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It’s Friday and you know what that means! Time for another Reader Case.
This week I’m writing from the Netherlands, where after coming down from the high of Chautauqua, we decided to stay with a friend for a week and play with her adorable kids.
One thing I’ve noticed about kids is that they have a tendency to suck you into a vortex with their adorableness. Even though I was only there for a week, it took a bit of time to come back to the real world and be my productive self again.
Despite not being as productive, I had a great time being a 5-year-old’s personal hero. And all I had to do was draw some Pokémon pictures and have deep discussions with him about PAW Patrol. When it was time to leave at the end of the week, he actually broke down crying, locked his arms around my waist and asked me not to leave. AWWWW! Kids have such low standards. It’s awesome.
That being said, it’s easy to see how great kids are when I’m not the one who has to do all the work of the cleaning, cooking, putting them to bed, dealing with temper tantrums, etc. So seeing how much hard work my friend and her hubby put in to raising her lovable children, I just want to say a huge thanks to all the Mom and Dads out there for all that you do. You are amazing.
Anyways, now that all the mushy stuff (eww) is out of the way, Let’s get to the numbers.
I was hoping you could analyze my position. Love you guys and highly respect your advice, keep up the amazing work on the blog-I’m obsessed! I unfortunately never realized retiring early was a possibility before so I didn’t start saving for retirement until 5 years ago. I’m currently 32.
Here’s the details:
Yearly gross salary: $73,016
Currently I contribute 25% + a automatic agency contribution of 1% + 5% matching. (This is currently the max allowable) this all goes into my tsp (fed gov retirement plan). In my tsp I currently have $50,714.
I also contribute to a brokerage account and a stand alone traditional IRA, currently those accounts have $13,824 balance. I reinvest all my dividends to avoid capital gains tax. I have these funds balanced between index etf funds (total market, domestic, international, emerging, REITs, us treasuries, tips and a small portion in bonds). I have $14,575 in cash (thinking this is too much to have in cash not making money for me?) This is my emergency fund/cash flow(12k) and the rest had previously been my savings for a house (silly me). I have no debt! (Yay!-thanks to Dad I was raised Uber frugal and paid off all those nasty American student loans aggressively).
Monthly net income: $2378
Rent:650 will likely be increasing to $1,000 (Chicago rent prices and moving in with my boyfriend as I’m tried of living like a college kid with 2 roommates)
Groceries: 400
Gas: 116
Miscellaneous ( gym/ healthcare copayments) 300
Entertainment/travel: 300
Only asset is a 2015 Mazda 3 hatchback
I’d love to be able to retire at 45. I’m open to working part time to make extra cash if needed. I’m trying to do my planning with the assumption that #45 (aka the big Cheeto aka trump) will eliminate social security. I also try to contribute my full tax refund typically 2k per year directly into retirement as well as any left over cash I have after expenses each month but there isn’t always any left over…
Love you guys! You are my inspiration! Thanks for changing lives by doing what you’re doing!”
RetireBy45
So from first glance, with zero debt (woohoo!), low rent, a high tsp contribution rate, and low expenses, it looks like Rb45 is doing really well! But since people complain all the time of not being able to retire early without a 6-figure salary, will her salary really be enough for her goal of retirement in 13 years, by the age of 45?
Let’s find out.
| Summary | |
|---|---|
| Total Annual Income (after-tax) | $28,536/year |
| TSP contributions (including matching) | 22,634.96/year |
| Total Annual Expenses | $1000+ $400 +$116+ $300 +$300 = $2116/month *12 = $25,392/year. |
| Total Debt | 0 |
| Total Assets | $50,714 + $13,824 + $14,575 = $79,113.00 |
Okay right away, I can see there’s something wrong with how much tax she’s are paying. She contributes 25% to her TSP which reduces their taxable salary from $73,016 to $54,762. And yet she’s paying $26,226 (or 34%) in taxes?!
Even if we assume she’s maxing out her traditional IRA at $5500/year, she’s still paying $26,226 – $5500 = $20,726 or 28% in taxes.
This seems way too high. Knowing that she lives in Chicago, when I put in her numbers in the tax calculator, I get:
And yes, I know it’s weird that I put the TSP into the “Itemized Deductions” bucket. It’s because the if I put the TSP in the 401(k) field, the calculator disallows further IRA contributions because having access to a 401(k) limits what you can deduct from an Individual IRA. However, a TSP doesn’t do this. It’s a bit of a stupid hack, but the point is, this shows there’s something wrong in RB45’s after-tax income. It should be in the $50k-$60k range, yet they’re reporting it $28,536.
So she’s are either over-paying taxes or forgetting money she put away into another retirement account. So my first piece of advice is to go FIND that extra money. Something’s missing and that’s bad.
Second piece of advice. What about 401(k)? Rb45 should check to see if her company is one of those government agencies that allow you to contribute to both 401(k) and TSP. Some readers who’ve written in have been able to qualify for both, meaning they’re able to save taxes like crazy by taking advantage of both accounts.
