[Jay’s at the beach all week collecting sea shells, so please to enjoy today a riveting article by our good friend Mr. “Good Looking, But Not Quite Sexy, Budgeter.” Who you may recall from past articles such as The Rule of 72. Today he shares his epiphanies with retiring, and drops some mad math skills on us all. See if you can follow!]
I’m 34 years old and have been doing an okay job with my retirement savings. In the last year, all the fancy pants finance bloggers have got me to start thinking of retirement savings in three new ways.
How much savings will I need when I retire?
I learned that the common advice is BS: you’ll need X% of your income the last year that you work. X is usually 80%. Let me check my crystal ball real quick and see what I’ll be making in the year 2040…
The new advice, which I like, is that you’ll need 25 times your expenses. THAT I can estimate a little better since I have a 10 year history of spending money. There are still some things up in the air, for instance: will my mortgage be paid off early? Will I screw up and buy a new house when I’m 55? Will my household robot be used or new? Will my car be powered by a Mr. Fusion?
Other than these clearly rational questions, I can take a conservative approach to assume about a 3% increase per year in expenses until I retire while reducing/eliminating some expenses (mortgage gets burned, no more 401k savings, 529 plans funded, etc.)
Let’s pretend we did some good math (I tried my best) and come up with a figure of $100,000 a year. This is expenses, so I have to assume some taxes coming out of this withdrawal, as well. I made a leap and assumed that tax rates will stay the same, but the income brackets will increase a couple percent a year. Running the present value of $100,000 in the year 2040 gets me a total tax rate of 17%. (I’d fair a bit better tax-wise, since I’ve been rockin the Roth since 2005). So I’ll need $120,000 per year to retire comfortably with zero decline in lifestyle. In fact, I added a couple perks like extra vacation dollars.
25 times this expense is about $3M. This is a BIG number. And if I work towards this number, I can retire at age 60, and increase my comfort level when I start drawing social security at age 62, 65, or 70. If I get $0 from social security… I’ll still be fine.
So that’s lesson #1. Lesson #2…
Waiting until “retirement age” to retire is for suckers.
You probably noticed that I shot for age 60 already for my retirement accounts to take over my financial needs. I still want to drop the commute earlier than that. My bucket list is full of cool stuff that requires a lot of time and very little money. For instance, I’d love to spend a summer in Yosemite, hike the entire John Muir Trail, and take a destination-less road trip to stay at random spots throughout America.
To enjoyably do these things, I need health and time. I can’t predict my health at age 55 or 60 (damn you crystal ball!), but I can probably assume that in regards to health: 50 > 60.
But there is a hole in my plan: all of my savings for retirement are in tax sheltered accounts that I can’t touch until I’m 60 (without incurring penalties). That means I need to save money into taxable accounts to float my life between age X and 60. X could be 50 or 55, who knows?
I call this period between when I stop working and start withdrawing from my retirement accounts my “Bridge Retirement.” (It’s going to be a thing.) So how much should I put into retirement accounts and how much into taxable accounts?
How much into retirement accounts = as much as possible. If I am putting the MAX into retirement accounts, then I can start thinking about taxable accounts. Otherwise, I gotta keep building up those contributions. I WANT to retire earlier, but I still have to set up my life at 60 as my first priority. Why? because it make financial sense to put money into tax sheltered investments…my dollars go farther.
But what if I make a lower income and never get to the max? Then I’ll have a cutoff point where I STOP contributing to retirement accounts and START putting money into a taxable account. When do I do that? When the Present Value of my money is equal or greater than $3M (the Future Value) in the year 2040. I calculate that number on Excel. Because, math.
=FV(rate of return,years until retirement,annual contributions,Current nest egg)
- Rate of return: Pick a number you’re comfortable with. Usually between 6-10%. I pick 10% (I’m an aggressive mofo)
- Years until retirement: 60 minus your age.
- Annual contributions: make this 0. You want to see if you have enough without putting another penny in.
- Current nest egg: Whatchu got now?
Filling in my numbers, I get this formula:
My solution is $2.145M… still well short of my $3M target. So I don’t make the switch, yet. (I’m actin’ cool, but flipping at the idea I’m already on my way to $2M+!) If I keep putting in max dollars, I learned I could get the PV value to meet or exceed my FV number in 3 more years, but we’ll see how that goes.
In the meantime, if I’m putting max dollars into all retirement account options, then it’s time to start putting more money into taxable accounts. That’ll give me a head start on my bridge retirement. Otherwise, I’ll reassess every few years and point 100% of my savings dollars to my bridge retirement when PV > FV needs.
How much will you need during your bridge retirement? Use the Present Value formula instead.
=PV(rate of return,years until retirement,annual contributions,Future Value)
- Rate of return: Pick a number you’re comfortable with. Since my bridge retirement is a short term need, I’ll be more conservative with my investments, so I’ll use 5%
- Years until retirement: 60 – the age of your bridge retirement start.
- Annual contributions: Put your expenses as a negative.
- Future Value: Put 0, it’s okay to run out since your real retirement nest egg will kick in at the end of this period.
My solution is $520k. If I have $520k at age 55, I can bridge the gap until I can withdraw money from my retirement accounts. I’d recalculate this number each year until my Bridge Retirement Nest Egg > PV.
A wise man once told me, “Saving money is like making money twice.” Bloggers expand on this to state that “every permanent drop in your spending has a double effect: it increases the amount of money you have left over to save each month, and it permanently decreases the amount you’ll need every month for the rest of your life.”
One nice trick is to calculate the FV of your expenses at each dollar. For instance, my formula to see how much my expenses today will be at age 60 is to run the same formula above with only $1 and a 3% inflation rate. I’ll automatically add the 25 times expense rule:
My solution is $53.91. Every dollar I permanently remove from my budget is $53.91 less I need in my nest egg. My weak spot in my budget is food. I spend over $19k a year on food. (We’re working on it!) If I dropped my annual expense down to $12k, which is still a luxurious amount of food, I would need $7,000 X $53.91 = $377,370 less money in my nest egg at age 60! Love your $120 cable? That requires $77,630 to sustain in retirement.
Challenge everything and you can retire earlier.
You can find Mr. “Good Looking, But Not Quite Sexy, Budgeter” over on LinkedIn. These examples above use assumptions, such as your spending during your bridge retirement would be flat, as is your rate of return, and you don’t account for any social security dollars kicking in at any point in your life. He recommends playing with the calculator on www.fourpercentrule.com to get a better picture of how much you’ll need. You’ll discover more accurate numbers, although it takes some trial and error.
EDITOR’S NOTE: Mr. GLBTQSB was kind enough to run my own numbers off my net worth tracker which resulted in $4.25M. Meaning, if all this math mumbo jumbo is correct, I’ll have over 4 Million dollars to play with when I’m 60 myself! Which is a $170k yearly withdrawal rate at 4% – Dayummmmm. If only we could check in on our futures :)
[Photo cred: Ernst Moeksis]