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ChooseFI | Financial Independence Podcast
Deep Dive: Putting the Middle-Class Trap to Bed | Ep 553
01:06:57
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- [00:00]
Brad
Hello and welcome to Choose a fi. Today on the show, we have our good friend Cody Garrett, who's a CFP and has been on the show numerous times. And we're going to talk about and hopefully really put to bed this concept of the middle class trap. I think it's something that has come to the forefront in the FI community this year in 2025. And I think there's just a lot of myths surrounding it. I think personally that it really doesn't exist other than in our minds, but that's an important place for it to exist. But I think the beautiful part about FI and the FI community is we all come together to help each other and to educate and to support. And I think hopefully that's what Cody and I are trying to do today is to look at what is supposedly a trap and say, no, no, no. Not only is it not a trap, this is the path to Phi. This is winning. But if you're scared, if you're worried in your brain, which is very legitimate, then I think this is going to be an episode that really speaks to you because Cody sets up four really interesting case studies where we just go through the numbers. And of course, numbers aren't always persuasive when you're talking about something psychological, but I think in this case it does a really wonderful job where we can just take a deep breath and say, okay, if this almost most simplistic way or the worst case way of withdrawing money from our accounts actually works and works wonderfully, then, oh, what if I look at all these other things really advanced five strategies that. That to me is the cool part about this. And Cody talks about the eight core realities on the psychological side of this middle class trap and maybe why people feel like there's a trap. I think this is a really important one. I wouldn't be spending so much time on this. On the podcast recently, we just did episode 5:43, and now we're at it again just a short while later. If I didn't think this is important, not because I think it's something that we should be worried about, but but because I think that the path to FI works as well today as it ever has. And we all need to understand that and know that you're not trapped. You are crushing the game. And I think that is the beautiful part about being in this community. So with that, welcome to choose fi. Cody, thanks for coming back. I love having you on. This should be a lot of fun.
- [02:22]
Cody Garrett
I love being here. I'm excited for our next deep Dive.
- [02:25]
Brad
Yeah, yeah. So this, as you always do when you do a deep dive, you put together a really exhaustive Google Doc that we're going to go through a lot of these case studies. I think you put four different case studies together on people in different scenarios of early retirement. And I think when we talk about this supposed middle class trap, which I think frankly, you and I both not believe exists in any way, shape or form, but some people feel that it does. And I think, I think the job of people like us is to take something that maybe they've heard of, right? They've heard, they should be worried about this. And we have to touch on both aspects, which is the psychological and the actual nuts and bolts of money. So hopefully this will be the final word on really putting this to bed once and for all that the middle class chap doesn't exist. It's actually either you're just not fi yet, which is what a lot of people in many of the scenarios that we've heard, that's the situation they're in, or you're actually killing it. You're doing great. Like, that's, that's the funny thing for me is every time I hear people come up with these examples of the middle class trap, I'm like, no, no, no. That's what I just spent eight and a half years on. Choose a fi trying to say, this is exactly the plan. You're crushing it. You have all this money in pre tax retirement vehicles. You are at FI. You probably can pay almost 0% effective tax rate or pretty darn low sub 5 or 7% in most cases. You're killing it. You are killing it. You shouldn't be worried at all. You just have to understand that you put a plan in place for 10, 15, 17 years and you did it. It came to fruition. And Cody, I think really the hard part for a lot of people is just saying like, okay, look, I've been saving my whole life. Now I have to spend now, as you told me, I have to turn assets into income. And I think that's a little difficult for people mentally. But goodness, if we let that stop us, then this is all for naught. FI is meaningless. If people come to the point where they have millions and millions of dollars in securities and they're just unwilling or incapable of selling them, then you're going to die with tens of millions of dollars. I can promise you that that money is going to compound for the next 50 years. You're going to have tens of millions of dollars and you probably would have worked for decades longer because you've contrived this bizarre scenario where some type of incomes are okay, like some weird dividend income or rental real estate income or business income. Like, that's okay income. But for some weird reason, Cody, like, selling securities isn't an okay. So anyway, you can tell I have really, really, really passionate feelings on this because I think, frankly, this middle class CHOP thing is like the biggest load of nonsense I've heard in the FI community in a very long time. And it just kind of makes me really frustrated that. That winning is being misconstrued as a trap. So I would love for us to put this to bed once and for all. And you are the perfect person to help me. So thank you.
- [05:34]
Cody Garrett
I appreciate it. And as you mentioned, right, as we're working on the path to fi, we're turning income into assets, all with the hope that someday we can turn those assets into income. And a little quote I put here is, you know, the point was never to preserve our capital, right. It was to preserve the life that we saved for. So we're going to dive into maybe the misconceptions around capital and, you know, preserving capital and what that means. But also we're going to have some real case studies showing, hey, you get to 45, you have reached 5 on paper. But you might feel trapped, either on paper or trapped in perception. So we're going to really dive deep and show real examples of the real numbers. You know, I have all these spreadsheets that I put together to ensure that all these numbers are actually what would have happened if somebody would have started on the path to phi and they're now retiring it or at least want to retire early at age 45.
- [06:16]
Brad
Yep. I love it. Cody, you put together a definition. And I know in this, the popular FI culture, it seems like the definition of this middle class trap has. Is a moving target. It seems like the goalposts keep getting moved. But can you give us a sense of this middle class trap as you understand it?
- [06:34]
Cody Garrett
Yeah. So the middle class trap, this kind of consolidated definition, at this point, it's. You followed all the quote, right. Advice. Right? The things that we've been talking about on the podcast, maxing out your 401k if possible. Right. Contributing to those traditional retirement accounts. Maybe you buy a house, right. And you live below your means along the way, which actually allows you to, of course, contribute. Contribute to your 401k, buy a house and so forth. Right. So at the end of the day, your net worth looks strong. On paper. Right. So you look at your balance sheet and your assets minus liabilities is, you know, over a million dollars, for example, but your wealth is quote, trapped. Right. So trapped in potentially three ways, really. Two, the pre tax retirement account. So you've been maxing out your 401k. So there's this assumption that you're going to be penalized. By the way, that's a word we have created, not a word that the IRS created. Penalized or taxed heavily if accessed before age 59 and a half. Also trapped in home equity, which most times in terms of primary residence doesn't produce enough cash flow, little to no cash flow, and it's psychologically difficult to liquidate. And third, if there's other non cash flowing, illiquid assets that you might have your money in. So it's really that you've done all the right things, right. You've been on the path to fi, and then once you get there on paper, you have the perception that you're trapped. So, so we're going to break down the technical and, you know, the qualitative and the quantitative aspects of this situation.
- [07:50]
Brad
Yeah, I love that. And I think that's a pretty good consolidated definition. Again, like we've said it, we've heard some different things. I know our good friends Scott and Mindy over at Bigger Pockets Money have talked recently about, I guess their example, and this might also be just the different audiences, but their example is $2.5 million to reach FI. And, and this is the middle class trap. And I think a lot of people, we've had a lot of really significant threads in our Facebook group with hundreds and hundreds of comments and some of the pushback is, oh wow, like, is $2.5 million the requirement for FI now? And I just want to really set the record straight that there is no one monolithic number that represents fi. We have said this from the very beginning, that the beauty of FI is that you control it. It's all dependent on what your life costs, not what somebody on a podcast or a blog tells you your life should cost or what. Susie Orman has always been the scaremonger that we've used. Right, Cody? It's Susie Orman says you need 5 million or 10 million or 15 million dollars to retire. She, she makes up these numbers and scares you because health care is going to cost a lot or some nonsense like you need $10 million. And like that's what I fear when people hear like these singular numbers that like somehow this is real or it means Something more. Because somebody told you that, like, it doesn't. I promise you this is nonsense.
