Financial Events. These are not the same as Flexible Spending Accounts (FSAs) offered by employers.

IRA (Individual Retirement Arrangement)  A savings or investment account which provides tax advantages by complying with special IRS regulations. A "traditional" IRA is tax-deferred; contributions and earnings are not taxable until they are distributed (withdrawn). Distributions cannot be taken before you are 59½ or you must pay a 10% penalty. There is an annual limit on IRA contributions; $5,500 in 2018 ($6,500 if over 50).

Keogh Plan  A tax-deferred retirement plan typically used by self-employed persons. You can contribute up to an annual maximum of $55,000 in 2018 (subject to cost-of-living adjustments thereafter). Contributions are tax-deductible. Distribution rules are the same as those for other tax-deferred plans such as a traditional IRA or 401(k).

Monte Carlo Simulation  A statistical method of determining probability by repeated sampling. EarlyRetire uses Monte Carlo simulation in two ways: 1) To estimate the probability of your plan's success. By executing the plan many times over randomly selected periods using historical stock, bond and cash market data, EarlyRetire can calculate the probability of your plan meeting its goals. 2) EarlyRetire also uses Monte Carlo simulation in the Portfolio Designer to estimate the probability of a given asset allocation achieving a certain ROI over an interval of time.

Municipal Bonds  Bonds issued by states or municipalities, the interest (or dividends) from which is exempt from federal income tax, and often from state income tax (depending on the issuer and state laws). EarlyRetire treats investments in municipal bonds or municipal bond mutual funds as totally tax-free.

MRD (Minimum Required Distribution)  See RMD

Qualified Distribution  A distribution from a tax-deferred or tax-free investment plan which conforms to IRS guidelines making it free of IRS penalties. All distributions after age 59½ are qualified and most earlier distributions are not, but there are ways in which earlier distributions can be qualified (education expense, first home purchase, etc). Non-qualified distributions are generally subject to both income taxes and a 10% penalty.

Reality Retirement Planning  A term coined by CFP Ty Bernicke, Reality Retirement Planning describes a concept gaining increasing attention as a more accurate retirement planning model. Reality planning assumes that a household's real spending will voluntarily decrease incrementally throughout retirement as indicated by the U.S. Bureau of Labor's Consumer Expenditure Survey, and adjusts spending estimates accordingly. Data from the Survey show that household expenditures actually decline as retirees age (for example, people 75 and older spend close to 50 percent less than those 55-59). Bernicke's research is corroborated by similar studies, and provides strong evidence that people of all generations spend less, by choice, as their age increases. Consequently, the studies suggest, people tend to oversave for retirement, underspend in their early retirement years, or postpone retirement unnecessarily. EarlyRetire implements Reality Planning (when this feature is selected) by decreasing Net Retirement Income by 3% per year between ages 55 and 75 (a conservative simplification of trends reflected in the Consumer Expenditure Surveys). This results in a larger Net Retirement Income at Distribution Start Age, but a smaller income (in today's dollars) after age 75. Even though it is based on actual statistics, you should realize that Reality Planning is less conservative than the conventional method, and even EarlyRetire's conservative implementation may add risk to your retirement plan.

ROI Rate of Return On Investment  The annualized rate at which you expect your combined savings and investments to grow each year.

Roth Conversion  Assets in existing traditional IRA accounts can be converted to Roth IRA accounts (making tax-deferred savings tax-free). The converted amount is taxable in the year of the conversion, but the converted funds no longer carry a tax liability. The converted funds must remain in the account for 5 years (or until you are 59½) before withdrawal or incur a 10% penalty tax.  EarlyRetire treats Roth conversions as Roth earnings during the wait period, and then the same as Roth contributions after that. If EarlyRetire must use Roth conversions during the wait period, they are not taxed as income, but the 10% penalty is applied.

Roth Conversion Ladder  Used as a way to use tax-deferred savings (i.e. traditional IRA) while under 59½ without the 10% penalty, a Roth conversion ladder is a series of annual Roth conversions (see above) which begin and end before you are 55. Because you have to wait 5 years before withdrawing converted funds, you must begin doing the conversions 5 years before you'll need to use the money. So if you plan to retire at age 50, you can start a Roth conversion ladder at age 45, and you will have tax-free, penalty-free funds available in your Roth IRA to use for your early retirement that originally came from your traditional IRA. A Roth conversion ladder doesn't have to start 5 years before you retire, it just has to start 5 years before you'll need to use money from a traditional IRA. It normally doesn't need to last beyond age 54 because once you are 59½, the 5-year waiting period no longer applies. To implement a Roth conversion ladder in EarlyRetire, create a "Roth Conversion Ladder" Financial Event.

Roth IRA  An Individual Retirement Account which is tax-free; earnings and distributions (withdrawals) are not taxable after you are 59½. If you take distributions before you are 59½, the earnings portion is taxable and penalized 10%. Unlike traditional IRAs, contributions to Roth IRAs are not deductible. There is an annual limit on Roth IRA contributions; $5,500 in 2018 ($6,500 if over 50).

Roth 401(k), Roth ERSA  A variation of 401(k) plans enacted in 2006 which allows non-deductible contributions which are then treated as tax-free; earnings and distributions (withdrawals) are not taxable after you are 59½. If you take distributions before you are 59½, the earnings portion is taxable and penalized 10%. Be careful to categorize contributions and savings in these accounts as tax-free, not tax-deferred as a regular 401(k) would be.

RMD (Required Minimum Distribution)  After age 70½, the IRS requires that you distribute (withdraw) a minimum amount from your tax-deferred savings plans (IRAs, 401(k)s, etc.) each year. This amount is determined each year using a method prescribed by the IRS.

Semi-Retirement  An EarlyRetire term referring to an interval of time during which you are neither contributing to, nor withdrawing from, your retirement assets (between your Retirement Age and Distribution Start Age). EarlyRetire makes no assumptions about where living expenses are obtained during this period, and applies the pre-retirement tax rates to earnings on your invested assets.

SEP IRA, SARSEP IRA, SIMPLE IRA  Individual Retirement Accounts typically used as employee retirement plans by small businesses. A SARSEP IRA has the same contribution rules as a 401(k), a SEP IRA has the same contribution rules as a Keogh plan, and a SIMPLE IRA has a $12,500 limit in 2018 ($15,500 if over 50). All have the same distribution rules as a Traditional IRA.

SEPP (Substantially Equal Periodic Payments)  See 72(t).

