July 25, 2011

Our Five Leg Retirement Plan

My wife and I have a money in several pots that is dedicated for retirement.  Today I'll look at the five different big pots that our retirement money is in and how they might add up to help replace our current working income.

For discussion sake I'm going to assume a conservative 6% growth in our investments and a 3% inflation rate. 

Social Security -    I pay into SS and I will a benefit when I retire.   The amount I get will ultimately depend on how many years I work and how much I make each year.  I should expect to get 20-30% of my income from SS.   My wife will also be eligible for at least 50% of my benefits so together we could have SS replace 30-45% of our income.  However it is quite possible that SS will be reformed sometime within the next 20-30 years.  Changes to SS could ultimately reduce the benefits that I might get at retirement age.   I'm going to be conservative and just assume 20-30% of income is replaced and plan that there is some benefit reduction by the time I hit retirement.  

Roth IRA - My wife and I both have Roth IRA accounts that we have contributed into.   This is post tax money so there will be no taxes due on this money once we retire.    If we continue to max out or Roth IRA contributions and get annual growth of 6% then we our accounts could grow to around $1 million by the time I'm 65.   This could replace about 20% of our income.

401k accounts - We also both have 401k accounts with some money in them.   My wife's 401k is from a previous employer and mine is at my current employer.   I don't contribute to my 401k at the present (there is no employer match).   So at this point there is no new money going into either of our 401k's.  If these accounts grow 6% a year then we'll have around $200k by the time I'm 65.    This should replace around 5% of my income give or take.

Rental Properties - As I've mentioned before, we own a few rental properties.   WE own two houses and also own 50% of two multi-units.   We have mortgages on the houses but not the multi-units.    By the time I'm retired we'll be free and clear of any mortgages on our rentals.    All together after expenses the rental properties should give us income that would replace about 20-30% of our income.

Employer Retirement Account - My employer contributes money for me into a cash based retirement account.   They do this instead of contributing a 401k match.   I get about 6% of my pay every year in the account.   If I were to work at this employer until I hit 65 then I'd have somewhere around $900,000 in the account.     This would be enough to replace around 15-20% of my income.   I also have the option to annuity from the money which would replace around 25-30%.

Plus Home Mortgage Free - While its not really a retirement account another way we plan for retirement is to have our home paid off and clear of a mortgage.  This will reduce our expenses during retirement and thus cut the amount of income we'd need.    Our current home mortgage will be paid off in 6 years or less.   We've been house shopping and if we do buy another house then we'll make sure its paid off by the time we hit 65 at minimum.

Add it all up and we get :

Income Replaced at Age 65


Social Security = 20-30%
Roth IRA = 20%
401k = 5%
Rentals = 20-30%
Employer Retirement = 15-30%

Total = 80-115%

We're on track to have a very healthy retirement income if I work until 65.  If however I decide to retire early then I can still replace a pretty large amount of our income.

Retire early at age 50:

Social Security =0
Roth IRA = 7.5%
401k = 0
Rentals = 20-30%
Employer Retirement = 10-20%

Total =37.5% to 55%

Having 37.5-55% of our current income and a paid off house would be enough for us to live off of.   There wouldn't be a lot of margin and we wouldn't have tons of money to take fancy vacations or drive expensive cars, but it should be enough to support ourselves.    One potential problem with retiring early will be the cost of health care.  That is a major unknown that we'll have to account for as I get closer to that goal.

Tax Treatment

I think its a good idea to hedge your bets on on the tax status of your retirement savings.  You don't want all your retirement funds to be taxable or tax free.

Social Security - 0% to 85% taxable. 
Roth IRA - Tax free
401k - 100% taxable
Rentals - Taxable with some deductions
Employer Retirement - 100% taxable

We have a pretty good mix of investments as far as tax status goes.

If I were to wait until 65 to retire then we'd be in very good shape financially.     I also have a fairly good shot at retiring early at age 50 with enough retirement savings to replace around half our current income.

2 comments:

  1. You've got the tax diversification thing down! A big chunk of your income will be tax free at 65. One point though on retiring at 50, you're showing 7.5% of your income from the Roth--not only will the income accumulated on the account be taxable at withdrawal, but you'll also have to pay a 10% penalty. Best to leave it until you're at least 59.5 when it will be completely tax free.

    Just an aside, but you're also smart to assign a relatively small percentage of income to your employer retirement. These days, you just can't know how long you'll be with any one employer.

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  2. Kevin, I was assuming that I would only withdraw the contributions from the Roth IRA's for the first few years. You can withdraw Roth IRA contributions without penalty before you hit 59. We'd have put enough in our Roth's that we could pull out contributions for several years without having to touch the growth till later years. I don't have the figures I used in front of me at the moment but as an example lets take the following example: Say that over 20 years I put $5000 a year into a Roth IRA and then it grew to about $200,000 total. I'd hve $100,000 in contributions and $100,000 in growth. I could take that $100,000 out at any time. I could then figure on taking out $7500 a year for the rest of my life starting at age 50 without any penalties.

    Jim

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