Financial Planning: A little math

The nest egg

Now we know that you need $Z per year, in today's dollars. On a gross level what would that take? Well, I'd assume you could invest to get the yield of T-Bills plus two percent, free of Federal Taxes. (The next section will show you how.) If T-Bills yield 5%, you could get 7% - no sweat. Thus, you would need (100/7)*$Z in the bank to retire.

Let's consider Ted's case. Ted has done the analysis and his $Z is $50,000 a year to live his happily retired life of luxury. (I picked $50k because it's a nice round number. If your $Z is $25,000 then you can divide the rest of this by 2.) At a 7% return, $700,000 will give Ted $49,000 a year income ($700,000*0.07) - Ted needs about $700,000 in his portfolio to retire.

Take a guess at the nest egg amount you need to retire and write it here:
          (100/7)*$Z = __________________

Do you crack the nest egg?

Now, suppose Ted is planning to retire at 65 and live to be 95. That means his money has to last 30 years. If Ted can sock away his $700,000 by age 65, when will his money run out? Never! Ted isn't spending his principle!

Every year Ted's $700,000 will generate the $49,000 in cash that Ted spends living like a king. Ted will die with that same $700,000 in the bank - I wonder if that's really part of Ted's plan?

fp_plana.gif (18643 bytes)

What if Ted is willing to die with no money in the bank at age 95? If Ted isn't planning to leave behind a $700,000 estate then Ted could afford to spend his principal and that changes the story a lot.

In very simple terms, Ted could spend his $700,000 over those thirty years between age 65 and 95 a little bit at a time. $700,000 divided by 30 years equals $23,000/year. That's a lot of cash. In fact, it is almost half of what Ted needs to spend each retirement year to live like a king!

What if on his way to age 65 Ted has saved $500,000 by the age of 55 and retired then, willing to spend a little of his principal every year? If Ted retired at 55 and invested his portfolio for a 7% return, his investments would give Ted an income of ($500,000*0.07) = $35,000 per year. Now that Ted is retiring at 55 he will have 40 years in retirement (95-55). Ted's $500,000 principle could be spent over the forty years Ted is going to live retired , so that adds ($500,000/40) = $12,000 per year.

Hmmm, if Ted is willing to spend his principle, he could retire at 55 with $500,000 in his portfolio and live on ($35,000+$12,000) = $47,000 per year. Hmmm.

fp_planb.gif (20225 bytes)

Ok, ok, I know... As Ted spends down his principal it generates less income each year. He can't really retire at 55 with $500,000 in the bank, but Ted doesn't need to die with $700,000 in the bank either. Somewhere in between those two points there is an age / net worth pair that tells Ted to leave his job and start living the good life. Ted can either work his financial plan to retire at 65 or do a bit more precise math - maybe pay someone to help? - and retire years early. The Quicken Premium retirement planner really helps you to see how this works. So will a for-fee financial planning professional.

What if you work after retirement?

Oh God, work after retirement you say? What kind of idiot is writing these pages? What if working an easy, stress free job part-time for 10 years meant that you could retire five years sooner? Five years of playing with your kids. Five years of three day weekends. Five years of every afternoon at the beach. Five years of reading ten books a month. If that's what I have to do, then I say, "bring on the work".

How does this compute? Ted's Plan-B is to retire at 55 with $500,000 invested. His portfolio and principle generate $47,000 a year. Let's say Ted figures he could pump a cappuccino machine at Starbucks and generate a stress free $10,000 a year for ten years after he retires. Ted works at Starbucks from age 55 until 65 and makes a cool $10,000 a year. He lives off his portfolio income (as if he was executing Plan-B) and saves his $10,000 salary each year. Now, when he really quits working at 65 Ted has an additional $100,000 in the bank.

But wait, Ted doesn't need $100,000 more! His Plan-B already takes care of him until age 95. What could Ted do with that money? I know, I know! Retire even sooner!

How long would that $100,000 last? If Ted needs $50,000 a year, that $100,000 lasts 2 years. But in those 2 years his extra $100,000 nest egg generates some interest - ($100,000 * 7% * 2 years) = $14,000 more. That's not very much in interest, so let's say the $100,000 only supports Ted for 2 years. Thus, Plan-C allows Ted to retire at 53, work ten years earning $10,000 a year, and really totally retire at 63. Not bad.

While Ted's new Plan-C gets him only 2 years, Ted's assumptions about post retirement income are pretty conservative. I've heard that 40-hour a week burger flippers at In-n-Out Burger make $14,000 a year. What if Ted was a pretty smart guy and could easily get a non-stress job that nets him $30,000 a year?

Well, this Plan-C generates $300,000 more ($30,000 x 10 years), which lasts ($300,000 / $50,000 a year) = 6 years. Plus that $300,000 generates an additional ($300,000 * 7% * 6 years) = $120,000 which will get Ted another 2 years; 8 years total.

The final Plan-C is to retire at 47, work until 55 at a job generating $30,000 a year and then really retire. Wow.

Do you have a plan like Ted's? Are you as smart as Ted?

fp_planc.gif (22049 bytes)

Where does the money come from?

Ah well, on to Step 3.

New Page 1