Tax-Deferred  An IRS designation given to certain types of investment plans which defers both federal and state income taxes on the invested money until it is removed from the plan. Such plans have restrictions on how much money can be contributed per year and when the money can be removed (distributed) from the plan.

Tax-Free  An EarlyRetire term referring to certain types of investment plans or securities in which the earnings on invested money is exempt from federal and state income taxes, and on which any tax liability has already been paid. There is generally no tax liability on future distributions from such accounts, but there can be IRS restrictions, such as with a Roth IRA.

Taxable  An EarlyRetire term referring to any money which produces annual taxable income. The term "taxable" refers to the income produced, not to distributions from such accounts, which are not taxable since taxes have already been paid.

UGMA/UTMA Account  A savings account set up for the benefit of a minor and taxed at the minor's tax rate. Minors receive an exemption for unearned income and are then taxed at the 10%, 15%, etc. tiers independently of their parents' income. For this reason, such accounts are frequently used as a tax shelter. Bear in mind that such accounts may only be used for the benefit of the minor, so they should not be assigned to meet goals unrelated to the minor. Also, when the minor turns 18, he or she assumes ownership of the account. Because Congress recently tightened restrictions on eligibility of these accounts for reduced taxation, EarlyRetire treats such accounts as taxable.

 

 


Net Retirement Income

This is the annual retirement income you can expect to receive starting at your Distribution Start Age (normally the same as Retirement Age). It is calculated as a fixed*, inflation-adjusted amount throughout the retirement period, after accounting for all cash flows in your plan, including distributions from your assets, Financial Events, and taxes you will pay. Note that it is Net Retirement Income, meaning that Financial Events and taxes have already been accounted for.

Since unusual or temporary expenses should be modeled by Financial Events, Net Retirement Income is intended to represent what is available for ordinary living expenses (like food, utilities and recreation). The last page of the Interview is meant to help you estimate ordinary living expenses. Your Net Retirement Income should be at least as high as the total of those expenses. What you choose to model with Financial Events versus what you consider ordinary expenses is up to you. For instance, if you don't create Medicare Events, you'll have to include Medicare premiums in your ordinary expenses, which means you'll need a higher Net Retirement Income to cover them.

Net Retirement Income is expressed in today's dollars unless you select Show/Enter Amounts in Future Dollars, whereupon it is adjusted for inflation to show (or allow you to enter) what the actual amount will be at your Distribution Start Age.

*By default, EarlyRetire calculates Net Retirement Income as a fixed income over your retirement assuming your ordinary living expenses will not change significantly. This is known as the traditional planning approach. Since it is becoming increasingly understood that overall spending tends to decrease with age during retirement, you can optionally turn on Reality Retirement Planning in the Optimization Settings. If you activate Reality Planning, your Net Retirement Income does not remain constant each year, but is reduced between the ages of 55 and 75. In this case, the amount on the Planner is the amount you would be receiving at your Distribution Start Age. To see how it would change over time, you will need to look at the Graph or the Distribution Schedule in the Report.

 

 


Assets at Retirement Age

This is the total value of your assets at your Retirement Age and is calculated by considering all contributions, growth, inflation, taxes and Financial Events affecting your three asset categories between your beginning age and your retirement age. It is expressed in today's dollars unless you select Show/Enter Amounts in Future Dollars, whereupon it is adjusted for inflation to show what the actual amount will be at your Retirement Age. You can't edit or calculate this field because it is dependent on both the pre-retirement and post-retirement variables simultaneously.

 

 


Preserve/Consume Assets

This toggle allows you to choose how your accumulated assets at retirement will be used to produce income. The Preserve option produces a constant* Net Retirement Income which preserves the value of your assets at your Distribution Start Age (after adjusting each year for inflation) through your Life Expectancy (your assets may fluctuate over this period since Net Retirement Income is always constant). The Consume option produces a constant* Net Retirement Income that consumes your assets in a specified number of years, which is determined by the Life Expectancy age (you can specify an amount to leave behind, Leftover Assets at Death). This option will provide a higher income since each year's income will include a chunk of your accumulated assets.

*If you have activated Reality Planning, your Net Retirement Income does not remain constant each year, but is reduced between the ages of 55 and 75. In this case, the amount on the Planner is the amount you would be receiving at your Distribution Start Age. To see how it would change over time, you will need to look at the Distribution Schedule in the Report.

 

 


Start Distributions at Retirement

Checking this box effectively "ties" your Retirement Age and Distribution Start Age together. You typically want to keep this box checked since most people plan to start living off of invested assets as soon as they retire, with no gap in between. You might want to uncheck this box if you know you will not need income from your assets until a certain age, for example you might have a part time job or a working spouse to cover living expenses for a period after you retire. When you uncheck this box, Distribution Start Age becomes a separately editable and calculable variable.

Note:  This item is only visible if Enable Advanced Features is checked under the Options menu.

 

 


Distribution Start Age

This is the age at which you begin receiving your Net Retirement Income. It is the age at which you begin taking distributions from your accumulated assets, and the age at which Other Taxable Income commences. Your Distribution Start Age is normally tied to your Retirement Age (by checking Start Distributions at Retirement), but it can be greater than your Retirement Age to create a period of "semi-retirement" (a period in which you make no asset contributions and receive no asset income). It can never be less than your Retirement Age.

Note:  This item is only visible if Enable Advanced Features is checked under the Options menu.

 

 


Life Expectancy

This is the age at which your assets will equal Leftover Assets at Death. The Calc button does not estimate your life expectancy; it calculates the age that allows the other variables in your plan to fit mathematically, thus it can be used to see how long your assets will last.

 

 


Other Taxable Income

This is the amount of taxable post-retirement income you expect to receive from external sources (such as company pensions, income from a business you own, or post-retirement employment). This income is assumed to start at your Distribution Start Age and is inflation- adjusted each year. It is included in your Net Retirement Income. It is expressed in today's dollars unless you select Show/Enter Amounts in Future Dollars, whereupon it is adjusted for inflation to show (or allow you to enter) what the actual amount will be at your Distribution Start Age.

Note:  This item is only visible if Enable Advanced Features is checked under the Options menu.