So I think her situation is even better than it seems, but if we look at worst case and use her existing numbers, she has an awesome savings rate of 50.38%, a yearly expenditure of $25,392, which will require a portfolio size of: $634,800.
In order to get this portfolio with a conservative 6% return over the long term, with her currently contribution rate and maxing out her traditional IRA each year, it should take:
| Year | Balance | Savings | Portfolio Growth | Total |
|---|---|---|---|---|
| 2017 | $79,113 | $she | $4,746 | $115,138 |
| 2018 | $115,138 | $31,279 | $6,908 | $153,326 |
| 2019 | $153,326 | $31,279 | $9,199 | $193,804 |
| 2020 | $193,804 | $31,279 | $11,628 | $236,711 |
| 2021 | $236,711 | $31,279 | $14,202 | $282,193 |
| 2022 | $282,193 | $31,279 | $16,931 | $330,404 |
| 2023 | $330,404 | $31,279 | $19,824 | $381,507 |
| 2024 | $381,507 | $31,279 | $22,890 | $435,677 |
| 2025 | $435,677 | $31,279 | $26,140 | $493,096 |
| 2026 | $493,096 | $31,279 | $29,585 | $553,961 |
| 2027 | $553,961 | $31,279 | $33,237 | $618,478 |
| 2028 | $618,478 | $31,279 | $37,108 | $686,865 |
12 years! So she’ll be able to retire at 44, beating her early retirement goal by 1 year!
Now, keeping in mind that we generally recommend setting aside as least 6 months of living expenses (or $12,696 in this case) for emergencies, so it’s great she currently has this already in cash.
Even when she reaches her goal by 2028, I would continue to work for 1 more year until the age of 45 so she can have some money set aside for a cash cushion.
Now, if she were to find the “missing money” and actually pay only 19.7% tax as indicated by the tax calculator, she’d have a monthly net income of $4885 instead of $2378, which would increase her savings rate from 50.38% to 70.73%, and shorten her time to retirement by:
| Year | Balance | Savings | Portfolio Growth | Total |
|---|---|---|---|---|
| 2017 | $79,113 | $61,363 | $4,746 | $145,222 |
| 2018 | $145,222 | $61,363 | $8,713 | $215,299 |
| 2019 | $215,299 | $61,363 | $12,917 | $289,580 |
| 2020 | $289,580 | $61,363 | $17,374 | $368,317 |
| 2021 | $368,317 | $61,363 | $22,099 | $451,779 |
| 2022 | $451,779 | $61,363 | $27,106 | $540,249 |
| 2023 | $540,249 | $61,363 | $32,414 | $634,027 |
| 2024 | $634,027 | $61,363 | $38,041 | $733,432 |
4 years! She’d be able to retire by 40! Unless there’s some deduction we don’t know about, this would be a FANTASTIC time to go over her taxes and figure out how she can shorten her TTR from 13 to 8 years.
What do you guys think? Do you think Rb45 is in good financial shape to retire by 45?
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For the person asking the question. I am from Chicago also. I noticed that you had gas as a line item. I am not sure where in Chicago the questioner lives (or if he or she lives in the suburbs). If you live in the city, it is very possible to give up driving and lower your expenses and increase your savings at the same time. Chicago has pretty good public transit in a lot of place, has great bike infrastructure, and has a very robust ride sharing market.
I have a family with a child and we manage to be car-free. It does present itself with some challenges and requires a little more planning but is totally worth it. There are also some great benefits besides the cost savings. I never have to worry about damaging my car or parking. Also when we rent a car to go out of town we can get the experience of trying out many different cars.
Agree! Owning a car brings lot of flexibility but gotta pay for that. I spend about 4000$/year on car only. Wish Texas had better public transport.
Is the monthly net income after her expenses also? 25,392 expenses plus 28,536 “net income” equals 53,928 plus 2k refund and RB45 is at ~$56k which is in “the $50k-$60k range”.
I did not take my expenses out for the net income amount. The only thing that was taken out was my taxes and my tsp/retirement contributions. Sounds like I need to go to an accountant! Yipes!
Do you have a preferred income tax rate calculator for Canadians? I always find that part confusing when you’re doing Reader’s Cases…
I found this one: https://simpletax.ca/calculator … not sure if it’s reliable or not. Based on my income ($75k, province, NB), I have a tax rate of 28% and should ‘net’ $53k, however bc of work place deductions (pension/union/ins, etc), I net $46k.
What I find challenging, is to find the extra money from net salary to be able to put into an RRSP in order to ‘free up’ the money to benefit from the deduction. If that makes sense….
With the above information, is there a target tax rate to aim for, in order to maximize deductions?
Oh yeah, Simpletax is the tax software I use to file my income taxes, so yeah. Hearty endorsement there.
As for target tax rate, not really. The target should be to max out all tax shelters every year. (RRSP, TFSA) Otherwise, you’re just paying taxes unnecessarily.
@Janna : You can invest in RRSP with pretaxed salary. I’m not sure exactly how it works and what forms to use, but basically you put in place a regular withdrawal (weekly, monthly, etc.) to your RRSP account and fill up a form to tell you boss about it. Your boss would then have to take into account a reduced remuneration subject to income tax.
