[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:
=FV(.1,26,0,180000)
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.
=PV(0.05,5,-120000,0)
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.
Challenge everything!
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:
=FV(0.03,26,0,25)
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]
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My retirement age is going to be more like 45. By then I should have all the pieces in place I need to comfortably generate an income without working at all.
I cringe every time I read an article in Money magazine where they use age 65 or 70 as the target retirement age. Too long for me!
45 would be awesome. 45>67! Since you have such a big bridge retirement, are you saving more into your taxable accounts than your traditional retirement accounts?
Great break down between the taxable and retirement account needs. This was an area that I had just started reviewing so I could begin setting up a strategy. Don’t want to get to 55 and realize I saved well but didn’t account for the age limit on my retirement accounts. Great information!
Well, that’s amazing. I have honestly never heard about using this method, but it really emphasizes the power or decreasing your expenses! This is also the first I had heard of using 25x your annual expenses, but I’m happy to find out that my calculations have been right on the money!
Yeah I only recently heard of the 25x expenses too but REALLY like that. Lifestyle plays a huge part with money, so of course it does with retirement too! As scary as that number is to look at ;)
I think we should be able to retire by 50 or so. It could be earlier for us if we didn’t have kids, but I don’t want to stop working until they are through college and weddings and all of that =) I agree that retiring at 67 is for suckers, but I think a lot of people just don’t know any other way. I even know people who say they would never retire early because they would be bored. I can’t imagine feeling that way- I can think of a million things to do!
I think the ones who say they’d get bored either use it as a cop out or just never thought it was possible so haven’t taken the time to actually come up with stuff they’d much rather do than work. Hell, you could even work on the same stuff you are now if you wanted to – you just don’t have to ever think about money anymore which has zero negative consequences, haha…
53.91 to 1, that’s powerful. On the other hand, I much prefer to intersperse my bucket list throughuout my life rather than saving it all. I don’t think I ever I want to traditionally “retire” anyway, so that might work for me.
Yup, I remember reading about mini-retirements in 4 Hour Workweek, which sounded like an awesome approach. For someone with more guts than me, that could be a fun life without regrets.
Great way to look at how to retire early. You’re right that all of the other calculations you see make you crunch numbers that are at the very best, guesses. What happens if you guess wrong? I like estimating using expenses as you’ve shown here.
Agree with the sentiment wholeheartedly :)
I think this is the key difference between those that work to live, or live to work.
Bridge Retirement is a good thing to call it. I’ve been investing aggressively into my retirement accounts and taxable accounts. But this all started back when I was planning on working in a traditional job until I’m old. I’ve scrapped that plan so I will need more in a taxable for my bridge retirement. Of course, my passive income should cover me but I should be safe in case something happens there.
The article title I was hoping J$ would choose was, “Bridge Retirement, it’s going to be a thing.” Are you hoping for your passive income to cover all your expenses?
I know you liked that one but wasn’t as catchy :) Plus it’s only a part of the whole general picture you wrote about which was to get our $hit in order way before our 60s! Which I absolutely love.
That’s why you’re the boss!
I wish I had the “problem” of wondering where to put my retirement bridge money! ;)
In the event that I do … where do you recommend it goes? How about a Roth IRA — where I can withdraw the principal without penalty? Or does the tax disadvantage (for those withdrawing at a lower tax bracket than when it was deposited) mean it’s a terrible idea and people should just invest their bridge money without going through the hoops of finding a tax-advantaged way to do it?
Yes, Roth is a good first place to put it, but let’s assume that you’re using those dollars to grow longer since the withdrawals are tax free. You’ll want that egg to grow to take the most advantage of it.
I recommend just a normal taxable account so you can still earn high returns that you lose with municipal bonds and still have full control. I’m still 2 years from switching gears, but have starter money in a Vanguard index fund.
WOW. That’s a ridiculously high number over there! Just wondering what you’ll be spending 100k per year on AFTER you pay off your mortgage! Do you really spend more than that now?