 

 


Calc Buttons

When you edit one or more of the variables on the Planner, the message Choose a variable to recalculate is displayed, indicating that the numbers displayed do not represent a feasible financial plan (i.e., the assets and saving/investment activity do not "add up" to the specified retirement goals). You must select one of the variables on the screen to be adjusted by the program in order to make the financial plan complete. When you click on the Calc button of your selected field, the program will use all the other variables to calculate it. After recalculating the variable you selected, the message Plan complete is displayed, indicating that all the numbers displayed now fit together mathematically to represent a complete financial plan which can theoretically be implemented. Read Overview for more explanation.

 

 


Retirement Age

Retirement Age is defined as the age at which you cease making savings contributions. It is also the age at which your ROI (return on investment) transitions from the pre-retirement rate to the post-retirement rate. Note that it is not necessarily the age at which your retirement income begins; this is determined by Distribution Start Age. Your Retirement Age and Distribution Start Age are normally tied together (by checking Start Distributions at Retirement), but can be separated to create a period of "semi-retirement".

 

 


Return On Investment (ROI)

These fields (pre-retirement and post-retirement) represent the rate of return applied to all of your invested assets on a yearly basis. The pre-retirement ROI is applied until your Retirement Age, after which the post-retirement ROI is applied. The separate pre-retirement and post- retirement fields are provided because it is common to choose a less aggressive investment strategy after retirement in order to incur less short-term risk.

 

 


Annual Savings Contributions

These three fields are the annual totals of Taxable, Tax-Deferred, and Tax-Free investment contributions you make to your assets each year between now and your retirement age. These values are represented in today's dollars, but each year's savings contribution is automatically adjusted for inflation in each of the succeeding years. For example, if an annual savings contribution is set to $10,000 and inflation is 5%, your second year's contribution will be assumed to be $10,500, your third year's will be $11,025, and so on (the Report provides a schedule which details each year's inflation-adjusted figures).

It is important to thoroughly understand the differences between the three tax status categories. Please read Tax Effects and Assumptions for a complete explanation of these differences.

 

 


Deduct Taxes from Savings

This switch determines whether taxes are deducted from annual savings contributions and earnings during pre-retirement. When this switch is on, the taxable and tax-free Annual Savings amounts and the ROI-produced earnings on taxable assets are reduced by the federal and state Tax Rates each year until your Distribution Start Age. Since tax-deferred contributions and earnings are not taxed, only taxable and tax-free savings are affected by this setting.

Normally, you will leave this setting off. This is because you will typically plan your savings contributions based on what you can afford using money that has already had taxes withheld, such as your salary. If, for example, you plan to contribute $1000 per year to a taxable savings account, it is because you plan to have the full $1000 available after you have paid all income taxes for the year. You expect the full $1000 to go into your savings. Likewise, even though the earnings in this account generate an annual tax liability, you generally do not withdraw funds from your savings accounts to pay these taxes; you prepay them along with the rest of your yearly tax liability with income tax payroll deductions.

You would turn this setting on if you wanted to compare the results of making a tax-free or taxable investment with an equivalent tax-deferred investment for analysis purposes. For example, if you wanted to compare the advantages of putting $2000 in a Roth IRA versus putting the same $2000 in a traditional IRA, you can only make a fair comparison if you consider the tax treatment of the investment in the year it was contributed. (Example: Turn on the Deduct Taxes from Savings switch, then calculate the tax-free and tax-deferred contribution fields separately with the other one set to zero. The one giving the lowest contribution amount is the best way to contribute.)

Also see Tax Effects and Assumptions.

Note:  This item is only visible if Enable Advanced Features is checked under the Options menu.

 

 


Beginning Status

This section shows the date on which the plan begins, your age on that date, your tax status, and the initial values of your assets. It reflects your current status at the time you create your plan, but is preserved as your "Beginning" status for when you review your plan later. Any time you update the value of your assets, the date of your plan is updated to reflect a new starting point and a new Beginning Status.

 

 


Tax Rate

There are two Tax Rate fields, Federal and State, editable in the Interview. Set each field to the percentage of your investment earnings which you expect to pay to the respective government branch as income tax. This is usually, but not necessarily, the same as the highest tax bracket you are in (see Tax Effects and Assumptions for assistance).

The Federal tax rate is not used after your Distribution Start Age, so compute this value based on your pre-retirement (and semi-retirement) income level only. After your Distribution Start Age, EarlyRetire calculates your federal income tax automatically (see Tax Effects and Assumptions). The State tax rate is applied in all years including post-retirement.

The Single/Joint/Head of Hs filing status option (corresponding to "Single" or "Married Filing Separately", "Married Filing Jointly", or "Head of Household") is used by EarlyRetire to calculate your federal income tax in post-retirement years. Pick the option that is most likely to fit your situation in retirement.

 

 


Inflation

The Inflation field is the average rate of predicted inflation over the span of both your pre- retirement and post-retirement calculations. The program adjusts for inflation each year in its calculations, and always treats the annual pre-retirement savings contributions as today's dollars, with the assumption that you will consciously make the inflation adjustments as you provide these amounts to your assets in future years.

You can select how future amounts (Assets at Retirement Age, Net Retirement Income, Other Taxable Income, Social Security Income and Leftover Assets at Death) are represented by selecting the Show/Enter Amounts in Today's Dollars or Show/Enter Amounts in Future Dollars option. When the Future Dollars option is selected, Assets at Retirement Age are shown in actual (inflated) dollars at your Retirement Age, Net Retirement Income and Other Taxable Income are shown in actual dollars at your Distribution Start Age, Social Security Income is shown at your Social Security Age, and Leftover Assets at Death is shown at your Life Expectancy age.

When editable amounts are shown in future dollars, they are colored purple instead of blue. If you are editing an amount that is being represented in future dollars, you should enter that amount in future dollars; likewise, if the amount is represented in today's dollars, you should enter that amount in today's dollars.

 

 


Portfolio Designer

This tool allows you to experiment with various asset allocations to optimize your ROI (return on investment) and level of risk. It can be used to estimate the ROI for a given asset allocation or to find the optimal asset mix to produce a desired ROI. You can adjust the proportions of three asset allocation components (stocks, bonds, and cash equivalents) while observing the effect on the expected ROI, probability, and risk factor. Be aware that the data models and methods used do not guarantee future performance of investments or accuracy of predictions and cannot be relied upon for anything other than a theoretical estimate.

Your current asset allocation will be the default initial settings. You can restore the settings to your current asset allocation at any time by clicking the Current button. You can manually adjust the Asset Allocation percentages and any other variables to create a hypothetical portfolio and view its theoretical Performance as described below. You can also set any portfolio to act as your designated portfolio for pre- or post-retirement (as described below) or display portfolios previously designated.

