Every year at least one time, I like to take everything I’ve learned about aspiring to a level of financial freedom and meld it all together into one big plan – OUR plan – my “money design”! It’s possibly one of the most brilliant things I’ll ever create – a blueprint for living off of passive income for literally the rest of our lives!
Why do I do this? For both my sake and yours. I’m a big believer that knowledge is only as valuable as your ability to apply it to something useful. For me, I like the challenge of crunching the numbers and seeing if everything we’re doing (or will be doing) is truly going to work out or not. For you, I encourage you to follow along and take away from my plan any portions that you see as being helpful for your own money design.
I can proudly say that with each passing year, our money design becomes a little more sophisticated. With each update, we’ve been able to effectively give ourselves a “raise” by being able to enjoy more money at retirement while all the while still ensuring the longevity and security for how long our money will last. If you’re really interested, you can take a moment to look back at previous versions of this plan from 2012, 2013, 2014, and 2016.
But Will We Really Retire?
That’s the million dollar question, isn’t it? After all, this is an “early retirement” blog.
Truthfully, who knows! 9 years from now is a long time, and who knows what will happen by the time we reach the point of financial independence. I know that if you were to go back in time 9 years ago and tell me about everything that’s happened since then (such as me battling cancer), I’d never believe you.
My wife and I have discussed a number of different things that we’d like to do once we get there. We both have ideas for small businesses that we’d like to run. We’d also both like to volunteer more, travel, and remain a big part of our children’s lives.
And then at the same time we’re both also open to the idea of continuing to work in the jobs we already have. Why not? For one thing: We both like our jobs and what we do just fine. Our kids will be of college age and I’m sure they’d really appreciate the extra financial help of paying for school. Aside from this, I’ve also got some pretty creative aspirations to create a “dynasty fund” which could theoretically provide wealth for multiple generations (more on these ideas to come in future posts, I promise).
A year two more of work could really help with any of these goals.
This is why I sometimes cringe to use the phrase “early retirement” because, for me, it’s not about “quitting a job as soon as possible” or anything like that. The point of financial freedom is to be FREE. Your decisions are no longer governed by your obligation to financial necessity. You can do what you want to do and pursue any ambition you have because it’s what you choose to do.
Anyways, enough of the psychology behind our decisions. Now for the fun stuff!
What is Our Target?
Our goal is to become financially independent by 2026. By then, I will be 46 years old. I estimate we will need approximately $6,000 per month after taxes to live as we do now.
Why 2026? To put it simply: My wife’s pension. In 2026, she will have met the minimum requirements necessary to become eligible to start receiving full pension benefits if she chooses. This would account for approximately $2,000 of income per month for the rest of our lives.
I should also mention that another HUGE bonus to her pension is the fact that it comes with the opportunity to buy in to a wonderful healthcare plan at a significantly reduced rate. As anyone who has looked into private healthcare, it is certainly not cheap! This would be a huge benefit to us in making sure we have all of the affordable care we’ll ever need.
Because of these two things, our plan is pretty much tied to this date. We could try to reach FIRE sooner, but then we’d be missing out on this pretty incredible benefit.
What Does Our Plan Look Like?
Here is a summary of what our entire plan looks like. I’m going to explain each part in more detail below.
Saving During the Working Years
To achieve our goal, we’ll continue to save our money according to tax avoidance opportunity and other benefits as follows:
Max out my 401(k). First and foremost, we will focus on saving money in my 401(k) because my employer matching contributions adds approximately another $4,000 on top of my personal contributions each year. In addition to this, I estimate that by maxing out our 401(k) contributions, at our tax bracket we save around $5,040 in taxes each year.
Max out my wife’s 403(b). For the same reasons as the 401(k), we do this because I estimate that it saves us around another $5,040 in taxes each year.
Max out our Roth IRA’s. We prefer to use a Roth IRA because it could help us fund the “early” portion of our retirement as well as diversify our tax situation. (Plus we don’t qualify to contribute to a non-deductible traditional IRA anyways due to our income level).
Max out my SEP IRA. The SEP IRA is something I can contribute to thanks to the side-income I make from blogging. By using it, I not only get to save even more tax-deferred money for retirement, but it also lowers the overall tax bill that I have to pay on my business income each year by approximately $1,000.
Anything extra? I’m not going to kid you. After all of that saving, there is pretty much nothing left in our budget to save. But on the rare occasion that we do find ourselves with an extra thousand bucks or so, I’ve been re-routing it to our emergency fund. The money just sits there in an online savings account earning a little over 1% interest, and I’m fine with that because I know it will be ready the moment disaster strikes.
When it comes to investing, I don’t do anything fancy with the funds I pick for our retirement accounts. All-in-all, we shoot for a 75/25 allocation to stocks and bonds. Most of it is simply in broad index funds.
Early Retirement: Once We Reach Financial Freedom
Assuming we have enough money by 2026 as planned and we decide to live off of our passive income, how will we do this?
