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!
1) My Money Design – October 2012 Update
2) My Cash Flow Plan – September 2012 Update
3) Social Security Spousal Benefits – Hook Me Up Elderly Sugar Momma!
Photo Credit: freedigitalphotos.net
Glen @ Monster Piggy Bank says
Top post! As I was reading through I was thinking – “I’ll comment and tell him that he is relying heavily on the stock market”. Then I read – “This plan is far too dependent upon the stock market” – lol
Honestly, I think this is great, you have inspired me, i’m going to plan out where I think I should be in my retirement and see how close / far away I am.
If you are interested still interested in setting up an eProduct in a month or 2 then give me a yell. I have a couple of ideas which you may be able to help me with and generate income for both of us.
Thanks the compliment Glen. I was hoping I could inspire people to do the same with their retirement planning.
I’m interested to hear your idea for the eProduct. I’ll send you a direct message on this later.
Looks like you’ve got a nice setup there. One thing you may have missed – as you get older, you need far less to live on, so maybe you have another inbuilt safety factor there too.
Thanks Matt! But I would argue that as you get older you may need MORE to live on – and what I’m getting at are medical reasons. I’ve read dozens of articles about how home care and medications can wipe out a lifetime of savings. Plus I plan to leave behind a fortune to my loved ones, so that is part of my reasoning for the large sums.
Yeah sorry, being a UK reader I just forget about medical reasons.
Most of that is taken care of by our national insurance contributions and taxes which are taken automatically from wages and pay for free at source health care regardless of age/status etc.
You’ve probably heard the jokes about the British having bad teeth, and there’s an element of truth in that, propbably because dentistry is the only thing we do have to shell out for.
With as many cut backs as they make to our medical and dental plans, we have to shell out more and more each year – so we might soon have similar reputations!
[email protected] says
We have a lot of the same worries and concerns that you do! And really- all we can do is plan. Unfortunately, we can’t predict the future but you will be way ahead of the game just for having mapped out what you hope to achieve. I think it is great!
You have lots of ways to diversify and not rely too much on the stock market, but it depends on how much risk you are ready to take. You can chose for example to consider your blogging income “virtual money” that won’t affect you too much if you lose it all, and try to invest in different vehicles in hope for great returns. Peer to peer lending, invest in a friend’s start up…
John S @ Frugal Rules says
Nice post and very detailed. It looks like you have some good diversification and I agree that it can be a problem to depend too much on the stock market for returns. My wife and I share some of the same concerns that you do. I think in light of what the current economic climate is that it’s even more important to have multiple revenue streams.
[email protected]&More says
Seems like a great start. You will definitely need to figure in inflation. Also, after you retire do you plan to move to more conservative investments or keep the same asset allocation? It may lower your return and the money you plan to pass on but it may be worth taking a little bit of risk off of the table.
Good point Lance. I do plan to move to more conservative allocations the older I get, but that for me would mean having a 40/60 stock bond model which some analysts say would still yield around 8%. My model is assuming a 6% return, so I think I have enough safety margin. If I really wanted to be slick, I’d build it at 5% and have very, very little risk.
Nice retirement plan. Things like inflation are hard to predict but you’ve done a good job with what assumptions we can make today. 5 figure monthly income in your golden years is not too shabby my friend :0)
Veronica @ Pelican on Money says
The fact that you have a plan puts you ahead of something like 50% of the population! Yeah, your plan is not bulletproof but you’ve put in a ton of safety measures. One thing I would note is how fast money depletes when you lose a job. I certainly can’t know where you stand job security wise but I can clearly remember my own situation and what happened after being unemployed for over a year. Savings drain so fast – it’s sickening.
That is a good point, and I have not factored in Job Loss. Obviously anything like that between now and 13 years (when this plan is supposed to start) would be a huge blow. I guess I’ll have to watch my back and keep on my toes.
[email protected] says
What is the saying, “If you fail to plan, you plan to fail?” You obviously don’t plan to fail. We are on about the same timeline. My husband will be eligible for a pension in 12.5 years, and I hope to be able to “retire” if I want. I think I will want to work, but, like you, I want to do it because I choose to, not to pay bills. We have retirement accounts that are in the stock market, but also want more real estate. We have one residential and one commercial rental now, and hope to add 3 more over the next ten years. You never know how the economy will be, so hopefully, we will have enough diversity to meet our goals, although not a precisely planned as yours. Great money design!
Thanks Kim. It seems we are thinking alike on this topic, especially in the area of not necessarily retiring but having the ability to not be dependent on our incomes. It would be interesting to have you (or any of our blogger friends) give this same exercise a try and see how things turn out, especially with your real estate projections.
Sounds like a plan and a very well detailed one.
I guess the reliance on the stock market might have drawbacks that can be addressed by going with more conservative asset classes to reduce risk.
Agreed. A conservative allocation could fix a lot of my concerns. Hopefully between now and then the economy will improve and interest rates will hike back up, and I could lock into some nice yields.
