Live Like You Make X per year

[Lagniappe]

I build my retirement budget from the bottom up, based on my expenses. I thought it would be fun to figure out what my "salary" would have to be to match my planned retirement spending. I remember a chapter in Work Less Live More that showed how much less in taxes a retiree payed than someone working for W2 income.

Lots of assumptions - single, maxing out 401K, no state taxes, most income from LTCG, etc. The bottom line was at a 4% withdrawal rate, you would need 16-18 X whatever the salary was you were trying to emulate.

I don't know why, but viewing it from a different angle somehow made me feel better/ more motivated. As if, in I can get my portfolio to say $1.6 Million, I can feel like I will be getting paid $100000 per year to surf the net, hike and travel - forever.

I can't figure out how to post a table or I'd show my calcs.

Live Like = Portfolio
100K = 1.628M
150K = 2.655M
200K = 3.625M
250K = 4.539M
300K = 5.520M

 

[OrcasIslandBound]

100k/1.628M = 6.14%
150k/2.655M = 5.64%
200k/3.625M = 5.52%
Many of us would be more comfortable with about 2.5 - 3.5% withdrawal rates.

 

[kumquat]

I think the OP is suggesting that one does not "live" on his working income. Some of it goes to things like savings, work clothes, commute etc so that if you made $100K, after subtracting those expenses you lived like you made $70K. Therefore you don't need 25 X previous income, just 25 X previous spending.

 

[Lagniappe]

I am not suggesting anyone withdraw 6% of their portfolio, I am suggesting that withdrawing 4% of a 1.6M portfolio allows you to spend the same amount of money as having $100K in W2 income.

After a single filer with no dependents has contributed to your 401K, paid federal income taxes, social security, and medicare, paid for long term disability insurance, etc, they have less than $60K left to spend. Even after adding in $8K a year or so for individual health insurance and another $2.5K income taxes on capital gains and dividends, they end up needing only $65K to have the exact same lifestyle they had when they had a $100K income. At a 4% withdrawal rate, that's $1.6 Million.

I did this calculation because several posters were asking about pre-retirement income (not spending, as is the usual approach around here) and I was interested to see what portfolio vs. income-replacement might look like.

 

[Jay_Gatsby]

Maybe I'm missing something, but does your calculation take into account the taxes on the $65k of passive income generated by such hypothetical portfolio of $1.6 million? One would think that at least 1/3 of that $65k would still go to taxes, bringing your post-tax income down to somewhere around $43k.

 

[LOL!]

Maybe I'm missing something, but does your calculation take into account the taxes on the $65k of passive income generated by such hypothetical portfolio of $1.6 million? One would think that at least 1/3 of that $65k would still go to taxes, bringing your post-tax income down to somewhere around $43k.

You would probably be wrong about taxes taking up 1/3 of that $65K of passive income. First return-of-capital is tax-free. Second, for low-income folks qualified dividends and LT capital gains are currently tax-free as well. If you get Social Security benefits and your income is low enough, that's tax-free as well.

But let's go to Taxcaster and estimate taxes. With $25,000 of qualified dividends and $40,000 of LT capital gains, the taxes for a single person is estimated to be: $3255.

If some of those dividends are from foreign stock funds, then one could make use of foreign tax credit. I know that I put almost all my foreign funds in a taxable account, so that I can claim as a credit all the foreign taxes that show up on my 1099DIV. That reduces my taxes by say $900 to $1200 a year.

To generate that $40K of LT cap gains, one probably had to sell more than $40K of your funds.

Of course, that single person was early-retired and not withdrawing from traditional IRAs yet.

 

[Lagniappe]

Maybe I'm missing something, but does your calculation take into account the taxes on the $65k of passive income generated by such hypothetical portfolio of $1.6 million? One would think that at least 1/3 of that $65k would still go to taxes, bringing your post-tax income down to somewhere around $43k.

It does take taxes on this into account. I assumed most of it was from long term capital gains, with a few thousand from interest and dividend income, and plugged it into turbotax. Actual tax stats for this scenario were 2K interest, 10K dividends, 52K LTCG, 8K RE taxes, 1.5K charitable deductions. I thought this was conservative, since in most years a portion of what you spend may not be a capital gain but return of principal. On this $65K of passive income, only $2.6K in federal income taxes was owed. I looked at some "What did you spend this year" threads, and that seems about right for retirees on this board in that income range. It illustrated the point for me that Bob Clyatt made in his book about taxes while working vs when retired.

 

[MasterBlaster]

It does take taxes on this into account. I assumed most of it was from long term capital gains, with a few thousand from interest and dividend income, and plugged it into turbotax. Actual tax stats for this scenario were 2K interest, 10K dividends, 52K LTCG, 8K RE taxes, 1.5K charitable deductions. I thought this was conservative, since in most years a portion of what you spend may not be a capital gain but return of principal. On this $65K of passive income, only $2.6K in federal income taxes was owed. I looked at some "What did you spend this year" threads, and that seems about right for retirees on this board in that income range. It illustrated the point for me that Bob Clyatt made in his book about taxes while working vs when retired.