- [09:20]
Cody Garrett
And I'll add to that that a lot of us within the FI community, we have this money vigilance, money script. And anytime, you know, the four percent rule becomes the three and a half percent rule or that number goes from one and a half to two and a half million dollars, even though we're, we act kind of upset about that. Oh my gosh, like now I have to do even more. There's actually a part of us that likes hearing that we need to make our life more conservative because we're always, I'm going to mention Social Security today. It seems like even though, like, we don't want to feel trapped, we actually kind of in a way love seeking out information that tells us we need more before we can retire. Like, you know, that the one more year syndrome, as we talk about.
- [09:54]
Brad
Yeah. And that again is another psychological thing we have to, we have to try to get over. And we're all susceptible to this. And I think that's the beauty of a community. It can act as a large, like self help group. Right. Because many of us are natural savers. We are. That's how we've gotten to FI in our 30s, 40s, or 50s. It's just we are natural savers. And yeah, it might seem hard to flip this switch and all of a sudden I have to spend when I don't have income coming in or I don't have a lot of income coming in. But that's been the plan all along that as Cody said, you're turning assets into income. This has been your plan all along. And yeah, it's going to be hard, but lots of things are hard in life that we get over. And once you test it out and once you figure out, oh, this is not so bad and oh, this thing that people have Talked about for 10, 15, 20 years, it actually works. And it's not so hard to sell some assets. Like, you actually do get over it and you realize, okay, the plan works. And like Cody said, it's easy to set up and to catastrophize. Right. It's easy to say, oh, the 4% rule isn't going to work, so I'm going to just fictionally make it 3% or, oh, my annual expenses are 40,000, so I really would only need $1 million to reach 5. But now I'm going to say they're 80,000 just to be safe. So now I need 2 million to reach 5. Like, or, oh, Social Security, I'm pretty sure even in a worst case scenario, 60 to 70% of it will be there in terms of the income that you're anticipating. But you know what, I'm going to count it as zero. When you start layering these things on top, like, what do you think happens? You work for 3, 5, 7, 10 extra years and that's a real opportunity cost, right, Cody, like that's almost a decade potentially of your life that has gone to a job when you were just scared.
- [11:43]
Cody Garrett
And I think that we're going to call this maybe moving forward instead of the trap we'll call it, we have Fat Fi Coast Fi. Right. And now we have Just in Case Fi. Right. Where you know you have more than you need. Just in case.
- [11:53]
Brad
I mean, that's great. I love it. That is really, it's all inextricably linked, right? This one more year syndrome, this conservatism and this feeling of being trapped. And I think again, like what we're trying to do is dispel this myth, not to play into it. And yeah, I think it's really important. So. Okay, Cody, that all said, we do sympathize with people who feel this trap and I'd love to hear your thoughts on that and what you do agree with.
- [12:20]
Cody Garrett
Yeah. So, you know, in my, my, by the way, if nobody knows here, I've worked with, you know, hundreds of people on the path to enter early retirement, like looking at everything in their life with a number on it, also understanding their unique values, desired outcomes. I certainly understand what it feels like. It feels like a trap. Right. So there are some parts of this that I agree with. When you talk about the middle class, trap one is liquidity does matter, right. On the path to and through early retirement. So imagine if somebody's working in their 20s and 30s and they're contributing everything to retirement accounts, right? And then they need to go to the doctor and they have like, you know, nothing in their checking and savings accounts. Right. They don't have an emergency fund. Right. We understand that liquidity does matter. And also not just the reality of liquidity needing to support those expenses, like emergencies or going on that big vacation along the path to retirement. But we also understand that liquidity makes us feel safe. Right. We all have that basic desire of the heart to feel safe and secure. And certainly liquidity gives us some of that feeling, not just in retirement, but, you know, on the way to. Another thing that I agree with certainly is that retirement accounts and home equity often feel off limits to early retirees. And I think that feeling naturally dissipates as we become more educated within the community. I always say that clarity precedes confidence, right? Before you can feel confident about using your retirement accounts and home equity in early retirement, you first need clarity. First of all, we have to understand where we are before determining where to go and how to get there. But we also need to really embrace education, whether through these types of resources or maybe work with somebody one on one, like a financial planner, to help you really go beyond education and go more into that personalized guidance. And the third thing that I agree with here is that this is a huge one. I think this is the biggest part of the middle class quote trap is psychology drives behavior more than the spreadsheets. So anchoring the endowment effect, the sunk cost fallacy, right? Those are real forces contributing to this inaction, this feeling of being stuck or locked in or trapped. And by the way, these are things that affect all retirees, not just for the FI community.
- [14:11]
Brad
And yeah, I certainly agree that psychology is critical in this. And it's interesting, Cody, that we're going to do a deep dive on. You've prepared these amazing case studies of four different examples, and we are going to hopefully help people realize, like, almost no matter what situation you're in, there's no trap. But at the end of the day, people need to feel that that's really the important part. And that's where simple education comes in. Right? And also, like I said, that camaraderie of understanding that, hey, it's okay, we all feel this, we really do, because we've been saving money for most or all of our adult lives since we found fi. Or if we're really fortunate, we still started saving beforehand and now we have to switch. And that is not easy. Nobody expects behavior change to be easy. But again, you have set this plan in place. And just because it's not easy doesn't mean that FI is fraudulent or that this is impossible or it doesn't work. Right? Like, none of these things. And we're going to go into your core realities here. And I know you listed eight of them, and I think this is a lot of where the psychology and the interplay of the money and the psychology comes in. But yeah, it's funny because I've seen a bunch of posts or threads or comments in the Facebook group and you have people who are now second guessing themselves. Like, I saw one woman who said, like, hey, I've been saving for years. I have $600,000 in the market. Like, is this all wrong now. I mean, goodness, I was. I told her, like, you're crushing it. Like, you were absolutely crushing it. There's nothing to be worried about. We are not reinventing the concept of fi that you need some, like, magical income streams just because, like, some niche communities, like, you're always going to find niche communities who tell you that you need their kind of income stream, right? Like, maybe the most kind of down the rabbit hole kind of people are the dividend investors who think, like, this is some magical income stream. And it's like, no, most people really think it's just about the same. Probably better, frankly, than selling equities because at the end of the day, the company's just giving a part of itself back to you. But people have deluded themselves into believing, because they want that safety, that dividends are magical income. That said, there are some real income streams, but again, it's. It's trading one thing for another. It's choice, right? So, like, yeah, you could take some of the, I don't know, let's say million dollars that you might have in the stock market, and you can sell that and then buy a business which kicks off income. You can buy real estate which kicks off income. But, Cody, it's very obvious when you say it like that that these are just simply choices, right? Like, at the end of the day, they are all producing income in the way that they produce income equities to a large degree, as you and I are defining it in terms of the FI journey, the way that it's producing. You're turning these assets into income is just simply by selling it. And that's been how the entire fight journey has been predicated from the very start. So to change the game in the bottom of the ninth inning to, oh, no, well, that type of income stream doesn't count anymore. Like, it's so utterly preposterous as to defy logic. And that's. That's truly what annoys me so much about this is like, you can't. With no facts whatsoever just based on, like, some people feel this in a poll. Like, we're not changing the entire definition of phi. When every rational person who's an expert looks at it and says, oh, no, there's no chop at all. You're crushing the game. So anyway, I'm going to have a lot of monologues today, Brody, but we'll go into your. You can respond to that, certainly, but your core realities, I think, are the response.