Fundwatch button launches the Fundwatch application (if installed), which allows you to search and evaluate individual securities that would best fit your portfolio objectives.

Use Monte Carlo determines how probability is calculated (described below).

Find Portfolio for ROI Pre/Post buttons automatically insert your Planner ROI and Period for either pre- or post-retirement into the calculator fields and find the portfolio with the highest probability and least volatility risk (as described below).

Set Portfolio for Pre/Post buttons save the displayed asset allocation percentages as your designated portfolio for the pre- or post-retirement portion of your Plan. When you designate a portfolio using these buttons, the portfolio will 1) appear on the Plan Report as your intended asset allocation over the pre- or post-retirement period, and 2) be used to calculate the Monte Carlo Probability of your Plan succeeding over the applicable period. It is not used to calculate your ROI, as that is determined by the planning process itself (you use the ROI to design a portfolio). These portfolios are saved in your Plan file.

Target ROI allows you to specify a desired ROI and view a portfolio's probability of achieving it. You can also have EarlyRetire calculate a portfolio to achieve it by clicking the Find Best Portf button described below.

Expected ROI is calculated from the Asset Allocation percentages and the Expected ROI Averages for each asset type. Be aware that it is not predicted by probability calculations but merely calculated from what you have selected (or entered) as "expected" ROIs.

Probability of mtg Tgt is the probability the specified portfolio will meet or exceed the Target ROI. If Use Monte Carlo is active, probability is calculated using the Monte Carlo method on downloaded stock, bond, and treasury data and is obtained by sampling the actual ROI of the portfolio over 100 randomly selected periods in history (the period length is determined by the Period setting described below). A Probability of 60% means the actual historical ROI met or exceeded the Target ROI in 60% of the samples. Adjusting the Period will affect the Probability. If Use Monte Carlo is turned off (or data is unavailable), probability is calculated using a statistical model based on historical data.*

Volatility Risk is a number ranging from 0 to 10 and is derived from the historical downside volatility of the asset type in the amount of time it is held (the Period). The longer an investment is held, the less effect volatility will have on its average rate of return, thus risk decreases with longer holding periods. Adjusting the Period will therefore affect the Risk.

Find Best Portf finds the asset allocation that produces the highest probability of achieving the Target ROI with the least volatility risk. The probability method used will depend on the Use Monte Carlo setting. The Period and the Expected ROI Averages for Asset Types may affect the results of this calculation.

Use Model generates a portfolio using a common formula based on the investment Period and a sliding scale input of your own "Risk Tolerance" (a subjective assessment of your comfort level with investment risk). A higher risk tolerance means you're comfortable with volatility in your portfolio and are willing to accept greater risk in order to obtain a higher return.

Expected ROI Averages for Asset Types (average rates of return) for the three asset components can be entered manually, or selected from one of the provided sets of U.S. market statistics*. The Monte Carlo avgs over Period selection calculates averages by sampling each category over 100 random periods in history (the period length is determined by the Period setting). To get Monte Carlo averages you must turn on Use Monte Carlo. Note that changing any of these settings will affect the performance of any displayed portfolio and potentially change the result for "best" portfolio calculation.

*The historical statistical data is obtained from several sources and may contain a blend of indexes. These averages are intended to provide a very general and hypothetical estimate of asset performance based on history. Historical performance does not guarantee future performance and cannot be relied upon for anything other than a theoretical estimate. Calculated asset allocations, probabilities and projections are also based on these estimates.

 

 


Interview

The Interview aids you in collecting and organizing the data required by the Planner. Most importantly, it is where you enter and maintain your tax status, spouse information, and the current value of your assets.

The Next and Back buttons at the bottom allow you to navigate through the sections of the Interview, and the Finish button becomes enabled once you have visited each section. At any time while completing the interview, you can save what you've entered and return to it later.  Even after you've finished the initial interview, you'll need to revisit the Interview from time to time to update your status--particularly regarding your asset values.

 

Personal Information
This section calculates your age from your date of birth, and allows you to enter your anticipated life expectancy or use a statistical (IRS) estimate based on your age. Set the tax rates to the average rates you expect to be taxed on your income. This is also where you will enter spouse information if you're married.

 

Current Assets
This section is where you will enter and maintain all information pertaining to your assets and Roth IRA contributions. You should update it periodically.

It's up to you how you break down your assets. For instance, if you have a 401k that contains three mutual funds, you can list each mutual fund separately, or you can simply list the entire 401k as a single asset. The important thing is that you not mix tax categories; e.g. do not group your traditional IRA with your Roth IRA since the first is tax-deferred and the second is tax-free. You can also import assets from a comma-delimited file if you have another program that already contains this information. The Allocation selection is important for estimating your return on investments (ROI). EarlyRetire also uses settings you can define on the Portfolio Designer to calculate ROI.

Debts and Liabilities: As a general rule, only short term or revolving debt (such as credit cards or lines of credit) should be entered as "Debt" in the assets section (entries will be shown as negative amounts). Long-term or installment debt (mortgages, student loans) should generally be modeled as loan payments via Financial Events.

The Sum of Roth IRA contributions and conversions field at the bottom (if you're under 59½) should be the sum of all Roth IRA contributions and conversions you have made in your lifetime minus any Roth IRA withdrawals you have taken. Do not adjust any of these amounts for inflation and do not include any earnings, gains or losses they may have produced. Do not exclude this amount from any of the entries you make in the above Roth IRA asset fields (those fields should simply reflect the current values of your Roth assets).

 

Annual Savings Contributions
This section appears if you are not yet retired and provides a guide to help you think of where you are currently contributing or planning to contribute savings. 

 

Retirement Income
This section asks you to set a desired retirement age and estimate income you expect to receive from outside sources such as pension benefits, social security, business income or employment after you retire. It also lets you specify whether you intend to begin drawing income from your investments immediately upon your retirement or later on. The age at which you specify to begin drawing income from your investments is also used as the age at which your "Pension benefits" and "Other retirement income" will commence. All amounts should be entered in today's dollars. If there is a source of income you expect to have that doesn't fit these assumptions, you can create a Financial Event for it in the following tab. Remember that all these variables can be adjusted later when you use the Planner to refine your plan. 

When you get to the Social Security button, you'll use the Social Security Wizard to set up your best strategy for claiming social security and Medicare benefits.