I figure we could live SUPER comfortably with ~40k (assuming no college, no mortgage, car payments, etc.). That’s with a few around the world trips in there too.
Does your $40k include just net expenses, or taxes, too? If I plug in $40k of expenses into the formula [=FV(0.029,26,0,40000)], I get $84k. If this is net expenses, then you have to account for taxes on top of it. Maybe 15% net taxes? That’s up to $98,800. I don’t know your age, but I’m 34, so I add 26 years to get to age 60. At age 50 or 55, I’ll still have a clan of kids living with me to support.
As a disclaimer, I’ll add two things: 1) I’m in the “Challenge Everything” phase now. I expect that we’ll get our number down. 2) I admit that we make choices that add to our number. The purpose was to share my math, not so much my situation.
Yeah – $100k is def. on the higher end but the math and all the equations are the takeaways as you mention. Really appreciate you spending the time to do so, brotha – I forget all that fancy math stuff ;)
GREAT article, thanks so much! I think J needs to go on vacation more often ;) (just messing with ya, J!)
Including the breakdown of the calculations is really helpful for those of us who can’t quite come up with those figures without a little guidance. I’m with some of the others – even if I tried, I don’t think I could spend $100K in retirement. I live quite happily right now on about $15K a year (paid off car, and ‘hacking’ my house so my roommates cover the expenses). I usually set my ‘retirement’ expenses at $40K which still seems pretty astronomical to me… but I figure one day I’ll have to grow up and have my own house without roommates to pay for the mortgage ;)
It’s terrible how black-and-white retirement is… it makes it seem like this impossibly lofty, nebulous thing that we’re supposed to sacrifice for now, but it’s SO far away! I prefer to think in terms of ‘financial independence’ – different words, same idea. I know that by leaving the rat race workforce, I’m not going to NEVER work again – even though I may not need to – but that knowledge comes from knowing myself and knowing that being productive is what makes me happy. But being financially independent will give me the freedom to pursue what I WANT to pursue – I can spend a week in Guatemala volunteering with friends without having to get permission & suck up my vacation days. I can spend a day at the barn and come home smelling like oats and horse dung and not have to explain it to anybody. At the same time though, I can start a business with a colleague, or do some independent consulting. The clincher is, I’m free to choose – that’s where the beauty of being financially independent comes in :)
This isn’t a popular statement to make, but it’s likely that I very well may NEVER work again after leaving the rat race. Why am I the only one? I know it makes me sound lazy, but I’m not.
I’d be curious what a reasonable expectation would be for making money doing odd jobs in retirement. Let’s say that I love hiking and backpacking, so maybe I create a little gig to lead people on Sierra Adventures. I keep and manage the equipment (rental income), plan the trips based around their ability and time frame (vacation planning), lead the expeditions (guide), etc. What would be a reasonable expectation of income for something like this? $10k per year? Not enough to live off off, but it’d move my number down a quarter million. Let’s say that even if I made $10k on it, I’d prefer to be in a position to turn around and use that $10k to introduce inner city kids in LA to the Sierras. Whoa, talk about getting sidetracked… :)
Exactly.. it’s all about freedom and knowing you don’t need the money to survive. I’m all about helping others, but you gotta be able to stand on your own two feet first! Once you’ve reached that independent stage, anything that comes in $ wise is just icing on the cake… icing that you can always turn around and give to charity or make micro loans with or or or …. :)
I love the math and I’ll be playing around with it for sure.
Your yearly retirement income is very generous, but that certainly makes it applicable to more people who are, um, much less frugal/cautious with $$. Right now, we have enough tucked away to not work for the rest of our lives, if we so chose, and I can guarantee you it’s much less than $3M! That being said, you made it easy for everyone to calculate their own “recipe” and that’s much appreciated. Thanks Mr. GLBTQSB. Sounds like you also made J$’s day ;).