- [17:50]
Cody Garrett
Sure. So these. These core realities. So there's eight so I'm going to go through them quickly so we can actually get to the case studies. The first core reality. So retirement accounts are accessible before age 59 and a half. We'll definitely break that down. Also, this might be a surprise, but early retirees are favorably taxed and we'll break that down as well. So it's often we hear, you know, we hear these boogeymen and the fear based financial parts of the industry that say, oh, like you know, there's this big tax bomb that's going to blow up in retirement and you're going to pay way more in retirement than you do while working. And that's actually the opposite when it comes to early retirees and actually most retirees in general. Home equity is not a trap, it's a choice. So we'll break that down. Some households aren't trapped, they're just not far yet. Our friend Shawn Mulaney, CPA calls us a sufficiency problem. It's not that you're trapped, it's that you simply don't have enough yet to retire early. Another one certainly is that psychology creates perceived traps. And we'll talk about the difference between perceived versus reality. So number six is there are many levers to generate income in retirement, like you mentioned, not just dividends and things like that. Selling securities, Right. Receiving that interest and dividend income. Charging rent. Right. If you have rental real estate, receiving pension or annuity payments and also yes, part time work. I know we've, in this community it's often like, oh, if you retire and have any money coming from earned income, you're not actually fi. Right. We're not going to be the FI police. Like it's okay to earn money even after you're financially independent. And that's a great way potentially to supplement your other sources. Number seven is the 4% rule. I would love to have a huge conversation on this. Right. The 4% rule in quotes wasn't intended to be an actual retirement distribution strategy. Right. So this originated as a historical analysis of worst case portfolio outcomes. And the way we use the 4% rule in the FI community is simply as a conservative benchmark, a direction. Right. For setting our FI targets. And lastly, number eight, many early retirees exclude Social Security retirement benefits from that analysis. So you know, the 4% rule often excludes this idea of receiving Social Security, which by the way, most of us probably listening probably will just based on what we know today. So that's another conservative assumption. If you exclude Social Security and you're using the 4% rule. You're making very conservative estimations for early retirement.
- [19:56]
Brad
Yeah, Cody, these are great. And we're going to get into your case studies here in just a moment. I wanted to slow down just really quickly on number six, which is there are many levers to generate income in retirement. And I think, yeah, another one of kind of the red herrings amidst this whole debate has been this odd, almost like purity test that some people have set up where like the only way to determine if FI as we traditionally see it works is if the only money that you're living off of is selling 4% of your securities basically to cover your annual expenses. And to me this is so silly. And it doesn't, it just, it defies reality of just how we all live. Which is frankly, if you've reached 5 in your 30s, 40s, or 50s in a 10 to 15 year span and had the ingenuity to do that, to imagine that you're just going to sit on the beach sipping umbrella drinks and not earn another dollar or do something interesting or like you said, have part time work or have rental real estate or have a pension or bring Social Security in or whatever it may be, it just defies logic. So just because fleetingly few people are solely and exclusively living off of just selling securities doesn't even with a shred of evidence prove anything. Like it's, it's utterly preposterous, frankly. So like that doesn't mean that FI doesn't work. It just means we are really dynamic, interesting people. This is a feature, not a bug. Let's be entirely clear. This is truly a feature. And from all the thousands of people I've met in the FI community, we are the most intelligent and forward thinking group I've ever met. And yeah, to imagine that somebody's going to sit around doing nothing, it's just silly. So yeah, it's perfectly fine if you have other income coming in in some weird way, even if it's just interest income sitting in a high yield saving. Like the calculation works. And Cody, like this is one of those things that people sometimes wonder like, oh, my life costs $60,000, but I have a pension and I have some rental income and I have some whatever, how do I account for that? And I actually say, like, this is the easiest thing in the world. Let's assume your annual expenses are $60,000. So multiply by 25, that means your fine number normally would be $1.5 million. But let's say you have a guaranteed money coming in of $20,000. Every year. Let's just say, hypothetically, it's a pension just so we can say it's. It's essentially guaranteed. Okay, well, you don't have to do any weird gyrations to figure out, like, how much is this pension worth? And a lump sum, even though I'll never get it. None of that. You just take, hey, my life costs $60,000 a year. I subtract the $20,000 a year that I'm contractually obligated to get. Or even in a less extreme example, like, hey, I have some rental real estate that gives me a net income of $20,000 a year. You just subtract it. Okay, your life costs then $40,000. That's what you actually need to cover from your investable assets. You multiply that 40 by 25 and you get $1 million. So your fine number is a million dollars. It's actually really, really simple. I know. Way back when on a pension episode with Grumpus Maximus, we talked about this, and it's like, wow, Cody, this is actually really quite easy. But it's easy once it's explained to you. But it's not when it's just something that's nebulous. So, yeah, again, feature not a bug on bringing in different income streams.
- [23:18]
Cody Garrett
So one thing to add on top of that is this idea of preserving principle. I often hear this from retirees. This idea of, you know, they say, hey, once they retire, I want to preserve my principal. Right. What they really mean is, I don't want my account balance to fall below what it was on the day I retired. Which, by the way, this actually isn't principal. And we're going to get into our first case study. I'll share an example of what the actual principal is versus what they might call principal when they retire. So are you ready to dive into the first deep dive?
- [23:43]
Brad
Oh, let's do it, Cody. I'm excited.
- [23:45]
Cody Garrett
All right, so this first case study, I'm going to simplify the numbers, but we have the real numbers, like in a spreadsheet, and all this stuff might be able to share with you, too. So our first case study today is an early retirement age 45, and I'm calling this the upper middle class. So we're going to meet two people. There's Katrina and Carlos. So they're both 45 years old in 2025, and they're retiring this year in Austin, Texas. So again, just laying out some basic groundwork along the way. So they're 45 years old now, and over the last 20 years, they've been earning a combined $100,000 per year. So that's kind of in that scope of what we've been discussing in this trap idea of know, somebody making between like, you know, 50 to $75,000 each. So each spouse is earning $50,000. So a combined $100,000 per year. And by the way, that's what they started earning 20 years ago together, $100,000. And they've been receiving, you know, inflation adjustment along the way. So they're now earning in 2024, 2025, $178,000. So. Right. So that inflation adjusted along the way. So over those 20 years, they were spending $80,000 annually, inflation adjusted, and, and contributing the remaining 20% to their traditional 401ks. They actually weren't able to max out their 401ks based on the contribution limits, but all of their 20% savings rate went into their traditional 401ks. So when they contributed, those traditional 401k contributions were excluded from gross income at the 25% and the 22% marginal tax brackets. So that was between 2003 and 2024. And by the way, their employer also added a 3% match, which is kind of normal conservative estimate here. And the couple invested consistently in the total US stock market index fund within their 401ks. Any questions there before I move on?
- [25:24]
Brad
No, it all is making sense to me now.
- [25:26]
Cody Garrett
Cool, cool. So now at age 45, so this is actually using real numbers on returns, real numbers on inflation, all these things. Their traditional retirement accounts are now totaling $2.8 million. Incredible. Wow. And by the way, this is like the feeling of being trapped. That's their only source of retirement income, you know, no pensions yet. They don't have any other assets outside of their 401k. And by the way, this is really fascinating. You know how I said preserving principle? The amount that the employees, you know, Katrina and Carlos contributed to their 401k over those years was 600,000. And now their 401k is worth $2.8 million using real total returns from the total US stock market.
- [26:04]
Brad
That is really astonishing when you think 2005 to 2025. And Cody, that's largely our own adult lifetimes. Right? I think you're a bit younger than I am, but it's pretty darn close. And that's amazing to think that they saved 20% of their income for 20 years. And really they started out, you know, I know you have this as upper middle class example, but they started out making $50,000 each. Like that's pretty standard. They got the standard raises. Nobody like got any kind of major, major promotion or anything wild. And they ended making a little less then $90,000 each. And now they have $2.8 million. That's an astonishing testament to the growth and compounding of the total stock market.