 

Financial Events
This section allows you to add Financial Events, which are simply individual variations to EarlyRetire's basic model you may foresee in your future. The dropdown list provides selections for most common events, and invokes a wizard that will walk you through the creation process. If you don't find an event in the list that applies to your specific needs, you can press Create your own Event to create any kind of event you want in the Financial Events editor. You can also wait until after you complete the Interview and then create Financial Events directly on the Planner (by pressing the "Add" button above the Financial Events list).

 

Anticipated Retirement Expenses
This section provides a fill-in-the-blanks guide to help you estimate how much income you will need to meet expenses when you are retired. The total is pasted into the Net Retirement Income field on the Planner when you press Finish or Save and Exit.

 

 


Financial Events

Financial Events enable you to include variations and temporary changes to your asset growth and consumption. Common examples of financial events include paying off a loan, sending kids to college, making a large purchase, making a Roth conversion, or receiving an inheritance. A Financial Event is simply a change to your assets that occurs at a point in time or over a period of time. Financial Events can occur at any time during your lifetime, spanning both pre- and post-retirement periods. They are extremely flexible and can be used to experiment with hypothetical ideas or model unusual circumstances. You can add up to 40 financial events, which are created on the Financial Event dialog that appears when you click the Add button over the Financial Events list on the Planner. You can also temporarily activate or deactivate selected Events in the list to compare ideas.

The Financial Event Wizard helps you setup an event, but you can setup an Event without it. The wizard provides a list of standard events and sets the fields on the Financial Event display with its recommendations. You can then change the event however you wish in order to tailor it for your circumstances. For certain event selections, the Wizard will actually create multiple events (for instance, a loan includes an amount received and an amount paid back over time). The Loan Calculator and 72(t) Calculator can help you determine amounts to enter when setting up these kinds of events.

Each Financial Event requires a unique name, either a date or time period, and an amount. If the event occurs at a point in time, enter the amount of change to each asset category which will occur at that time (if the event represents a reduction in your assets, enter the amount as a negative number). If the event occurs over a period of time, enter the annualized amount of change in each asset category. For example, if you're paying college expenses for your daughter, enter the amount (as a negative number in this case) you will need to withdraw from your savings annually to pay the expenses (annual amounts will be automatically prorated for partial years). If you expect the money to come partly from tax-deferred savings and partly from taxable savings, enter the corresponding portions in each category. You can specify a transfer of assets from one category to another by entering a negative amount in one and a positive amount in the other. Amounts can be entered in today's dollars or actual dollars (inflation-adjusted to the start of the event) by setting the Today's/Actual toggle.

Generic vs Specified Categories
For many events, it is desirable or even necessary to specify the asset category(s) which is to be the source or destination of funds (for instance, you may get a tax advantage by paying college expenses from a tax-deferred account). However for many events it may not matter which category the money will come from, and it may be difficult or impossible to use a single category to pay the entire event. For instance, if you have a temporary loan payment that occurs over ten years, your taxable assets may not last that long and you may need to switch to using assets from another category. You must be careful when assigning withdrawals to specific categories because an event will draw from the specified category even when it runs out of money, causing a negative balance to accrue within the category. If you don't know or care which category the event will be paid from (or paid into), make the event generic by selecting the Generic toggle. Generic withdrawals (negative amounts) will be drawn from the most efficient source available at the time (as described in the Distribution Algorithm), and positive amounts will be deposited into Taxable assets. Bear in mind that all generic outflows will be treated as fully taxable and subject to penalty (see below) if they are drawn from assets with a tax liability. Note that even if an event is not generic, generic amounts can be used in combination with specified category amounts.

Adjustments (The yellow help box in this section provides helpful tips for setting adjustments.)
Check the Taxable box at the bottom if this will be a taxable event. For instance if you are receiving proceeds from the sale of your business, the money will be taxed before it is added to your assets. Likewise, if you are withdrawing tax-deferred assets to pay for something, they will be taxed when they are withdrawn. If you check Taxable, in pre-retirement years EarlyRetire will reduce the specified amounts by the appropriate tax before adding them to your assets, or will increase the specified amounts by the appropriate tax before subtracting them from your assets ("tax-deferred" deposits and "taxable assets" withdrawals will not be taxed). In post-retirement years, the amounts deposited or withdrawn are not changed, but the applicable tax is calculated and withdrawn from your assets according to the Distribution Algorithm.

The Tax-Deductible check becomes available for certain category changes. If it is checked, in pre-retirement years EarlyRetire will increase the specified amounts by the tax saved before adding them to your assets. In post-retirement years, the amounts deposited or withdrawn are not changed, but your calculated taxes are adjusted by the applicable tax deduction.

The Subject to Early-Withdrawal Penalty check is enabled for certain taxable events occurring before age 59½. If you are making an early withdrawal from tax-deferred or tax-free assets, you should check this box unless you know that the event is "qualified" (consult IRS publication 590 or a tax attorney for a list of qualified early withdrawals). If this box is checked, EarlyRetire will apply a 10% penalty tax on the taxable amount of tax-deferred or tax-free early withdrawals.

The Inflation-Adjusted checkbox appears if the event occurs over a period of time, allowing you to specify the annual amount to be increased each year for inflation. You can designate college expenses, for instance, to be increased each year by checking this box, or conversely, you may have a post- retirement pension or annuity you don't want to include in Other Taxable Income on the Planner because it is not inflation-adjusted (or not taxable), and thus is better represented as a Financial Event.

Inflation Rate allows you to specify what inflation will be applied to the event. You can choose the base inflation rate (from the Planner), an offset added to the base rate, or a fixed rate you enter. This allows you to account for differing inflation rates that affect individual expenses, such as health care costs, tuition, or adjustable-rate loans. Be aware that this rate is also applied to the starting value of the event even if it is not inflation-adjusted. For example, if you specify the sale of your home to be worth $250,000 in today's dollars in the year 2020, the event's inflation rate will be used to determine the actual value of your home in the year 2020. If you expect your home's value to grow at 5% annually between now and 2020, you would set the inflation rate for the event to a fixed 5%. If the event occurs over a period of time, the event's inflation rate will be used to 1) adjust its beginning value IF you entered it as Today's Dollars, and 2) to adjust its value each year it occurs IF you check the Inflation-adjusted toggle. 

