Posted by Tim Stobbs on November 30, 2012
So after four days of numbers you think I might be done, well mostly yes, but I did want to touch on a few other issues today in a wrap up post.
1) Backup Plans
As some people pointed out they feel my rate of return is much to high, which is totally fine. Every person will pick different numbers for different reasons, which is partly why this is a plan. I fully expect things to shift a bit as I go along and that is ok. Yet on a risk management basis, what happens if the entire plan goes sideways? Do I give up? Nope, here is where a few backup plans become very handy.
The biggest backup plan I have is the equity in my house, which I never used in my calculations. While yes it is tied to one asset and not very liquid, so I do have the option to sell that at some point and use the cash to fund my living expenses if I screw up royally on these calculations. That provides roughly a decade of living expenses. Alternative scenarios include moving to a new house and putting in a rental suite to turn some of that equity into a cash flow or downsizing and investing in a house with very low utility bills (due to extra insulation, a solar hot water, etc) which while that doesn’t raise cash, it does lower expenses.
Some other backup plans include the fact my wife fully plans to phase out her work, when I assume she stops cold turkey. So in reality she will be providing so extra income for a few years and likely have a higher CPP payout than I’ve estimated. In addition, I’ve put our to work threshold so very low at $3000 a year for vacation, that I can see easily exceeding that which again provides some extra cash and likely higher than predicted CPP payout.
Perhaps one of the more up front risk management tools I have is once I am fully convinced I am financially independent I won’t quit immediately. Instead I plan to work one more year from that point building up a slush fund of cash (which don’t show up in any of the calculations). This pile should be big enough to keep me out of touching any of my investments for the first two or three years if required. This then allows me to not sell any investments if I happen to hit a bad spot in the markets just when I stop working full time.
So the cumulative summary of all of these backup plans is I feel comfortable with if any of my assumptions fail. Regardless of your plan I highly suggest you also have a few backup plans yourself.
2) The Really Short Way to Calculate Your Retirement Date
After four days of calculations and assumptions you might be wondering…how on earth do you expect the average person to do this for themselves? In fact, I don’t assume they will do this complex of a set of calculations, so you might wonder if there is a short cut. Good news, there is one.
I will apply the standard caution here, the more simple things get the less they cover for detail. This is fine if you just want a quick estimate. If that is the case, you use Jacob’s little formula for savings rate which he covered in his book Early Retirement Extreme, which is also covered in this post at MMM.
So all you need to figure this out is your current savings rate. So take your annual savings (don’t forget to add in work pension contributions if any) and divide by your after tax income. In my case that works out to about 66%. Now look at MMM’s post, he has a nice table which tell you how long you have to save if you start from zero. In my case the closest value is 65% which works out to 10.5 years. Yet I’m not starting from zero, so I take my current investment net worth and divide it by my annual savings amount (or $175K/$48K = 3.6 years of saving done). I deduct that from my 10.5 value to get 6.9 years to retirement. So according to my very quick calculation method I can retire at 41, rather than 42. Which given the excess cash in my plan is likely fairly damn close estimate for being done in 2 minutes.
That is the very quick way to do these calculations. Or if you like you can use Jacob’s original formula to plug in alternative rates of return or play with alternative savings rates.
Posted by Tim Stobbs on November 29, 2012
Well today I pull together the last few days of numbers and see if I can pull off a retirement at 42.
I’m going to assume my real rate of return drops to 4% at age 42 to reflect the fact the portfolio is going to get a bit more conservative. I will also assume that I don’t touch the principle from my pension and TFSA accounts. I will only be using the investment income. So that means at age 50 my pension account which is expected to be at $350,341 at 4% should produce $14,013/year income. The TFSA at 42 is expected to be at $140,112 should produce $5604/year income.
So working backwards at 67 between half of our OAS, and our CPP, which was $13,295 (from Part III) we add in the above TFSA and pension income that totals $32,912/year which is in excess of our spending target of $29,700. (Recall all these values are in today’s dollars so there is no inflation adjustment, that was handled by using real returns). So it is nice to know that I have an extra cushion as I get older and our traditional retirement should work out just fine.
Yet I still have to live from 42 to 67. Now my TFSA will be producing $5604/year income starting at 42. So I will deduct that from my spending target. That leaves a shortfall of $24,096/year which needs to come from my taxable and RRSP accounts (or $2008/month). If you add up my RRSP and taxable accounts (from Part II and Part III) that equals $353,832 at age 42. So using that handy compound interest calculator again I input my starting amount of money and put in a negative savings rate of -$2008 per month at 4% for 8 years (until age 50 when my pension dollars kick in). The result: I still have $260,272 left when I turn 50.