- [26:46]
Cody Garrett
And by the way, when you think about this, like, these weren't like the tech professionals with equity compensation and like, you know, the old school version of how some people describe fi, like, you know, these could have been, you know, maybe like teachers plus some like, you know, side hustle. You know, again, these are, you know, the average, what I call upper middle class from back then. We also have a lower middle class example next for those who are like, well, I don't make that much. Right, so we're going to definitely dive in. But I also want to share, you know, the idea of preserving principle. What's funny is whenever Carlos, Katrina, whenever they retire, if they have that feeling of being trapped or being scared to like sell their, their basis, right, Their principal, they're actually going to be saying, we want to make sure it stays at 2.8 million, when in reality the principal, their actual like quote unquote basis was their contributions of 600,000. So it's funny how whenever somebody retires, they immediately think what they retire with is their principal. And. And they want to protect that versus actually protecting the real principle of the 600,000 they contributed.
- [27:38]
Brad
That is a very interesting point. And yeah, but again, it's all psychological, right? All of this stuff is psychological.
- [27:44]
Cody Garrett
That's why the quote unquote comes in. Right?
- [27:46]
Brad
Yeah, I love it. I love it. And right. So this is the stark example because I actually had some people good naturedly yelling at me from one of my earlier episodes on this supposed middle class trap where I basically said like, I found it hard to imagine that there are going to be that many people that reach FI in a shorter time span, like a 10 to 15 year period who had nothing in a brokerage account. And I think what's interesting, Cody, is, and hopefully people understand this is like in my mind when I'm speaking to literally hundreds of thousands of people, when I'm saying just about everybody that to me is like, okay, 95 to 99%. Like of course they're going to be anecdotal examples for everything. So everybody just take a deep breath. Like just because you fit in as the anecdote, like, you know, 99% is, is probably I can round to just about everybody. So I say that very good naturedly because I love, I love when people push back on that because yeah, the reality is everybody's situation is different. And I love that's why you set this up, Cody, as, as a pretty stark example of okay, look, they have $2.8 million and it is all in pre tax retirement accounts.
- [28:49]
Cody Garrett
Right? Right. So yeah, this was that kind of if you were to make like a very aggressive case for the middle class trap, this is like that version of like everything's like fully quote, trapped in this account with no other access to no other liquidity whatsoever. So I'm hoping this kind of makes the case for like if we could take one of these worst case scenarios and break it down, this might be a good case against the trap. So you might be wondering, like, how are they going to gain access to that 2.8 million that's all locked up or at least perceived to be locked up in their 401ks. So, Sean Mulaney, our friend in Choose FI episode 475, how to access your retirement accounts before age 59 and a half, and also as follow up in episode 491, answering your questions on how to access money before 59 and a half, Katrina and Carlos are going to access those funds penalty free before age 59 and a half by rolling their traditional 401Ks into respective rollover traditional IRAs and setting up what's called substantially equal periodic payments SEPP. Also, we often call this a 72T plan under IRS rule 72T. So I'm going to record a little video showing step by step how these numbers work because it's a lot. But effectively, Carlos and Katrina, they're going to be using the amortization method with a maximum allowed 5% interest rate. They begin annual distributions of $163,000 and they must continue that for the longer of five years or until age 59 and a half, which is 15 years for them. Since they're, you know, in five years they're going to be still much younger than 59 and a half. So first of all, great, they gain access to that money, right? They have that money that's going to be a fixed distribution every year for the next 15 years. So they have access to their money to live in early retirement. But you might be wondering, but wait, aren't they taxed heavily? Even without the 10% penalty? Aren't retirees taxed humongously? Right. So I actually broke down the tax liability in 2025 with taking those distributions. So their adjusted gross income from those IRA, those SEPP 72T distributions is $163,000. They have a standard deduction, which is effectively a 0% tax rate on the first $30,000 of ordinary income. So that brings their AGI down to a taxable income of $133,000. So when you plug that 133,000 into the brackets, married, filing jointly, you know that's going to be taxed at the 10%, then the 12%, then the 22%, their effective taxes owed. So their total taxes owed on the federal level is about $19,000 on that distribution of 163,000. So after the taxes of 19,000 have been taken away from their 163, they received from the IRA, they have net living expenses of $143,000 a year. So. Right. So they actually have to take out more than they need to live to cover the taxes. But good news, the effective average tax rate, you might be thinking, oh, Is it like 20%, 30%, 40%, 50%? Their effective tax rate is only 11.7% that year in 2025 versus the 25% and 22% marginal tax rates that they excluded that income from when they contributed along the way.
- [31:46]
Brad
Yeah, and that's the beautiful part about putting money into a pre tax account under the whole FI concept. And Cody, I've always said control what you can control, which is you're contributing money to a pre tax retirement vehicle like a traditional 401 or traditional IRA at your top marginal bracket when you are working and presumably making the most money. And then down the road, really the entire concept here is just, it's more or less just a bet on income tax rates or how inexpensively income tax rate wise or effective tax rate wise, you can pull the money out. And more or less, if the rate is lower, when you pull the money out, you are winning. Right? And this is the perfect example, right? Like they put this in at let's say 24% or maybe even 32% and they're getting to pull it out at an effective tax rate of 11.7%. So is it zero? No, it's not zero. But this is, this is a pretty stark example of them pulling $163,000 each year. And it's still, that's one of the craziest numbers I've seen in a FI calculation. And the effective tax rate is still 11.7%. This is with nothing, no optimizations or anything. This is essentially a worst case scenario. Like you said, of all the money stuck in traditional 401ks or IRAs, and they're pulling out this very large number for most people, and the effective tax rate is still only 11.7%.
- [33:14]
Cody Garrett
Yeah, that's right. And Sean Mulaney and I are big tax nerds. And this is a concept called tax rate arbitrage. And I love this quote that Sean uses. He says, effectively your goal is to pay tax when you pay less tax, which in this case they pay less tax in retirement. So rather than choosing Roth contributions, again, it's different for different people. But in this case it actually made sense and they won the game, the tax game of contributing pre tax and distributing that in retirement. And I want to come here and say, yes, there is some inflexibility of this 72t plan, right? I said they have to do this for 15 years. But I want to step back and say, hey, let's say, for example, again, they're even less efficient and optimized with this. Let's say they just take that money straight up out of their 401 IRA without using the 72T plan. So even with a 10% penalty on normal distributions, without setting themselves up with a 15 year old Runway for having to do this, they would have to distribute about $23,000 more with an effective tax rate of 23%, including that 10% penalty. So again, it's still not really a horrible result because again, we said they excluded that income from 25% and 22%, and then even if they took it normally non efficiently with a 10% penalty, they're still only paying a tax rate of 23%. So it's kind of like a wash. So even though they weren't optimized, like that's very much like the worst case scenario of, you know, even getting the 10% penalty, which the IRS calls an additional tax, on top of taking the normal distributions. So again, we can see here that they still won even if they take the most inefficient path.
- [34:38]
Brad
All right, Cody, this is great. And like you said, Sean Mulaney really went into this on episode 475 of Choose a Pie. That was one of the best episodes we've ever done. And he really illuminated me to this 72T and I didn't realize there's a lot of nuance. So a, this was something that a lot of us in the fight community never looked at until this recent rule change that Sean goes through, and it became a lot more viable. And also he talked about being Able to really, in a granular fashion, be able to split up your IRAs into different little buckets where you can set up this 72T on very precise amounts of money, which to me, Cody, was the most interesting thing I've heard on shoes of I in years. Because I think a lot of people have some trepidation with the 72T just because the lack of knowledge. But the cool thing is you can do it in these little buckets. So it's not an all or nothing. Like, again, you set up this very large, kind of like worst case, monolithic example. But they didn't have to do it this way, which is cool. So my two questions to you to follow up. So they took out $163,000, but they paid 19,000 in tax. So that leaves about 143, $144,000 approximately. Is that what their living expenses are?
