I was very pleased with the level of interest and positive reaction I received for my previous post on how I plan to retire early in Money Design update in October. However, that update was only merely a sketch of where I wanted to be. As I’m sure any designer can tell you, no blueprint is ever really complete until you put numbers to it – even if it’s a blueprint for your plan on how to achieve financial freedom.
In this update, we’ll seek to build upon my earlier retirement income strategies by making some assumptions about how much money my family could expect to take in from our multiple developing income sources. Please feel free to compare my decisions and estimations to what you think would be reasonable for your own situation.
As I’ve mentioned several times before, remember that the goal of my money design is not necessarily to retire early or quit our jobs. This is not an “I hate working” kind of blog. For me, achieving financial freedom means getting my finances to a point where our assets generate enough income to take care of us for life. See the difference? Whether we continue to keep working or not is inconsequential at that point because we’d have the resources we need to be financially independent. Basically we could do as we please without the fear of monetary consequences.
Our Income Needs and Timing:
Through review of my budget and looking ahead to how old my kids will be, I’ve narrowed down a monthly target for my retirement income as being somewhere between $5,000 and $7,000 per month. The high and low of these figures are based on a lot of varying factors such as whether or not the house is paid off, the kids are out of college, what kind of car payments we have, what our medical bills might be like, modest inflation, how luxurious we want to live our lives, etc.
Unless I’m about to come into any sudden wealth, the current state of my finances are no where near able to declare having achieved financial freedom. Knowing that the earliest possible time my wife can start receiving her pension is in 13 more years, I have decided to set 13 years from now as the tentative target to start withdrawing from my retirement funds.
Review of My Previous Retirement Income Strategy:
So you don’t have click backwards too much, here is the graphic from the My Money Design October 2012 Update. To recap, I thought it would be the most effective to group together all of my retirement income sources by when the earliest I could touch them without penalty.
In the latest version, one of the first things you’ll notice is that I don’t use every one of the retirement income strategies I brainstormed in this version. That is because I just wanted to see where my current sources would take me. Why bother with 10 income streams when a stable 5 will do?
If my new money design proves insufficient or could be improved (can’t it always?), I’ll start adding in more!
Going Forward – My Updated Money Design for How to Achieve Financial Freedom:
Here it is – my revised money design and plan for how I will achieve financial freedom with my family. If this illustration is too small, don’t worry – you click the image and it will get larger. But don’t feel the need to – we’ll be reviewing each column separately in more detail below.
Right away you’ll notice it is still in the same setup as my previous plan, only it has been greatly expanded to include numbers and estimations. Here’s a few things you should know about how I put this together:
Assumptions / Key:
• PV: This stands for present value, and it represents the starting balance of the income source prior to the number of years listed.
• Years: This is how long this income source will be used (within this column).
• Gain: This is how much this income source will grow each year. Unlike how most financial resources tell you to assume using an 8% average annualized growth rate, I’m going to create a safety margin by using 6% instead. That way if my funds happen to under-perform, my model will still be okay. Or that also gives me the option to invest more conservatively.
• Withdrawal: This is how much I’m going to take out of each income source within each column. It is helpful to use a percentage rather than a dollar amount, so that is why it is shown as a percentage.
• PMT Gross: Stands for gross payment or how much money will be going in and out (before taxes). If the number is negative, that is money going into this income source in the form of an investment. If the number is negative, that is money going out of the income source in the form of income to my family. I have shown this in both monthly and yearly payments.
Note that in my 401k category, I will not include my employer contributions. This another safety factor. If I get them, great! I’ll have more money saved. If I don’t, then fine. They vary anyways and are not guaranteed, so I have no issue not including them into my model.
• Taxes: This is how much money I’ll be paying in taxes. For almost everything as a safety margin, I’ll assume a 25% tax margin.
• PMT Net: This is the same as PMT Gross but after taxes. Because being financially free means being concerned with how much money actually makes it into our pockets, this is the number we’ll be adding up to see if we’re hitting our target income requirement.
• FV: This stands for future value, and it represents the ending balance of the income source after the number of years listed. Obviously, we want to minimize the chances of turning any of these income sources to zero because that means no more money would be left. Therefore, all the PMT amounts have been carefully selected to make sure they do not.
One more major assumption: I’ve NOT included “inflation” in this round for simplicity. Yes, I know – shoot me. If I like where the numbers are going, I may go back in a later revision and work it into the calculations.
With that said, let’s look at each column of retirement income strategies individually to see how this fits into my plan for achieving financial freedom.
Pre Age 59-1/2 Column:
In the first column, our goal will be to utilize my investment funds that are available to us prior to cashing in the traditional retirement accounts at age 59-1/2. Here are the main ones:
• Pension – My wife will be available for a full pension starting at age 48. If we take the option with spousal benefits, we have to sacrifice 25% of the payout. Plus we’ll lose 25% to taxes.
• Dividend Stocks – My dividend stock fund I started just this year. I plan to fund this income source using profit sharing, blog income, and the dividend income I receive from these stocks. In a controversial move, I may also shift some of my contributions from our 403b account to these stocks (I’ll have a follow-up post on this move later). As much as I’d like to only live on the dividend income from this income source, this seems to be my best bet for funding Column 1. Therefore, I’ll be taking out a pretty high withdrawal of 10% of this fund (about 4% dividend income and 6% stock growth).