Self-Calculating Events
Certain Financial Events generated by the Event Wizard display a symbol in the Change to Assets section indicating they are Self-Calculating. Examples include Medicare Premiums and Subsidized Healthcare Premiums. Such premiums vary depending on your taxable income. A Self-Calculating Event will determine amounts in the Change to Assets section in each year of the Event's active time period based on taxable income in the previous year. Such adjustments only occur during Plan recalculations (clicking a Calc button) and are thus unpredictable beforehand. Therefore, the amounts shown on the Event are not necessarily the actual amounts that will be or have been applied to the Plan. To see what actual amounts are applied, you must view the Event in the Yearly Details of the Plan Report after the Plan has been recalculated.

 

 


Graph

The Graph plots the growth and consumption of your assets (by tax category) according to your plan. A marker can be slid over the graph using the lower scrollbar, and causes your age, your annualized income, contribution, event inflow/outflow (including social security), and the value of your assets at that age to be displayed at left. If you select the Income tab, the graph shows the various components that make up your Net Retirement Income.

You can click anywhere in the Graph to see the value at any point. Your Retirement Age and Distribution Start Age define the boundaries of the pre-retirement, semi-retirement and post-retirement regions (colored pink, yellow, and blue). Your Financial Events are displayed in the lower section of the graph. Red events represent outflows, green events represent inflows. Holding the mouse over an event region will display the event name, and clicking on it will allow you to examine or edit the event parameters.

The Today's Dollars and Actual Dollars option controls how the graph and all the amounts at left are displayed (see Show/Enter Amounts in Today's/Future Dollars).

 

 


Plan Report

The Plan Report provides a comprehensive description of your financial plan, including a detailed schedule of your savings contributions in today's or future dollars, and your post-retirement distributions and tax liabilities. To understand the how the distribution schedule was generated, see the Distribution Algorithm. You can use the report as a guide for implementing your plan (with the help of a financial advisor), or simply to track your progress.

There are two displayable (and resizable) sections. The upper section shows the report itself and can be scrolled. The lower section will show details for a given year when that year is selected in the upper section. Only rows representing years in the savings and distributions schedules (described below) can be selected for display in the Detail section. Either section (entire plan or yearly detail) can be printed.

Parameters you have chosen to define your plan and their results (essentially the same information which appears on the Planner) are reported in today's dollars.

The Annual Savings Schedule (not produced if you are already drawing distributions) of required savings Contributions and Financial Event inflow/outflow uses your ROI, tax rate, and inflation rate to calculate the value of your net worth at the end of each year. The amounts in this section (and the next) can be shown in either today's dollars or future (actual) dollars.

The Annual Distribution Schedule (not produced if you have excluded post-retirement) of asset distributions (withdrawals), shows how all your distributions, retirement income, financial events, and owed taxes combine to produce your net retirement income. The schedule runs through your Life Expectancy age. The "Estimated RMD" column shows your Required Minimum Distribution when you are over 70½, and your 72(t) distribution amount when you are under 59½. Be advised that the distributions, taxes and RMD estimates on the plan should not be relied upon for anything other than high-level planning. Consult a financial planner or tax accountant to determine what your distributions and taxes should really be.

A note to avoid confusion: The "Distrib" columns in the Distribution Schedule show distributions (withdrawals) from the three asset categories. "Taxable Distrib" means distributions from taxable assets, not that the distributions are taxable (which these never are--see Tax Effects and Assumptions). Technically, taxable distributions are not actually distributions since they do not come from a qualified plan, but are labeled "Distributions" for consistency.

If you click on a row in either the Savings Schedule or Distribution Schedule, details pertaining to the row you clicked on are displayed in the lower Detail section:

The Detail section breaks out the financial activity in the one-year period represented by the row you selected...

The Detail in the Savings Schedule shows Financial Event activity, social security, contributions, RMD-related penalties, and asset growth. The top row shows the beginning asset values for the year, and each row under "Adjustment to Assets" shows the effect of each activity (e.g., Financial Event, social security, contribution) on its associated asset category(s). Each of these amounts is shown after being adjusted for taxes and penalties, which may reduce amounts being added or increase amounts being subtracted. "Asset Growth" includes growth due to ROI, reduction due to inflation (if shown in today's dollars), and IRS penalties for failure to take an RMD. Each column adds to the totals in the bottom row showing asset values at the end of the year.

The Detail in the Distribution Schedule is more complex, showing how your annual income is obtained. It includes Financial Event activity, social security, where you will take distributions, what your tax liability and penalties will be, how your asset totals change in value, what borrowing may be necessary, etc. The example above shows a post-retirement year in which money is being withdrawn to pay for health insurance and tax-deferred assets are being distributed early using the 72(t) rule.

The top row shows the beginning asset values for the year. When you are under 59½, tax-free assets are divided between "Roth Earnings, Life Ins" which are taxable and subject to early- withdrawal penalty versus other tax-free assets which can be used tax and penalty-free. The "Adjustment to Assets" section shows the net distributions taken from each category, amounts borrowed, and "Asset Growth", which includes the change in value due to ROI growth, interest paid on negative balances, and inflation (if shown in today's dollars). Distributions can be positive or negative, depending on whether money was removed or added in the asset category, and are shown as debits to assets and a credit to income. The amounts in this section are added to the beginning-of-year asset amounts to obtain the end-of-year asset amounts.

The "Events and Other Income" section shows how Financial Events, social security, and Other Taxable Income are broken out between asset categories. Note that these amounts are adjustments to income, not adjustments to assets. Each outflow is treated as an expense payable during the year, and each inflow is treated as contributing to yearly income. Only the totals in the column at the far right are added from top to bottom to show how Net Income is obtained. Excess income from this section is added back to assets and is thus reflected in the distributions shown above.

The "Taxes" section is a separate column showing taxes, penalties, how they were calculated, and the highest federal tax bracket you fell in for the year. Taxes are calculated on Gross Taxable Income minus Deductions. The total tax is a debit to income in the right-hand column.

Negative distributions: A negative distribution in the Distribution Schedule itself is a contribution. Contributions to assets during post-retirement can occur for several reasons: the excess portion of an RMD from tax-deferred assets is contributed to your taxable assets, excess income from Financial Events is contributed to taxable assests, Financial Events that cause an asset category to become negative may be repaid with excess income in subsequent years, etc.

Negative balances: A negative asset balance indicates EarlyRetire is borrowing assets which it will pay back in later years. You can see more details about how borrowing is occurring by clicking on each row.