You’re welcome! Glad you liked the article. J$ entertains us, and I like to think he employed me for a week to be the nerdy guy with a green visor and a spreadsheet for a week. My number will be less than $3M, too, which is why I advised to play with your own numbers. I just tried to keep the article as simple as you can when talking about complex formulas.
Oh yeah! We’re all about reducing our expenses as much as possible–both to enable enough savings/investments to retire early & withdraw 4%, but also to simply need less money to live on IN early retirement. We’re on track to retire at 33/34, but we’ll still pull in some income. I think that’s another key–most calculations assume you’ll make $0 in retirement. Thanks for this!
Wow, I’m 34 now. Out of curiosity, is all of your money saved in taxable accounts?
I have always assumed that I’ll be healthy and able to travel, hike, ski, skate, swim, cycle . . . well into my 70s. But there are no guarantees, as I see more and more. You’re smart to plan for the freedom to choose retirement by 50 or soon afterwards. Thanks for the equations. (What do you eat? That’s quite an impressive food bill!)
Don’t even get me started with my food bill!! :) Doesn’t everyone hire an omelette chef to make your eggs in the morning? We do eat pretty fancy meals and host pretty often…but I’m certain we could cut our bill 25% with little effort and 50% with a lot of effort. We’ll get there!
Of course! The omelette chef. I should have known : )
I agree that running the numbers can give you a good estimate of your future retirement bliss. Almost always people in retirement cut back and live frugally, so expenses will decrease unless you want to travel the world, every year in retirement. (I doubt that)
Also the calculations do not take into account other passive income sources someone can build before they retire, and the nest egg does not have to be so sizeable. A 2 family home invested can possibly provide1 grand in future income, also dividend payments increase as well with time. So that 3 million might not be needed, if you can get income from other places, maybe you can be free by 45. (Just another sexy blogger Idea)
Your comments are awesome because you’re right on the money (even with your age you pulled out of thin air). I had another version of the article that included all of these things, but I opted to leave them out because the article wasn’t about me, but just sharing my math, reasoning, and approach to retirement. I figured this was complicated enough for those that don’t love Excel as much as I do.
I’ve thought about the Bridge Retirement account before, our plan is to rely on rental real estate and leave the sheltered investment accounts alone until “real retirement”, but as time goes on I would like to have an emergency fund of investments which would be similar.
That would be sexy!!
I am not really interested in retiring early to be honest. That is NOT to say I don’t want to do my own thing. The truth is I like to work and get a lot of purpose from it. I do want to have more freedom in my finical life and be able to call the shots.
You can still do the same thing in “retirement” if you want. I think of it more as Financial Freedom. You *choose* to still work because they’re meaningful to you vs for money. Imagine doing your job without ever having to think about $$ anymore? Hot dogs!
Great way of thinking about it. There is no retirement age but instead there is a game of “how quickly can I retire and watch everyone else still work” in my opinon!
Jay
As you said, challenge everything…..and along those lines – I’m with Debt and the Girl – why do I want to retire early? Personally, I don’t identify with, and cannot understand the want of so many people to retire early. I assert that if your goal is to save up enough money to retire early, you picked the wrong career path. But hey, to each his own. But for me, I LOVE being a software engineer. I love being on the bleeding edge of technology, and solving the problems that come along with making it work. I can count on one hand how many companies can offer the job I do. That’s freaking awesome to me. It’s not like I don’t want to do other things, I certainly do. Between vacation and paid holidays I have over 6 weeks of vacation to go relax on a tropical beach, or run a marathon in some remote part of world. But after about 4 days, I need to get back home and get my brain moving again. I agree with you, retiring at 67 is for suckers. Why would I want to retire so young???
To each, his own! You might be right about me. I like my work, but I’d still rather spend a month on the John Muir Trail with my wife and read books each evening. You sound like a lucky guy to have it all.