A couple of comments...

Are you confident that capital gains rates will stay as low as they have been ?

I suspect that most people have a collection of after-tax/401k/IRA/Roth IRA accounts. To include only after-tax accounts may not be so applicable to most of us.

Unless you need the Vulcan mind-meld to help you cope with the job, why not stick to the tried and true 25X spending/expenses to judge your nestegg size?

 

[traineeinvestor]

Regardless of the need to adjust assumptions to reflect personal circumstances or expectations about the future (both of which are necessary for any financial planning exercise), I found it to be a useful additional sanity check on the sustainability of my retirement finances.

Thanks for posting.

 

[donheff]

This doesn't need a whole lot of analysis. OP is simply stating that he enjoys the mental exercise of imagining the "typical" earned income a worker (still in the savings/SSA stage) would have who spends what he plans to spend from his 4% SWR. It is a just a different perspective on what we all do when we complain about advisors who tell us to plan to replace 80% of our income instead of evaluating the actual expenses we need to support.

 

[Midpack]

This doesn't need a whole lot of analysis. OP is simply stating that he enjoys the mental exercise of imagining the "typical" earned income a worker (still in the savings/SSA stage) would have who spends what he plans to spend from his 4% SWR. It is a just a different perspective on what we all do when we complain about advisors who tell us to plan to replace 80% of our income instead of evaluating the actual expenses we need to support.

+1. Nothing is certain, the OP was illustrating a point re: taxes. It's something that typically benefits non-working retirees so a fun exercise, I didn't take it as a certainty...

 

[donheff]

What's with the new avatar Midpack? Some kind of metamorphosis going on?

 

[chinaco]

I understood the OP.

There is a cost to working (e.g., certain local taxes maybe, FICA, for some parking, gas, on and on), and a cost to saving for retirement (e.g., 401k, IRA, etc).

 

[ziggy29]

The way I see it, if one earns $100K today but puts $25K away for retirement and spends $5K on work-related expenses (commuting, wardrobe costs, maybe the need for a second car), that household can live just as comfortably in retirement on $70K -- give or take based on differences in travel and health care costs.

And it could be even less than that, because you aren't paying the 7.65% payroll taxes (or 15.3% if self-employed!) *and* because the progressive nature of the income tax means a lower percentage of your income due in federal tax.

If nothing else this reinforces the idea that it's not really right to plan a retirement based on "percentage of current income". It's your actual expenses and how they are likely to change that matter.

 

[W2R]

The way I see it, if one earns $100K today but puts $25K away for retirement and spends $5K on work-related expenses (commuting, wardrobe costs, maybe the need for a second car), that household can live just as comfortably in retirement on $70K -- give or take based on differences in travel and health care costs.

And it could be even less than that, because you aren't paying the 7.65% payroll taxes (or 15.3% if self-employed!) *and* because the progressive nature of the income tax means a lower percentage of your income due in federal tax.

If nothing else this reinforces the idea that it's not really right to plan a retirement based on "percentage of current income". It's your actual expenses and how they are likely to change that matter.

I definitely agree that getting a handle on expenses is an important part of retirement planning.

My salary, which was definitely less than $100K was divided as follows, with $22K going to the TSP (including over-50-catchup), and then taxes, pension, SS, medicare, and health being subtracted from the remainder:

(X-$22,000)*.68

The factor of .68 was empirically derived from looking at my paychecks in 2008-2009. Health at that time was about $4K/year, so adding that back in and assuming a $100K salary and your $5,000 work expenses, we get

($100,000 - $22,000 + $4,000)*.68 - $5,000 = $50,760 after taxes.

Now, assuming that this person also saved 25% after taxes for retirement, not an unreasonable assumption for our group,

$50,760 * .75 = $38,070 after taxes.

If this is done right, then I think an after-tax income of $38K as a retiree today (perhaps $44K before taxes) would be equivalent to a before-tax income of $100K before retiring.

At 4%, this would imply a nestegg of $1,100,000. Probably the difference in my figures from those of the OP, is in part due to assuming a different amount of saving for retirement while working.

 

[Lagniappe]

A couple of comments...

Unless you need the Vulcan mind-meld to help you cope with the job, why not stick to the tried and true 25X spending/expenses to judge your nestegg size?

I need every ounce of creativity I can find to keep plodding through every day on the job, so exercises like this, which give a slightly different perspective on the same issue, help immensely.

 

[ziggy29]

I need every ounce of creativity I can find to keep plodding through every day on the job, so exercises like this, which give a slightly different perspective on the same issue, help immensely.

I agree. I sometimes approach it like a recovering alcoholic going through AA: "one day at a time." Because if I think about having to endure many more years of this corporate garbage, a bullet to the head starts looking better and better.

 

[BellBarbara]

Thanks for posting this. I like thinking of it in this way.