Retirement planning using cash flows

The question comes up often as to what amount is needed to retire.  Money in the bank and diversified assets are indeed important, but the critical measurement of what gets you buy on a daily, monthly, and yearly basis is your income.  For most, a retirement will be short lived if you live off of only the cash that you have on hand.

Ideally, your retirement income will come from multiple robust sources.  This will act as a hedge against having your income collapse in the event of adverse conditions.  Social Security may play a part in this, however, if it plays a substantial part for your retirement planning, you are likely short of what you truly desire for income in retirement.  So, how much is needed?

The current median income in the top quintile is currently $111,000 a year.  This means that this income is higher than 90% of all American households since it is in the middle of the top quintile (80% to 100%).  If your income is $111,000, first of all congrats on the hard work.  Second, your current lifestyle in retirement can be sustained on less.  The amount required is about 50% as work related expenses, commuting costs, and taxes at the new 50% income will decrease.

Now the question becomes, how is a retirement had at $55,500 per year?  To answer this there is a simple formula that FPO has developed as a starting point as well as a personal goal to shoot for.  This amount can be met by accumulating nine buckets of $500 extra income per month as described in the four part FPO series (1, 2, 3, 4) on creating extra income.  At least seven of these buckets must come from income generators in the first three parts, with two being permitted to be from part 4.  More than 2 from part 4 is welcome, however the effort to create additional savings would not be beneficial at the expense of achieving that seventh bucket.

>>> When broken down like this, seven buckets seems achievable, right?  Of course it is, but it is never explained like this.  Many financial experts frame a funded retirement as something that only the most disciplined can achieve, and that it is some sort of lofty goal.  In reality, it is easier than advertised when broken into chunks.  However, expect that it won’t happen overnight.  But aim for creating one of the seven every five years and you’re set.  Start at 25 and retire at 60.

The magic number for retirement

Its a common topic. The question: “What is that magic $$$ number needed in order to retire?” There are many models (we provided an example earlier) to figure this with each one being restrictive in its application, ours included. A retirement plan needs to provide a solution unique to each individual. This is the FPO concept.

First, there isn’t a magic age that one can or should retire. It could be anywhere from the mid 30’s to the mid 70’s. Also, is retirement defined by the point of where you completely quit the workforce or just go to part time? Is part time 20 hours or 30 hours a week? Due to this ambiguity, it is recommended not to think in the term retirement because it puts too much definition on goals. The principle of “work whenever, fish forever” is sufficient. It’s simply going from where you are to where you want to go.

Retirement savings modeling

The retirement scenario generated by FPO (we’ll randomly post different retirement scenarios) shows the importance of the cash flow concept mentioned in the previous post.  This is also the bread and butter for FPO; growing your income, shrinking your expenditures, and maintaining/grow your quality of life.

Here’s an example of what would be a working solution based on FPOs model for figuring out how much money is needed to retire.

Year: 2012

Age: 47, Spouse: 46

Earned income before taxes: $60,000/yr

Taxes on earned income: $6000/yr

Earned income related expenses = $6000/yr

Last year of mortgage. Payment = $12,500/yr

Other expenses: $17,500/yr

Saving rate: $18000/yr

Starting in 2013: Primary residence is paid off.

Assets: $500000 rental property, $500000 high dividend and master limited partnership (think oil+gas income)

After tax income: $27500 real estate, $27500 high divident, etc. total: $55000

Note that $1000000 is assets completely replaces the earned income in transistion. These assets were building up over several decades prior to 2013. The result is cutting income by half in 2012 if there is no more earned income, but the assets still generate $55000 in income. There are only the normal expenses of $17500 year. The only unknowns would be health insurance and long term care insurance. even budgeting $12500/year for these two categories still leave $25,000 in savings rate per year. Take some of that for vacation and fun. An added plus is that someone following this example will likely figure out in some spare time to make some extra money at a high rate per hour, but that parts optional.

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