• Roth IRA – Another questionable decision. Technically you can tap into the principal of your Roth IRA without penalty (since it was already taxed once). Therefore, that does make it an option for adding income to my Pre Age 59-1/2 Column.
Total projected income: $5,177 per month (or $62,130 per year) after tax.
Post Age 59-1/2 Column:
In the second column, we can now tap into the next phase of our retirement investments and cut back on the dependency of the accounts from Column 1. Here are the changes:
• Pension: No change.
• Dividends: Now that we’re open to the other income sources, we’re going to cut way back and just use only the dividend income for living income (assumed 4%).
• 401k: We’ll start withdrawing a modest 4%.
• 403b: Same as the 401k, we’ll start withdrawing a modest 4%.
• Roth IRA: Again, we’ll start withdrawing a modest 4%.
Total projected income: $9,653 per month (or $115,839 per year) after tax.
Post Age 70 Column:
In the third column, we can now redeem the absolute maximum Social Security benefit and further cut back on our dependency of the retirement income from Column 2. The goal now will be longevity of maintain income for financial freedom. For that, I have assumed that the accounts must last me another 30 years which will take me to age 100. Here are the changes:
• All preceding accounts have now been cut back to a 3% withdrawal rate except for the dividend stocks, which I’m still assuming will only be the 4% dividend income only.
• Social Security: This will be the biggest new addition to my retirement income strategy once my wife and I fully qualify for Social Security spousal benefits. Many of my fellow bloggers keep telling me that it won’t even be around. So as a safety factor, I have done two things: 1) I have reduced the payout by 75% per the under-funding that Social Security believes they will be dealing with. 2) I again reduced the payout by 75% because of Survivor benefits. I then further made this money completely extra and in addition to Column 2. So even if I got nothing, it wouldn’t hurt a bit. (But I’d still be sad if I paid into that long and got nothing.)
Total projected income: $12,538 per month (or $150,457 per year) after tax.
Things I Like About This Plan:
1. On paper, it works! Hooray! Assuming the markets perform to average (or even just slightly less), we should be okay. I’m just meeting the minimum income needed for Pre Age 59-1/2 and exceeding my numbers after that.
2. I have a lot of safety factors built in. Using 6% instead of 8% and assuming I’ll live to age 100 will help ensure that I exceed my goals don’t under fund my needs.
3. My income will increase, not decrease with age. If all works out, life should be like fine wine and get better with age. That means more ability to travel, see and do things, and take care of unforeseen medical issues. This is a big relief because as we get older, we’ll have less opportunity to go back to work and earn an income. So I want to hedge my bets as much as possible!
4. I’ll have something left to pass on. Though not a huge concern, it would be nice to pass my life savings on to my family, children, or a strong cause. Looking ahead and seeing that I won’t die without a penny to my name is very nice to know.
Critiques of My Own Financial Freedom Plan:
1. For starters, I’m not generating enough Pre Age 59-1/2. If the upper income target for my retirement income is $7,000, then I need to get a little more creative about how I’m going to make up the difference.
2. This plan is far too dependent upon the stock market. What if the markets don’t return an annualized average of 8% (or 6% as I have modeled here)? Making withdrawals while the balance is low will greatly reduce the potential for my money lasting forever.
3. This plan isn’t Recession proof. Wouldn’t it just be my luck that right after I declare having reached financial freedom that we have another Great Recession like in 2008. How quickly would my finances drain after only a few years of withdrawals?
4. I need more guaranteed returns. Along the lines of critique Numbers 2 and 3, I’d have a much better chance of maintaining my wealth if I added more reliable or even guaranteed forms of income to my money design.
I have purposely not included but also not ruled out the possibility of turning to annuities for guaranteed income. If I did, this would mean taking a sizable investment from one of my Post Age 59-1/2 accounts and making the purchase. However, it would be hard to gauge what sort of interest or return rates would even be available 28 years from now. Perhaps in future updates I could include this as an option but estimate a very modest return rate.
5. I need more diversification. With that, I mean that I have no real estate or eProducts of any kind in this model. This year I have given much thought and exploration into the topic of picking up homes for rent. I have also thought about and lightly researched what it would take to create some type of eProduct such as an eBook, etc. Income streams from sources such as these would definitely improve my income potential in the Pre Age 59-1/2 category.
6. I don’t want to tap my Roth IRA early. I don’t really like the idea of tapping or under-funding any of my Post Age 59-1/2 accounts before their due. Even though you are technically allowed to take out the principal money without penalty, this is still not the point of the account. The point is to provide a person with money that is tax free! So by reducing this account early, I’m sabotaging my opportunity to have tax-free money.
7. I’m not making use of the 72T. I’ve often commented and known about the 72T as one of my possible income strategies for accessing our Post Age 59-1/2 money. But checking the interest rates of today, they are only paying out at a measly 1.38%. 1.38% – really? That’s not achieving financial freedom. That’s committing your hard earned money to a pretty pathetic return; especially for a sum of money as large as I would need in order to produce the income I’d be looking for. Perhaps in 13 or so years when interest rates go back up, this option will turn out to be a much more attractive option.
Readers – Thank you everyone for making it through this wallop of a post. What do you think of my latest money design update? Does anyone have any tips of their own to share for how to achieve financial freedom? I’d be interested to see what other designs people have to share!
Photo Credit: freedigitalphotos.net