Formatting printed reports: When you press the Print Report or Print Detail button, a popup appears allowing you to specify a header containing custom text, which you can have printed at the top of the first page or every page. Additionally, you can designate fields from the Client Detail and/or the Consultant Information Detail to appear within a subheader on the report or the report detail. You can also elect to include the pie chart and graph, title pages, and appendicies as well as a specified number of yearly details in the report. The Print Preview display allows you to print the final report or save it as an HTML file.

 

 


Leftover Assets at Death

This field allows you to specify or calculate an amount of assets left over at your Life Expectancy age when you are consuming assets. For example, if you set this field to $10,000, EarlyRetire will calculate other variables so that you will have consumed all but $10,000 of your assets when you reach your Life Expectancy age. It is expressed in today's dollars unless you select Show/Enter Amounts in Future Dollars, whereupon it is adjusted for inflation to show (or allow you to enter) what the actual amount will be at your death.

This is handy if you know what your asset consumption in retirement is and want to see how much you'll leave behind, or if you want to specify a buffer for unexpected expenses, funeral arrangements or a bequest.

 

 


Loan Calculator / 72(t) Calculator / Mortgage Acceleration Calculator

These calculators can be accessed from the Analysis Details menu or the Calculator pull-down button.

The Loan Calculator allows you to determine any parameter for an amortized loan, such as the monthly payment amount or the term needed to pay off the loan with a given monthly payment. This information can be useful when setting up a Financial Event for a loan.

Similarly, the 72(t) Calculator allows you to determine the parameters to use when setting up a 72(t) early distribution (SEPP) plan. For instance, if you know how much you would need to receive each year from such a plan, you can determine how much of your tax-deferred assets you would need to set aside in a separate IRA. You can also experiment with and compare the various methods available for calculating the distribution. You can use these parameters to control EarlyRetire's automatic 72(t) calculation in the Optimization Settings, or to create a Financial Event for a customized 72(t) plan during or before your retirement (since it is possible to have more than one 72(t) plan, you could even do both).

The Mortgage Acceleration Calculator allows you to calculate the date you can payoff an existing loan if you increase your monthly payment, or how much you would need to increase your payment to pay it off by a certain date.  It also shows the total interest you would pay over the remaining payment period, and the amount of interest you would be paying in the first year (usually a tax deduction).

All these calculators allow you to calculate any parameter by entering the others. If you know the loan amount, interest rate and term, for instance, you can calculate the payment. Likewise, if you know what payment you can afford, you can calculate the amount or the term, etc.

 

 


Client/Consultant Detail

Client Detail: Information entered here describes the plan participant and is saved in the plan data file. Each line of information can be optionally shown on the printed Plan Report in a heading section on the first page (and on each yearly detail). Once you set which information is to be shown on the Plan Report, EarlyRetire remembers those settings for every client.

Password protection for the current file can be set in the Client Detail, and is optional and independent for every file. The presence of a password does not encrypt the entire file, but the password itself and key personal data such as asset values, account numbers, etc, are always stored in a non-human-readable format. Warning: Once a password is set for a file, it will be required to reopen that file. Once a password-protected file is open, the password protection can be changed or removed (by un-selecting the "Password Protect" toggle or editing the password field).

Consultant Detail (accessible via Data Details menu): EarlyRetire will save company and personal information for a financial consultant and will optionally print this information (by selected line) on the Plan Report. The information is printed next to the client information in the heading section. The consultant information is saved independently of plan files and will appear the same way on each report printed for any plan for any client.

 

 


Import/Export Assets

You can import the Individual Asset information in the Interview from a comma-separated-value (csv) text file, or from a Fundwatch™ data file.  You can also export the asset information in the Interview to a csv text file. A csv file can easily be generated using Excel, Quicken and most accounting programs. If you have your financial information already recorded in another program, you can transfer it to EarlyRetire with minimal effort using this feature.

Importing from a CSV File:

Step 1: Use your other program's export function to store your individual asset or account information (containing account names and balances) to a csv file.

Step 2: Open the csv file in Excel (or another spreadsheet) and edit the saved information (rearrange or delete columns) so it is in the following format required by EarlyRetire. Each asset must be on one row and contain the following fields (columns). Order of the columns is essential, but only the first two are required to have values. Values for the remaining columns are optional; if the information is missing, you can fill it in or leave it blank, but make sure any values you supply are in the correct columns on the spreadsheet (if you edit this file with a text editor, you must leave a comma for each blank value that precedes a value you supply). No header row is needed. Make sure you save the edited file as a csv file.

EarlyRetire's format:
column 1         column 2          column 3        column 4          column 5             column 6
asset name,    asset value,      owner,            tax category,    asset allocation,   annual contribution

asset name:       Text name describing the asset (e.g. "Lucent 401k" or "Fidelity IRA")
asset value:       Numeric integer or decimal (no dollar sign or commas)
owner:               Either the word "You", "Spouse" or "Other" (or leave blank)
tax category*:    Word(s) describing the asset's tax category (e.g. "401k", "IRA", "Roth", "Deferred", "Taxable", etc)
allocation*:        Word(s) describing the allocation/composition of the asset (e.g. "Stock", "Bond", "Cash", "Balanced", etc)
contribution:      Numeric integer or decimal (no dollar sign or commas) of the amount you contribute annually to this asset

Examples:
Fidelity Roth,        23400,     Spouse,      Roth,      Conservative Mix,    3000
USAA Account,    11000,     You,           ,             ,                             5000
Bank Account,      6000

*For help with wording of these fields, look at the choices in the pull-down menus on the Asset grid in the Interview.

Step 3: In, EarlyRetire, select Import under the File menu and specify the filename of the edited file (you can also drag and drop the file directly onto the Assets grid in the Interview). Once the assets have been imported, you can view/edit them in the Interview and use the Interview's Finish button to paste them to the Planner.

Importing From Fundwatch™:

Fundwatch™ tracks portfolio information for investment analysis and portfolio design.  To import asset information from a Fundwatch™ data file, simply select Import under the File menu and select the Fundwatch file you want to use for importing (or drag and drop the Fundwatch file onto the Assets grid in the Interview).  All securities in the file with non-zero holdings will be imported.

Exporting:

EarlyRetire's Export function will create a csv file containing your individual assets in the format described above. You must have entered your asset information in the Interview using the individual asset method.

 

 


Probability Analysis (Monte Carlo Simulation)

When this switch is turned on (checked), EarlyRetire will perform a Monte Carlo simulation of your plan to determine its success probability each time you recalculate a variable. Monte Carlo simulation is a time-consuming process and may be slow depending on the speed of your computer. The result of the analysis is a separate probability percentage for the pre-retirement period, post-retirement period (whichever is active), and the entire period of the plan. The last of these figures is displayed on the Planner as Probability, and the others are shown above their respective sections.