- [35:53]
Cody Garrett
That's right. So that was, you know, how I said they started with 80,000 of living expenses. That's what the 80,000 is in today's dollar. It's kind of assuming that they're still spending what they did, inflation adjusted. So now that 143 is going to cover their living expenses in early retirement.
- [36:06]
Brad
Okay, that makes sense. So, right, that's inflation adjusted on the 2005 figure of 80,000. So, okay. But then I can't help but notice that they're taking out $163,000 out of a $2.8 million nest egg, which is more than our 4% normally 4% rule of thumb, safe withdrawal rate. It's closer to almost 6%. It's 5.8%. So I'm curious about that and I guess kind of the intersection of maybe are these people 5 by a traditional 4% rule, because their living expenses now are 143,000 on 2.8 million.
- [36:40]
Cody Garrett
Yeah. So I would say if you're using the strict definition of the 4% rule, keep in mind the 4% rule, those distributions are gross distributions, right? So that includes the taxes. So if you were saying, hey, like, you know, I'm only going to retire if the 4% rule works perfectly, right? Like just set in stone as a standalone. They are not actually 5 in that definition. I would say the reason I feel comfortable with this example of them taking out about 5.8% with the SEPP is that as I mentioned before, I looked up. So even if they retire at 45, I looked up their estimated Social Security income, you know, using today's, using what's currently known and within our control, their Social Security income is on track. Even with those years of zeros between now and when they claim that benefit, their combined benefit is looking at $53,000 per year starting at age 67. So full retirement age. So this is one of those kind of. Again, 4% was a general goal post, But I would say, you know, going into the more comprehensive details of retirement planning, I would say this is a pretty reasonable way to start.
- [37:41]
Brad
Yeah, that's great. So for everybody out there, Cody has set up a worst case scenario, essentially in your mind, in many of our minds, that, oh, they're not five by the exact definition. Oh, they have all their money in a 401k. They have nothing in a brokerage. They are actually factoring in the real amount of Social Security. Like, a lot of us count it preposterously as zero, which makes no sense. So Cody is kind of testing your boundaries here just a little bit, which is lovely. But the nice thing is he's a cfp and he's worked with hundreds and hundreds and hundreds of clients. And he knows this works and he knows that it makes sense. And I think that's what people like me have to take a deep breath and people like you and take a deep breath and say, okay, look, this is really interesting. This kind of works. And wow, these people are pulling out $163,000 and they're only paying under 12% federal effective tax rate. That's not too shabby. So, Cody, I'm really liking this. And yeah, I'm glad you can respond to these questions because I have these, like, wow, these people aren't fire. Oh, they're taking out almost 6%. How is this possible? Like, what's going on here? I'm sure other people were questioning that too, but, yeah, I love it.
- [38:46]
Cody Garrett
That's right. And yeah, the 4% rule doesn't account for real life. Right. So variable income sources, expenses. That's why I do generally tell people, even DIY investors using, like, a financial planning software like Bolden or, you know, Prona can really help you, like, add in those kind of variable parts. Again, I would never recommend somebody actually try to use the 4% rule as a distribution strategy. Just as a directional rule of thumb of, like, I'm pretty much there now I can go into the software and really, like, pull the levers on all these other variables.
- [39:14]
Brad
Nice. Okay, what's next, Cody?
- [39:16]
Cody Garrett
Cool. So I want to tag on. So if these early retirees are 45, let's say they had two kids age 15 in this example, they'd also get a child tax credit for each of the kids. And their effective tax rate, as we mentioned before, was 11.7%. It would actually be an effective tax rate of 8.8% because of the tax credit. And not only that, because they owe less taxes, they actually don't have to take as much out of that, that account. So instead of taking out 163,000, they could in this example take out 157,000 because their taxes are lowered by those two child tax credits.
- [39:47]
Brad
That's nice. Okay, so right. Getting into more realistic examples here. I like it.
- [39:51]
Cody Garrett
Right, right. Yeah. I'm always trying to add variables and people like, but what if, what if, what if I try to add little what if?
- [39:57]
Brad
Saying that's right. That's so hard. So, so yeah, if you're listening to this and you're like, okay, look, my life is a little bit different, you know. Okay, yeah, that's fine. So we just need to do some research. Ask in our new Choose a Pie forum and local group app on choose a vi.com I think this is where hopefully most of our, most of all of the activity in our community is going to take place. You can't miss it when you go to our website. And now we have cody@choose.com feedback we have this really cool thing happening where people can ask questions on all of these different categories and world class experts like you who have started it. You were my test dummy and Sean Mulaney. Now I have Carsten and Chad Carson and Fritz and all these incredible people. Dr. Bobby and hopefully Dean Turner. On fitness. We have a lot of amazing people who are there to answer questions. So send your questions in. But understand that look, there are different situations and that just it is what it is. You have to kind of expand your horizons a little bit. Thanks for listening to Choose a five and for all your support of our mission here. The absolute best way to support Choose a Pie is when you sign up for your next rewards credit card to use our cards page at choose a buy.com cards. I keep this page constantly updated so it should always be the top resource for you. Thanks for being part of our community and for your support. Okay, Cody, I think we nailed example number one. We set up a lot here with doing four of these. So let's, let's bomb through to number two.
- [41:25]
Cody Garrett
Sure, sure. Yeah. The first one lays out the most and some of these are a little bit repetitive. So moving on to the second one again people are saying, well, I'm not going to spend 163,000 or 143,000. I'm a little bit lower class than that, or in terms of, you know, not lower class necessarily, but in terms of maybe my expenses are going to be lower than that. So let's go to case study number two, early retirement at age 45, but with a lower middle class example. So this time, meet Debbie and Don. I love it. They're 45 years old in 2025 and retiring this year, also in Austin, Texas. So over the past 20 years, they've earned a combined $60,000 per year. Right. So they started earning 30,000 each, adjusted for inflation. Now they're together combined earning $107,000. Right. In today's dollars combined. So along the way, they spent $45,000 annually, inflation adjusted, and contributed the remaining 25%. So they had a 25% savings rate all put into their traditional 401ks. So again, those contributions were excluded from gross income at the 15% and the 12% marginal tax brackets between 2003 and 2024. Like last time, their employers also contributed a 3% match. They invested in the US total stock market. Their traditional retirement account balances now at age 45 are $2 million, again as their only source of income. And in this example, they contributed $500,000 to the 401k and it's now worth 2 million. So you can see about 25% of the total balance is actually what they contributed. The rest is from the employer plus all the earnings on those contributions. So similarly, they access the funds in early retirement using the 72T plan, and they set up annual distributions of $87,000 per year using the same method with the same interest rate. And they must continue that, similar to Carlos and Katrina, they continue that for 15 years in this example because they're taking less out of their IRA. This is the fascinating part about the marginal versus effective tax rates, their tax liability. In 2025, we take their gross income of 87,000 from their IRA distributions, less the standard deduction, married, filing jointly of $30,000. Their taxable income is 57,000, and they only owe $6,000 in federal income tax. So they net to their 80,000 a year that they want to spend, and their effective tax rate is only 7% versus the 15% and 12% when contributing. And then lastly on this, if they also had two kids age 15, their effective tax rate would only be 2.1%, only paying $1,700 in taxes federally. And I also, again, just a Little extra Sidebar for those wondering what about health care? In this example with this family with two kids retiring at age 45, they get $19,000 a year in premium tax credit going toward their health insurance premiums. Meaning they can actually get free health care in early retirement.