DC @ Young Adult Money says
Those are some awesome spreadsheets! I’m definitely impressed.
Spreadsheets are one of my specialties! Glad to impress.
Stunning level of detail. I love this stuff. Congrats on laying the entire plan out. Now, like anything, it’s down to execution.
That compliment actually means a lot to me Joe. I know you have a special bias and understanding of all this stuff, so I was hoping my plan would impress you. Not to toot my own horn, but the spreadsheet is a little bit of a work of art. But pretty or not, now I have to make it all come true. Back to hard work and discipline!
Have you thought about adding a business that can generate residual income during your retirement? As always, this a well written post on retirement.
Thanks Shilpan! Yes, I have thought about adding some type of business – consulting, writing, speaking, perhaps becoming a financial adviser??? I’ll definitely keep my ear to the ground in terms of online marketing opportunities like selling an eBook, product, more blogging, etc. However, technology can change very quickly and I am not very clear on what the online market will look like ~15 years from now.
I think you may have a bit of a misunderstanding of the 72T rule. There is no requirement to base 72T withdrawals on interest rates. There are 3 acceptable withdrawal methods.
1. life expectancy method (basically based on RMD tables)
2. Amortized over life expectancy
3. Annuitized over life expectancy.
#3 will depend on the annuity payout interest rate but there is no reason to choose that methodology.
Option #1 also has the potential benefit of changing every year as your balance changes and your life expectancy changes. This would likely increase your payment over time.
Option #2 and #3 will lock you into a fixed payment until such time as you end the 72T distributions and switch to post 59.5 distributions.
Thanks for the explanation Apex. Perhaps “interest rate” was the wrong term to use. I actually got that figure from a calculator on Dinkytown:
I follow your descriptions for each of the three options and understand how option 1 can vary slightly. But regardless, I think all three options at this rate are far too low of a payout. I’d rather take my chances allowing the money to grow another 5 to 10 years at market rates.
You also have to keep in mind volatility when considering your actual withdrawls. The market may return 8% over twenty or thirty years, but it doesn’t do it consistently year to year. Hence, your constant 4% percent withdrawl of your nest egg doesn’t lead to a steady, stable withdrawl amount for every year with your nest egg increasing in value 2% as projected every year.
For planning long term you can look at this as your estimates, but to be practical you need to consider the strategy you will use close to withdrawl to be reaping gains in good years from the market and storing to make up for the shortfall for the lean years. The practical side of the withdrawl is as important as the input side of the house and is what will get you through three or four years of down returns without seriously impacting your income and goals.
Point well taken. This is absolutely just an estimation. For a more detailed analysis, I would probably run these figures through a Monte Carlo analysis to see what the likelihood was of failure.
I also didn’t really address asset allocation which will play a big part in the potential stability of my returns.
anthony a. (financial freedom ideas) says
Great article. It seems you really have a direction in the retirement phase. Still, diversification is a good thing to consider. And maybe you can set a desired lifestyle and from there, adjust a passive income that can sustain it. If we can retire early, the better. Money must work for us.
Thanks Anthony and welcome to the site. It’s all about building the perfect income solution to fulfill what it is we need and keep it sustainable. I imagine that by my next update I’ll probably consider more diversification strategies. Making sure my money lasts me forever is becoming one of the most important goals of this whole process.
Financial Samurai says
Nice layout Matt! I have to ask some basic questions as I’m confused. PV = Present Value right? So pre 59.5 means you currently have around $1.6 million in assets presently correct? Or is this the level you are shooting for by 59.5?
Any thoughts on diversifying into real estate given the majority looks like it’s in stocks?
Thanks for clarifying.
I’m sorry to disappoint, but my name is not Matt.
Yes, PV stands for present value. The first column “Pre Age 59-1/2” represents some point in the future that I am targeting to be mathematically financially free. Right now that is set to Age 45. The $1.6M in assets you noticed is my target for that goal.
The “15 years” is how long I have until I make it to the second column. The second column represents my finances when I hit Age 60 and the third column represents my finances at Age 70 and beyond.
I’ve given quite a bit of thought on diversifying into real estate, but haven’t made the plunge yet. I know that it can be a good investment, but I feel as though I need to educate myself more on what I want before I blindly throw any money into it. Another avenue that I have been focusing on is trying to stabilize my online income, both with creating a niche site as well as with my main site.
Financial Samurai says
Thanks for clarifying. Hope you get there! One of the more interesting topics is whether you’ll be able to stop once you get to your age and or financial nut goal b/c you might be hitting your stride in terms of making the most in your career.
Good point! In some ways, I feel I may have already hit that peak. That’s part of the motivation for seeking income else where. Once you realize there is a glass ceiling for how much your employer or even an industry is willing to pay you, the only thing you can do is change the game and make your own set of rules. This is why passive income is a repeating theme on my blog.