Monte Carlo simulation is a method of determining probability by repeated sampling. EarlyRetire executes your plan 100 times over randomly selected periods in history, using historical stock, bond and cash market data which it downloads from Yahoo!® each time you run the program.  EarlyRetire uses historical data (instead of randomly generated ROI) to more accurately simulate reality.* This analysis measures what is generally considered to be the greatest uncertainty associated with retirement plans: rate of return and market fluctuation. Even though EarlyRetire precisely calculates a plan based on your pre-retirement and post-retirement ROIs, the success of the plan is dependent on those ROIs being achieved in reality over the course of many years, and is vulnerable to ROI fluctuations which may cause your asset valuations to drop in early years when you're making withdrawals. By testing your plan over many periods in history, its likelihood of succeeding in the future can be quantitatively measured.

Since there are separate ROIs for the pre- and post-retirement phases of your plan, a separate Monte Carlo simulation is performed for each phase, as well as the entire plan.

Because the simulation tests ROI, the results are highly dependent on your asset allocation, that is, the stock, bond, and cash proportions of your assets. Since you are likely to make adjustments to your asset allocation during the pre- and post-retirement periods, EarlyRetire allows you to designate an asset allocation (portfolio) for each of these periods using the Portfolio Designer. If you setup a portfolio for one or both of these periods, it will be used to perform the Probability simulation over its applicable period. If you don't designate a portfolio, EarlyRetire will use a formula-generated asset allocation for the applicable period(s) based on period duration. 

EarlyRetire requires downloaded data to perform Monte Carlo analysis (which it obtains from Yahoo!®). If it cannot download this data for some reason, the Probability feature will become inactive. You can attempt the download again by clicking the Probability checkbox to re-enable the feature. You can also temporarily disable/enable the Probability feature at any time to speed up design of your plan (this setting is remembered when you exit and re-run the program).

*To make maximum use of available stock, bond, and cash data, the randomly selected periods of each asset class may not be the same period in history. For instance, an 11-year period for stocks may start in 1986 while the same period for bonds may start in 1992. Because the periods don't line up, the portfolio ROIs calculated in this manner may never have truly occurred historically. Since portfolios are typically diversified to take advantage of non-correlated asset classes, this randomization has the effect of adding artificial volatility to the portfolio and skewing estimated probabilities downward. Furthermore, whenever the Monte Carlo period exceeds the span of available data for an asset class, that class's ROI from the Portfolio Designer is substituted for the simulation, artificially reducing portfolio volatility and skewing reported probabilities upward. If the period exceeds the available data span of every asset class, Monte Carlo probability cannot be calculated.

 

 


Social Security Wizard

The Social Security Wizard (obtainable under the Analysis Details menu or via the Social Security Plan button) uses personal benefit information for you and your spouse to determine your best strategy for taking social security benefits as a couple over your lifetime. Because you have many options, strategies can be complex, but taking the proper actions at the right time can make an enormous difference in the amount of money you receive. The Wizard determines your best strategy by calculating every combination of options available to you for every eligible year and choosing the strategy that produces the highest lifetime benefit. To use the Wizard, simply complete the fields and selections (as described below) and click Add this strategy to plan.

You must supply a known annual benefit amount at a known age for your own personal work record (and your spouse if married, divorced or widowed), which you can obtain from the Social Security Administration’s website (SSA.gov button). It doesn’t matter what age you provide as long as the benefit amount you enter corresponds to that age. Make sure to annualize your benefit amount.

If you're single, the calculator will produce a table of all possible Start Ages and their associated Benefits, or if you have a current or ex-spouse, the calculator will generate a Strategy Timeline of filing dates and instructions that will maximize your benefits over your lifetime.

Note that lifetime benefits are also influenced by your Life Expectancy and the ROI you will earn on savings. (The ROI factor assumes your Social Security benefits will be combined with your own savings to provide living expenses and will therefore offset withdrawals from savings invested at that ROI. If you will rely solely on social security for living expenses, you should set the ROI equal to the displayed inflation rate to negate its effect since benefit payments are annually adjusted for inflation.)

Click the checkbox if you've already begun receiving your own benefit (not a spousal or survivor benefit) or if you've definitely decided to start taking your benefit at the age you entered at the top. If you're already receiving benefits, make sure the age and benefit amount entered are as current as possible.

Next, enter the amount of spousal or survivor benefits you are already receiving. If you haven't filed for spousal or survivor benefits, leave this field zero.

If You’re Single

The Table shows all eligible Start Ages and their associated first-year Income amounts available to you. Additionally, your Lifetime Benefit is calculated for each Start Age according to the Life Expectancy and ROI. You can use the up/down arrows on the left side of the table to see values for Start Ages by tenths of a year. The Graph shows the benefit curve as a function of your start age, showing the effect of delaying your start age and how the shape of the curve changes as you adjust other variables such as Life Expectancy and ROI. The calculator automatically highlights your best Start Age, but you can select any row on the table.

Married, Widowed, or Divorced

Again, you must provide personal information obtained from the Social Security Administration for your spouse. Spousal information you enter here should pertain to your spouse's primary benefit. The calculator will determine spousal benefits for both you and your spouse. The checkbox indicates whether your spouse has already begun receiving their own benefits (or was already receiving them at time of death) or if your spouse has decided to start taking their own benefit at the age associated with the known benefit. If your spouse is already receiving benefits, make sure the age and benefit amount entered for your spouse is as current as possible. Lastly, enter the amount of spousal benefits your spouse is already receiving.  Remember to enter annual benefit amounts.

The Best-Strategy Timeline shows the ordered steps you should take to maximize your lifetime Social Security benefit (along with reminders to apply for Medicare) in the month, year, and age for each individual. “File-and-suspend” means filing for your benefit but simultaneously suspending it. Filing a “restricted app” means filing only for your spousal benefit using a special application. For more information on these procedures, consult the Social Security Administration (these options are being phased out for younger filers, so may not appear depending on your age).

Add this strategy to plan (at the bottom) will produce Financial Events to model all current social security income and all recommended future filings on the part of you or your spouse. It will also ask if you want it to automatically add Financial Event(s) to model Medicare premiums. The Medicare Events it adds are self-calculating and will determine your premium each year based on your taxable income.