- [44:06]
Brad
Yeah, that's not too shabby. Not too shabby at all. So 7.3% effective tax rate or a little over 2% if they had two kids. Yeah. That's incredible. And this is much closer to what people would think of as fi. Right. They have about 2 million bucks. Their life costs 80,000. So that's the 4% rule. Exactly. And this just works. And they are again, this is a one stop shop with just doing it all in one fell swoop in this 72t. I mean Cody, there are, as you know and Sean Mulaney Talked about on 4 75, there are a ton of different ways to access money early, which is great. I mean for years we've talked about the Roth IRA conversion ladder and maybe or maybe not we'll talk about that today. But people have money in different buckets in most real life scenarios. You and I did a deep dive on tax gain harvesting where we talked about, hey, if you have money in a regular brokerage account, an after tax brokerage account, the government showers benefits on us that up to I know in 2024 it was $94,050 could be your taxable income and you paid a 0% tax rate on long term capital gains. So there are just a myriad number of ways to pull this money out. And we're just looking at the most simplistic way. Just like a one stop shop. You don't have to do any kind of crazy things. You don't need five years of living expenses in taxable brokerage accounts like you would for a Roth IRA conversion ladder. You don't need anything. You are as many people might oddly look at this, you are trapped, quote unquote. And I say that dripping with sarcasm. You are trapped with all of your money in this pre tax retirement account. But lo and behold, you're not even close to trapped. You do one little election, in essence set up this one 72T and you are golden. And you're paying essentially nothing in tax either. So this is yet again another way that no, you're not trapped. You are winning at life.
- [46:01]
Cody Garrett
And I want to add to that earlier, Brad, you mentioned this idea of having multiple IRAs, like creating a 72T plan IRA and then, you know, separating out a non 72T plan IRA with more flexibility. And by the way, in the second case study with Debbie and Dawn, they only have to use about 1.5 million of their 2 million to set up the 72T plan. And that actually provides even more flexibility that if they do need to take more out, like, and, you know, or like, they need more flexibility, they actually have more flexibility than Carlos and Katrina. But again, none of these are truly, like, trapped in terms of, like, I can't retire. They have a lot of flexibility even on top of using the 72T plan.
- [46:35]
Brad
Right. So, okay, right. In this case, then they have an extra 500,000 that's just sitting in a separate IRA that no money is being withdrawn from that because they don't have to by any means. And they didn't set up a 72T on it. So it's just sitting there compounding, which is wonderful. And unlike the first example, you actually didn't include Social Security in this. So, like, they're actually much better off than it even looks like. But again, you're setting up these uber conservative ways of looking at it, and that's what's so great. Like, this is a traditional five person. And, yeah, it just works.
- [47:09]
Cody Garrett
And this is a lot closer to that 4% rule. Like, real hard and solid 4%.
- [47:14]
Brad
Yep. Love it. Okay, number three.
- [47:17]
Cody Garrett
So now we transition between, you know, the trapped. Talk about two potential feelings of being trapped. One is the traditional retirement accounts. Now we're going to move into home equity. And by the way, I want to say here that I think the home equity in a primary residence, in a rental property, I actually don't think just generally that it's that much different in terms of the perception and the ability to choose being trapped or not trapped. So I want to mention here, this is actually a case study with somebody who refuses to sell the house, refuses to unlock that equity. So this is the classic example of being house rich and cash poor. So this family, at age 45, they have a net worth of $1.5 million. Their traditional retirement accounts are 500,000, and their home equity is $1 million. So, by the way, this is pretty common for people who live in, like, let's say, California or other areas that really just skyrocketed in home values over the last 10 years. They have no taxable brokerage savings, you know, zero bucks. And what they see is they look at their net worth statement, they look at their balance sheet, right? And it says that their net worth is 1.5 million. And they're like, well, that's great because our living expenses are $60,000. Right? And 60,000 into 1.5. Like, we've hit 5. Like we hit our 4% number. That's great. And by the way, that even includes 22, 500. That's a part of their mortgage in that home. So again, on paper, they're like, we're five. That's so great. But then they're like, wait a minute. But $1 million of our 1.5 is locked up in our home. We're trapped. Right. We cannot retire. We're trapped.
- [48:42]
Brad
Yeah. And Cody, I'm so curious to see where you take this, because my initial off the cuff response is just simply, These people aren't FI. They have $500,000 of investable income, which means that would, at the 4% rule, that would be $20,000 a year. Their annual living expenses are 60,000. So they're actually 1/3 of the way to FI. But they do have this net worth. But again, people make choices, and nobody is telling them that they have to sell or they have to get out of California or wherever. You said it was like, we're not here to prescribe what you have to do. But I look at this and just simply say, like, okay, if they're not willing to sell or make any changes whatsoever, they're just not fine. I mean, they've over how many ever years, if they're 45, over 23 years of being an adult, they've saved $500,000, which is admirable, let's be clear. But you're just not fine. So that's how I look at this. But I suspect there's more to it.
- [49:38]
Cody Garrett
Well, I kind of think about Jillian, John's rood who talks about retire often. I think that let's say this couple didn't want to sell their house. They absolutely refused to sell their house. They say, well, we have 500,000 right in our traditional retirement accounts. They could retire early for seven to 10 years. But then they'd have to make that ultimate decision on do we sell the house? We got to do something at this point. Either go back to work or sell the house or find another option. But I want to mention, yeah, just like you said, without selling the home, they are not financially independent. Right. So they feel trapped, but they aren't. They're just choosing to sit on that $1 million in home equity. And I mentioned here, they're only 5 because they won what I call the home equity lottery, which Is they got 7% annualized growth rate on their home over time. So this is one of those examples of like, wow, our house appreciated way more than we thought it would. And we're fi on paper, but now it's really opportunity cost and a trade off decision on, you know, do we want to live into our fi lifestyle fully by selling our home or do we keep our home and just, you know, just realize that we might have to look at other trade offs and opportunities. And I want to mention too, you know, we've been talking a lot about numbers, and I want to touch on some emotional, psychological things that are real. One is this endowment effect, right? People assign more value to things that they own. But also, I want to mention this. I call it this, you know, emotional patina, which is as the house evolves into a home. So think about a house versus a home, everybody. You know, if you live in a house, your primary residence, you probably kind of have this idea in your mind, like the house is the. The property and the home is the kind of how it feels to live here, right? So your home accumulates memories, milestones, a sense of meaning over time, right? So it adds qualitative value that doesn't fit into the spreadsheet. So we don't want to just say, hey, well, you know, if you want to live by, you've got to sell your house. Right? Like, we understand that's a hard decision. Like, that's an emotional decision. You know, you raised your kids there, right? Like, when you leave this house, you're going to miss certain elements of the house you may or may not be able to duplicate in the other place that you move. And a lot of people, by the way, are saying, like, but if you made them move, like, where would they live? Right? And we'll actually dive into that in our last case study.
- [51:37]
Brad
Ooh, a cliffhanger. Cody. I like it. So, yeah, listen, this is really important. Fi is about living a good life. And there's nobody, certainly Cody, nor I will ever tell you anything what to do. But you have to understand that you're an adult and you make choices, okay? And those choices matter, like Cody said. And I talked about an episode 5:43 with Mindy and Chris where we talked about is the middle class trap a real thing? Mindy had this example of this person who had $3 million in home equity in California. And yeah, my response was exactly yours. I mean, to the word Cody, which is, they won the lottery. They won the housing lottery. You called it the home equity lottery. Sometimes you just get really lucky. You're in the Right place at the right time, and things go wonderfully for you. Should you cry about that? Should you be upset? No, you should be thrilled. In this case, they had a $3 million net worth because of that. In your case, they have, what, a million dollars in home equity because they won this lottery. That's wonderful. It gives you options down the road, but you get to exercise those options or not as you see fit. But you can't besmirch an entire concept of financial independence because you have made the decision to not sell your winning lottery ticket. You're just sitting on that. And that winning lottery ticket will be able to be sold whenever you decide to or not. But it doesn't render FI as something that doesn't work because you won the lottery and you just decide to sit on that money, then that's perfectly fine. You're allowed to do that. But just really simply, you're not fi. In their case, Cody, they had 23 years of an adult life, and they managed to save $500,000 in their accounts. In this case, all in retirement accounts. Again, that puts them ahead of so many people, and nobody's. Nobody's talking down to that at all. But are they FI with a $60,000 annual expense, with $500,000 saved? No, they're not even close to FI. So just the answer is, you're not FI.