Travis – what if you could still do your job but never have to worry/think about money again? I guarantee that would be more exciting ;) Which is the takeaway for me anyways with this “early retirement” stuff – being financially free. In your case you just choose to do your normal job instead of hiking/hustling/vacationing/etc which is more the norm out there.
Wow! Are you guys serious? Have ANY of you raised a child with disabilities, put kids thru college debt-free, helped out (financially and otherwise) elderly parents, supported a family when your spouse became disabled? This SUCKER has done ALL of that, has way more than 25 X expenses, over 50 yoa, still “working” ’cause I actually MAKE a difference in others’ lives and love what I do and I am NOT retiring any time soon. Too much fun to work and too many responsibilities not to. Oh – and get this – I can still ski/hike/travel etc all while caring for grand kids. What world do you live in? Is it really only just about YOU and your $???????
It’s more about being financially free than “not working anymore” in my opinion. Imagine if you could still do your awesome job and help everyone you love but not have to worry about money anymore? The title of this post is of course meant to grab attention, but more so to get $$ stuff in order way earlier than later like most people do.
I was going to let you take first shot on this comment. :)
Short answer is, “Yes,”this article is just about me and my money.: (this is a financial blog, isn’t it?) The long answer includes all the things FI let’s me do. We spent our first 8 years of marriage care taking for my wife’s elderly, partially demented grandmother, so I don’t need the preaching. We deferred some life goals and a lot of experiences to do that, and we’d do it again. Next time the opportunity comes up to take care of family, we’ll be in a better position to do it. Plus, our planning will help make sure our grand kids don’t have to take that role with us in 60 years.
Great article! I don’t plan on officially retiring, because I will always be doing something I want to do. I do plan on being able to do anything I want, whenever I want, by the time I am 45. I am 27 now, so I see that as being quite possible.
I am sure I am not the only reader who needs you to spell out the math a bit more. I get what numbers you’re asking for, but what are you doing with them, exactly?
I’ve just started trying to figure out how much my retirement savings will be worth in 15 years, vs how much I need to save for my bridge retirement (genius phrase there). I can see you’re giving me the tools I need but I don’t know how to use them!
I found the answer – if you open excel and search for FV and PV in the help, you’ll get some calculations to copy into your spreadsheet. Once the calculations are in place, you can start crunching numbers.
(I didn’t know how to do it either – so you’re def. not alone ;))
If any of you want me to run numbers for you, I would be happy to do it. Just contact me through LinkedIn, or something.
Traditional retirement plans and pensions are becoming a thing of the past so i believe traditional retirement should be as well. We’re living longer than ever before and we need to make sure our savings reflect that. Great point about the value of keeping expenses low. That is the bedrock of a great retirement for anyone not making millions of dollars a year.
Hi… stumbled onto your site… loved it. I became concerned with the line about screwing up and buying a house at 55. I did just that. So… what should I do? Divorced female homeowner with not so much in the bank. Procrastinating on $$$ repairs and remodeling. Had a little anxiety attack fourth paragraph down. Lol… but thanks for the insight!
Yikes – sorry to hear! At least you’re on this blog reading and looking for ways to get a handle on stuff – that’s good! It’s hard to advise without knowing you or your situation, but just remember that anything’s fix/changeable. If you’re not happy with a situation you can always change it even if it’s scary/hard. We gotta do our best to be happy as often as possible, right?
Interesting information. If you live a frugal life and disciplined enough to handle your finances, then it’s easier to retire early.
I totally agree with your post. I retired the first time at age 51. I just retired again now age 56. I want to say that you can get to your IRA money without penalty by using the IRS rule 72t monthly equal distributions. It is tied to your age at retirement and the 72t start-time treasury rates so when rates are low like they are today it lowers the payments allowed. Its pretty restrictive but that is how I fund my retirement.
Hah! You’ll be retired from retiring soon :)
“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?”
Not true, my friend. Look up 72(t) and Substantially Equal Periodic Payments. You can pull out money from your tax sheltered accounts whenever you want.