My wife’s pension. As I mentioned before, my wife’s pension will account for approximately $2,000 of income per month ($24,000 per year).
72t / SEPP. $2,000 per month is a good start, but we’re still going to need an additional $4,000 per month after taxes.
So where will this money come from? From our retirement savings, of course.
But wait – neither of us will be old enough to met the age 59-1/2 eligibility requirement for taking out retirement withdrawals penalty free? So how will this be possible?
Thankfully, I’ve done a ton of research on this topic. In fact, I got so into the subject that I put it all into an ebook called “How to Unlock Your Savings Before Age 59 ½ Without Penalty“. As it turns out, your money is NOT locked up forever, and there are actually quite a few useful ways to get at it.
For this year’s edition of our money design, I am going to simplify the process as follows:
- Move all of our 401(k) and 403(b) savings into our traditional IRA (a rollover from my previous employer’s 401(k) plan).
- Use a little-known tax rule called a 72(t) to create a series of substantially equal periodic payments (SEPP’s) that will provide penalty-free income from the traditional IRA.
Because the SEPP amount is pretty fixed according the IRS rules, we will make up any remaining difference by taking contribution withdrawals from our Roth IRA’s. Just a reminder: You can technically withdraw the “contribution” portion of your Roth IRA any time you want. It’s the “earnings” portion that you have to be careful of, or else you’ll pay taxes and penalties. More on all of that here.
What’s different from last year?
Backdoor Roth Conversion. One strategy that I left out this year but really like is the Backdoor Roth IRA conversion. It’s a really cool trick that you can use which basically converts all of your tax deferred savings into tax-free income over five year increments.
I started off my updated plan using it. However, removing it and just using the 72(t) alone proved to make things incredibly simpler. One interesting note: The Mad Fientist did an awesome study comparing each of the various early retirement withdrawal strategies, and he found that a 72(t) beats outs all other options, including the Backdoor Roth conversion. Who knew?
Dividend Stocks. In the past, I had always talked about using the dividend payments from stocks to provide some portion of our early retirement income.
I LOVE dividend stocks! But unfortunately, we don’t have any at the moment. I had to sell them all to help finance our moving to a new house a year and a half ago. Ever since then, aside from the savings goals I mentioned above, we’ve been prioritizing the building back up of our emergency fund. Once it gets back up to a level that I feel is “good”, I’ll happily go back to building back up our dividend portfolio.
Watching our withdrawal rate.
Altogether, I estimate that the total amount of these withdrawals will not exceed approximately 3.5% of our total nest egg balance. According to popular retirement research greats like Bill Bengen and The Trinity Study, a rate that low should put us in a very good position for portfolio longevity
After Age 59-1/2
As you might imagine, after age 59-1/2, all the barriers that are keeping us from accessing our savings will fall away. Withdrawals from ANY of our retirement accounts will suddenly become penalty-free, and we can take from them as we please.
As before, our target will be the ability to take out an inflation-adjusted $6,000 per month ($72,000 per year) after taxes. To do this, we will:
- Stop taking the 72t distributions.
- Start making regular withdrawals from both our traditional and Roth IRA’s.
- Again, the withdrawal should not exceed roughly 3.5% of our overall nest egg balance.
Social Security and RMD’s
Though its a long ways away, our plan has also given attention to both Social Security and Required Minimum Distributions (RMD’s).
Social Security. As long as our plan remains stable and things don’t get off track, my wife and I will put off taking our Social Security payments until as late as possible. This will help to maximize the distributions that we will be entitled to.
Once we start receiving Social Security, we will use this money to help offset how much money we’re withdrawing from our nest eggs. This will again help perpetuate the longevity of our nest egg.
RMD’s. Having spent some time behind the scenes learning about how estate planning and trusts work, assuming our fortune has grown to where I think it will be, I have some pretty creative plans for how to reduce the value of our IRA’s while still reaping its benefits, such as setting up an irrevocable trust fund. More on this topic to come in future posts.
For those of you (like me) who want to know more about the mechanics of our plan, here are the assumptions that are being built into our model:
- Yes, this plan is inflation-adjusted at an average rate of 3% per year.
- Our anticipated annual growth rate for our investments is only 6% nominal (that’s a real rate of 3% after inflation). This is by far one of the lowest return rates I have ever used when doing retirement planning, and I’m doing this on purpose to increase the safety of our plan. Why? Because even if we experience some turbulence in the markets over the next 10 years, building our model with this lower “modest” return rate will help ensure that our goals will be met.
- Our model goes until we are 100 years old. Yes, even then there is still money leftover.
Just in case you’re curious, here is what madness looks like: This is a screen-capture of the Excel spreadsheet I use to run this analysis and model everything. It’s using the same concept as Finite Element Analysis (FEA) engineering.
Readers – What does your plan for financial freedom look like? What sort of goals or milestones does it have? How are you doing on getting there?
Featured image courtesy of Flickr | Albert Huynh