- [53:38]
Cody Garrett
And I want to, like, take away the home for a minute, because I know we have a lot of emotion built up in homes. Imagine somebody who, like, bought a Pokemon card when they were, like, a little kid, right? And now they have, like, a PSA 10 Charizard. Like, you know, and they're like, again, that's a similar thing of like, hey, like, I could sell this Pokemon card, right? And again, just a crazy example, just to kind of remove this. They could sell that Pokemon card, and with that money that they receive, like, oh, I'm fine now. Like, I can actually cash flow my life moving into retirement. But again, it's like, if they hold onto the card, that's not really a trap, right? It's holding onto that Pokemon card worth a million dollars isn't a trap. It's just a choice of saying, I'd rather hold onto this holographic card than trade it in for my ideal lifestyle in early retirement.
- [54:18]
Brad
Yep, Nailed it. And again, nobody's here to tell you what's a right or wrong choice. But just understand, you're making a choice even by not making a choice. By staying in the house, you are making a choice. You're making a choice every single day. And that's fine. Like you said, houses carry a lot of emotion. And this is where we live. And we have to then find somewhere else. We have to find maybe a lower cost of living area or whatever it may be. Like that's up to you. But again, it is a choice. So. Okay, let's go to the fourth and final example here, Cody.
- [54:48]
Cody Garrett
Awesome. So this one is the same early retirees at 45, but they decide they are willing to sell the home. So I just want to show a little bit more detail about the home. They purchased that home in 2010 for 450,000 and now it's worth 1.2 million. But they have a mortgage on there still. But the home Equity is still $1 million. And so they end up selling their home. They're like, hey, like we'd rather live a fi lifestyle than even feel the perception of being trapped. They sell their home and, and now they're financially independent. So first of all, when they sell their home, there's something called a section 121 exclusion. So the first $500,000 of the gain from selling the home, the primary residence is excluded from taxable income. They end up paying capital gains tax upon the sale. Cause again, they had a massive gain on that home. They pay about $50,000 in taxes to sell the home, which again, that's one of those trade offs that they made. So after selling the home with the mortgage and paying off the mortgage, their living expenses are only $37,500. Anything to add to that before I dive into the more detail?
- [55:46]
Brad
No, I mean that, that all makes sense. The right living expenses after sale. Because their living expenses were 60,000. But you said the mortgage made up 22,500 of that. So obviously, and I know you're going to touch on this, there's no housing expenses included in their new living expenses after sales. So we have to account for that clearly. And yeah, that Section121 exclusion, I don't want people to get bogged down in like IRC code or anything like that. But what's really great is, and like Cody said, these people hit the lottery. For most people, our houses have gone up. But again, the government showers us with benefits when we're investors and we get this exclusion. And Cody, you can correct me if anything's been updated, but if you've lived in your primary residence for two of the last five years. So for most people, we fit that. But that's the rule as I understand it. Then if you are a single person, you get to exclude $250,000 of your gain. And if you are married, filing joint, you get to exclude 500,000. So even not including anything else that might have raised the basis, just the most simplistic version of this, if you are married and you bought the house for 300,000, it went up to 800,000 when you sold it. That would be a $500,000 gain. But every single dollar of that 100% is excluded under this section 121. You would pay zero dollars in federal tax on that. So it is capital gains, which actually is preferential rates. I know a lot of people get bogged down and oh no, I'm paying capital gains. Like, no, capital gains are great. Those are really preferential rates. But because you get this exclusion, you pay $0 in tax on that, which is wonderful.
- [57:24]
Cody Garrett
Yeah. And if you're thinking, well, what about rental real estate, keep in mind you have to keep track of not just capital gains, but also consider what's called depreciation recapture. And we won't go into too much detail, but I don't think there's that much difference. Right. There are some taxes you have to consider, but I mean, again, it's a choice to whether you hold onto that property or not. So I want to say here, if they sell that home, they just unlocked $900,000 in taxable brokerage funds. So after the fees, paying off the mortgage and the capital gains taxes, they can fund early retirement without even needing to touch their traditional retirement accounts early. In fact, they have significant control over taxable income, the premium tax credit. So those health insurance premiums. And they can possibly do Roth conversions maybe even at the 0% tax rate, which Sean calls the hidden Roth IRA. Right. In future years.
- [58:09]
Brad
Now that's on the 500,000 that they already had in the pre tax accounts, right?
- [58:14]
Cody Garrett
That's right. So the 500,000 they had in the pre tax accounts, they don't even have to touch for early retirement, but they could actually do some Roth conversions with that money. You know, again, once they meet their desired living expenses, then they can say, what other opportunities, such as tax gain, harvesting Roth conversions, can I play with now? So they've just unlocked incredible flexibility by selling the house. And I guess the next question is, but where do they live now?
- [58:35]
Brad
Yeah, that's the big one because yeah, just again, doing the math, that $900,000 is fine to cover their expenses of 37,500, but we still have not included. Where do these people Live.
- [58:47]
Cody Garrett
That's right, that's right. So again, we solved this last on this case study, which is if they want to live on 60,000 a year, which is what they did before, they can either rent or they can buy a less expensive home, right? So if they rent, kind of the examples here looking at like 1500 or 2000amonth. So by selling their property for 1.2 million, that also reduces their ongoing home related insurance and property tax payments. So think about this, right? Somebody sells a home worth 1.2 million, not only are they getting rid of the mortgage, but I'm guessing that if they weather downsize or maybe even move sideways, they could be looking at potentially reducing their property taxes and their home related insurance, which of course you have to bake that into that the cost of renting as well. Because renting isn't just paying somebody else's mortgage, they're also paying property taxes. And there's other things that are kind of like hidden but we need to be aware of.
- [59:32]
Brad
Okay, I got it. So, right, we're saying basically take the amount of money they were spending on their mortgage and other real estate taxes and such that were included in their original $60,000, and if we can get a rental amount or potentially a less expensive house, that it roughly gets them to the same, then their expenses are roughly around that same 60,000. And now instead of having this equity locked up, it's all liquid and they have the 1.5 million approximately. We're all just rounding here of course, Cody, and that gets them roughly to that 4% rule. Now naturally if you're selling your house and then just renting something that costs more, significantly more than you were paying or buying something, and now in new interest rate environment or whatever, like that doesn't really help you. So again, like we all make decisions, but we need to do it intelligently, not just like Cody said, to sell your house and it's guaranteed. Like no, Cody didn't say that. Like you have to see what are the facts on the ground when you're listening to this. We're recording this in June of 2025 and interest rates are still pretty significant. And who knows in June of 2028 if they're down to 3%. Again, I'm not prognosticating that by any means. I have no reason to believe that. But like when you're listening to this, you need to figure it out. And I think that's the beauty of Fire is like we're all really intelligent people. We look at the situation in the world as it is. Instead of just saying like, oh, I heard this one person say, so therefore I believe it and I'm going to shut my brain off. Like, this is just knowledge to seed your brain with and then to go forward and make sense of what works in your life. And Cody, that's what I love about these examples.