So now that $14,013 from my pension kicks in and reduces my spending again, so that drops the spending from my RRSP and taxable accounts to $10,083 for ages 50 to 67 (or $840/month). So staring with $260,272 with a savings rate of -$840 at 4% for 17 years. The result is $268,309 at age 67. Yes that is right…it went up since it accounts are producing more income than I’m taking off. So that would mean I could boast my spending at age 67, but an extra $10,732 which would take the grand total after 67 up to over $43,644.
So yes, apparently freedom 42 is still a done deal with lots of cash to spare, which is a good thing since the allows me to have one or more of my assumptions fail and I would still be fine. So a lower than expected rate of return or a further reduction of government benefits would be something we could deal with. The nice thing now with the calculations all done is you can easily go back and change any assumption you like and see the fallout.
Yet that isn’t the only safety cushion I have to these plans. I’ve also got some backup plans which I’ll discuss tomorrow and present a faster way to estimate all these calculations.
If you have any other questions, feel free to ask.
Posted by Tim Stobbs on November 28, 2012
Now some important consideration to my plan is having a mortgage free house. After all when those pesky mortgage payments are gone you don’t need any where near the same amount of cash flow to live. Now a question I’ve previously been asked “am I depending on downsizing my home to retire early?” The answer is no. Using any equity in the house would be used as a backup plan in case the main plan ran into problems and I’m would also considering downsizing houses and taking some that equity into upgrading the smaller house to reduce my utility bills. Either case that won’t be to primarily fund the retirement plan so other than noting this I’m not going to include any equity in these calculations.
So what happens now with the taxable account? Well the reason this account is still in the plan is I literally won’t have enough contribution room in our RRSP’s or TFSA’s to shelter all the money. Actually so far in these calculations I’ve left a some contribution room out of the calculations to keep things simple. We’ve got about $24,000 in TFSA contribution room that I haven’t accounted for yet. So the idea is to keep dividend paying stocks in the taxable account as much as possible to keep the tax liability low, but towards the end I might also have to accept paying some tax in my plan. I’m again combining my wife’s account and mine to make this simple.
Starting at $19,500
Adding $1667/month at 5%
In 8 years I will have:$225,339
Tomorrow I will get into the specific math of estimating do I have enough to retire at 42, but for now we need to review two other sources of income that will come up when I hit the more ‘traditional’ retirement age of my 60’s.
First up is the Old Age Security (OAS) Pension, which my wife and I should both qualify for the full amount see here for details. The current payment rate is $544.98/month per person. So in total that is $6,539/year per person ( and it is indexed for inflation). Now this program is out of general government revenue so there is the risk it could be cut or reduced. So depending on your personal feelings on the idea you might want to reduce the benefit in your own calculations. I like to hedge my bets and assume we only get half. That way we can handle either a pension cut or the sudden death of one of us and the other one should be fine. Also keep in mind I’m covered by the new rules for OAS and I won’t be collecting it until 67 (see here for more information).
Next is the Canada Pension Plan (CPP), which is paid for with our contributions and is held in an arm’s length fund from the government (see here for more info). So it doesn’t face the same risk as OAS, there is more than enough money in that fund to cover pensions until I’m likely dead. Now your CPP benefit is calculated in a complex manner so if possible request an estimate of your pension. It at least gives you a baseline to work with. Something to keep in mind if you retire early is you are going to reduce your CPP pension by doing it. You see when they calculate your benefit they drop out 16% of your lowest earning years from 18 till 65 (plus drop out years if you were raising young kids). Keep in mind you also can take CPP early at 60, but doing so reduces your pension by 0.6% per month permanently (check out the changes to CPP that kick in from 2011 onwards).
So what does this all mean to me? Well I’m expecting a low pension amount. You see there are 42 years between 18 and 60, and I’m going to have zero incomes for 18 years (age 42 to 60) when that 16% drop out will only cover 6.7 of those. Then I could get a 36% reduction for taking the pension at 60, to offset this a little I will take it at 62 instead. In the end I’ll have a low number. So the best way to get an estimate of your pension is to plug your data into this calculator and adjust your income level down later on to simulate your early retirement. It takes some work but it does give you a number (see this post for detailed instructions). I plugged in all of my values and get an estimate of $5556/year for me and $1200/year for my wife.
Therefore in grand total I expect these two programs, OAS and CPP, will provide $13,295 of income after age 65.
Tomorrow I will pull together all this income and savings estimates to figure out if I have enough to retire at 42.