- [61:12]
Cody Garrett
Yeah. And to end this, you know, part of this perceived trap is that regret avoidance, a big part of the pressure is if I sell the home and end up retiring early, what if I change my mind? What if I'm like, oh man, like I really love that house. I wish I wouldn't have sold it. So a part of this perceived trap too is like the idea of feeling trapped later. Not just now, but like, oh, at some point I might feel like I made a bad decision. So that regret avoidance is certainly something we need to think about and work through. And I love this by the way. Just the timeliness of this is amazing. In choose fi Facebook group, there was a post today from somebody, I won't mention their name but they said after hearing all of this middle class trap stuff, right. I realized I'm actually fi. It says I've got a net worth of about $2 million. I do have limitations as most of my net worth is tied up in real estate which isn't cash flowing and my business is as well. But what's the solution? I'm selling my house, hoping to net about 800,000 when the dust settles. The middle class trap is not a trap. It's actually a great gift. Which I thought was a beautiful way to illustrate, like, wow, that's a real person. No, we didn't pay anybody to say that. That's a, that's a real person. In the Facebook group today that said that, I was like, wow, like that's an example of somebody who said, hey, like I'm choosing not to be trapped. I'm going to figure out what are the opportunity costs and the trade offs I have to make to live my desired FI lifestyle. And they did it and I'm really excited for them.
- [62:21]
Brad
That is really wonderful. And I think that is the key is we are trying to educate that you have lots of options. Cody. Actually, while Cody gave these incredible in depth examples, really he just looked at 72t for the standard sense. But like we've talked about since going back to 2017, the Roth IRA conversion ladder is a massive option for people. And that's just but one of many examples of how you can access money before 59 and a half you're not trapped. And my great friend Mindy from Bigger Pockets Money actually sent me a text and she said, yes, people feel this trap, but we want them to know about their options. We just did an excellent super in depth episode about the 72T with John from Equity Trust, and it really gets into the nitty gritty about how to use it properly. That would be a great episode for us to listen to. And she went on to say, we just want people to know they have options to access that money and start thinking about where they're putting their funds. Sometimes everything makes sense after tax brokerage. Roths are amazing, et cetera, et cetera. And I think, Cody, that's what that post in the Facebook group shows so beautifully is. Hey, just by the awareness of this. Yeah. Do I think that this middle class chap is sensationalized and is really a load of nonsense? Yes, I do. Truly, I do. But if it helps even just this one person or helps you out there listening, who's saying, like, oh, I used to think I was trapped, but I'm really not at all. I'm winning. Then we succeeded here. And our friends at BiggerPockets money and different places that are talking about this, they have succeeded too, because this is not a trap. This is the prototypical, beautiful path to Fi and it gives us so many wonderful options. And Cody, you and I have spent many, many episodes talking about this. And as always, my friend, I really appreciate you coming on.
- [64:09]
Cody Garrett
I appreciate you. Yeah, you know, ask yourself questions you haven't asked yourself before. That's a big part of this community, is not just to come in and, you know, go with confirmation bias of hearing what you want to hear, but saying, oh, wow, like, that's a new perspective. Right? And yeah, I would love to just end today by you know, saying again that clarity precedes confidence. So, you know, once you have clarity on again, you don't have to, like, optimize everything in your life, but once you have, you know, good fundamental education, you have an amazing, supportive community. I would also say the Choose a Phi website is really changing, like, huge overload. And I'm really excited to move away from Facebook into the Choose a Phi group. But again, like, if you feel like you need confidence, you first have to start with clarity. And you're going to get that with Choose Fi. And also, again, bigger pockets money, huge shout out. That was actually one of the first podcasts I listened to in 2018 when I moved from. From music to money. You know, it's like Teamwork makes the dream work. We all have to work together to really share the fears, but also dispel the fears with real information.
- [64:59]
Brad
Beautiful, Cody, as always. Thank you. So people can find you at Measure Twice money. Com. You're a CFP and you provide just a wealth of resources. And anybody who subscribes to my newsletter will see that I reference Cody at least once a month just because he's so prolific and he's just producing incredible stuff. And now he's taken up residence at Choose Comm. Slash feedback. And it's really, Cody, you're amazing. It's remarkable how you've dove into that and are just willing to help. I think that's. That's what I just find so wonderful about you as a human being is you just genuinely want to help. I know you've said before you don't have space to take new clients. You're not looking to get any. Any advertisement here. You're just looking to help. And I think that's what's so cool about seeing good people succeed wildly and just want to give back. So a huge thank you to you. And did I miss anywhere else people can find you?
- [65:50]
Cody Garrett
No. It's funny you just said we're not going to advertise, but I do want to show. You know, Sean Mulaney and I are working on a book I mentioned before, Tax planning to and through early retirement. We're not going to make, like, giant pitch. We're not affiliates. But I want to say that if you really want to learn, like, if you want to see, like, step by step how these calculations work for, like, I think, like, 35 or 38 chapters, you've written over 100,000 words. Like, you know, I don't want to call it, like, the bible of tax planning and early retirement, but it's going to pretty much have, like, you can just go to the book instead. So once either the big beautiful bill or the small ugly bill comes out, whatever it ends up being, hopefully we can launch that book later this year. We're not even trying to make money off the book. It's just like, how can we help people as efficiently as possible? So you'll probably hear about that in the future with Sean and I, but we're super excited to answer your questions through Choose a Phi. Again, like, whenever you share a question, it's probably a question that hundreds or thousands of others are asking, too. So don't be scared. There's no stupid question. We won't call you out. We're just going to give you the information you need to live that amazing, you know, that big juicy life in early retirement.
- [66:46]
Brad
Yeah, I love it. And people can find and get on just an email notification about the book release@measure twice money.com book book. And yeah, I can personally vouch for Cody and Sean. They are amazing. They've both been on this podcast so many times. Just get on that email list and they'll send you an email when the book's coming out.
- [67:04]
Cody Garrett
And no spam, I promise.
- [67:05]
Brad
No, of course not. Of course not. All right, on that note, hopefully, hopefully this will be the last time we talk about middle Class Trap. And I really appreciate it. So this has been fun and thank you as always for listening to Choose a Vi and being part of our community.
- [67:19]
Cody Garrett
Thank you for listening to today's show and for being part of the Choose a Vi community.
- [67:23]
Thank you.
- [67:23]
If you haven't already, the best ways to get involved are first subscribe to the podcast. So you're listening to this on a podcast player. Just hit subscribe and then subscribe to my weekly newsletter. I actually sit down every Monday and write this by hand and I send it out Tuesday morning. So just head over to choosefi.com subscribe and it's really, really easy to get on the the newsletter list right there. And I would greatly appreciate it. It's the best way to get in touch with me. You can actually just hit reply to to any of those emails and it comes directly to my inbox.
- [67:55]
Brad
So that's the way that I keep.
- [67:57]
Cody Garrett
A pulse of the community and how we keep this the ultimate crowdsourced personal finance show. And finally, if you're looking to join an in real life community, we have choose a vi local groups in 300 plus cities all around the world. So head to choose a vi.com local and you'll find a list of all of Those cities in 20 plus countries all across the world. And if you're just getting started with FI or you have a family member or a friend who you think would be interested, two easy ways choose a Fi episode 100 is kind of our welcome to the Fi community. And even though it's a couple years old at this point, it still stands up and it's a really great just starting point to get an understanding of what is financial independence. What are we doing here? Why are we looking to live a more intentional life where we save money and use it as a springboard to live a better life and then choose if I created a Financial Independence 101 course that's entirely free. Just head to choosefi.comfi101 and again, thanks for listening.