Sorry if my explanation is not very good, english is not my first language!
More info : https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/payroll-deductions-contributions/income-tax/reducing-remuneration-subject-income-tax.html
I have faith in this gal. Good salary with good savings rate, and NO DEBT!
Taxes seemed too high. She could also consider putting some in Health Savings Account, which tax deductible, plus she can invest those dollars for future medical needs too.
She could also consider owning real estate for further tax benefits.
Hello Rb45. I live in downtown Chicago and agree with Kevin, get rid of the car. If you are Uber frugal, use transit and Lyft/Uber/Divy to move around. You can lower your taxes by claiming the tax free monthly mass transit benefit. Your expenses seem to be missing the parking, insurance and maintenance. All of my co-workers walk or use public transportation to get to work.
Retiring before Medicare is preventing any of my co-workers from even considering retiring early. Our BCBS monthly premiums range from $1,200 – $2,750. You will need to plan for insurance, out of pocket expenses and other fees if you plan to live in the US after retirement.
Withdrawing money from retirement plans including IRAs before the age of 59 ½ can be tricky and restrictive. Beware of the 10% penalty and investigate further, plan accordingly.
Go Bears!
Our BCBS monthly premiums range from $1,200 – $2,750.
———-
Ouch. Hard to see many people retiring early based on those numbers.
Obamacare! It’s still around (for now).
Follow up question! Within my tsp contribution there are two options and this is how I have it distributed:10% to traditional and 15% to Roth. Wondering how this factors in.
Thanks!
Rb45
We’re not super familiar with the inner workings of a TSP, but if you can elect to have the contributions tax-deductible (like a Trad IRA) or non-deductible (like a Roth), I’d contribute the max to the tax-deductible side so you get a current tax cut.
Again, check with a tax professional before taking American tax advice from a Canadian blogger.
new to this. Sorry >link to a previous blog entry that explains? please
how do you know she wont run out of money at 45 with $685,000 saved?
using the 4% rule?
http://www.fourpercentrule.com/
i plugged the numbers, was very tight!
Correct. 4% rule means that you can take their living expenses, multiply by 25, and that’s your retirement goal.
Check out the investment workshop on the top menu bar for articles we’ve written on this.
The TSP is basically a 401k and like any 401k it has an $18k contribution limit. There is a Traditional (pre-tax) option and/or a Roth (post-tax) option, or a combination. You can’t contribute to both a TSP and a traditional 401k. Traditional IRA’s are deductible if the AGI is less than $99k, so she should be in this situation.
For your second table, I’m not sure how you’re getting $61k in savings with $73k income and $25k expenses….? Let’s say she makes $73k = $18k to Trad TSP + $5.5k Trad IRA + $13k additional taxable savings + $25k expenses + $11.5k taxes (estimated). Add $3.6k of matching for annual savings of about $41k or a savings rate of 56% –> ~12 years to FI.
Using the 4% rule (25* her annual expenses) is a good starting point, but it seems a little foolish to assume this will stay the same for the next 50 years. What’s the plan for healthcare after early retirement? This alone could increase monthly expenses by almost $750/month and add several years of working. On the other hand, if she combines income with her financially savvy, debt-free, middle-class boyfriend, they could combine forces and perhaps be FI in less than 10 years.
Nice analysis FireCracker. It certainly seems like she’s doing well, and that’s very sensible advice to work that additional year to build up the cash cushion.
With 12 years to go, a lot of things could change in her life. A salary change, and apartments change, and a job change could easily modify this plan’s timeline in a positive or negative direction.
Even her marital status can change that tax rate. Who knows, maybe she’ll have a couple kids of her own one day! Those kiddos always throw parents for a loop! 😉
The important points are — be frugal, always be saving money, always be investing.
As kind of hinted at in one of the replies above, the missing money from her paycheck likely isn’t from taxes, it’s from all of the other “fees” that govt. employees are subject to, to include healthcare costs, life insurance, contributions to FSA’s, contributions to charity, etc. Once you factor in all of those additional expenses, it can really take a big chunk out of your paycheck.
I’m a little confused by this:
“I reinvest all my dividends to avoid capital gains tax.”
If she is earning these dividends in a taxable account it doesn’t matter whether she takes them in cash or reinvests them. She has still earned them (and they are subject to tax). I think this is a very common misconception.
Is that $4,885 number overstated. Looking at this I derive the following:
$73,016.00 Starting Point
$18,000.00 TSP Contribution Individual
$55,016.00 Pre Tax
$40,624.00 Post Tax (taking the 14,392 #)
$3,385.33 Monthly
$2,927.00 Monthly after linear spread of IRA contribution
$2,116.00 Expenses Current Lifestyle
$811.00 Residual Monthly for Investment
Hi FC,
I personally think that the reader will be able to retire by 45. The most important thing is that she ensures that her lifestyle cost does not undergo inflation. She should be on track to an early retirement, possibly before 40.
Ben
How do you retire at 45 by living off your TSP or 401k savings without paying taxes on the withdrawals?
You can use something called a “Roth Conversion Ladder” to withdraw from your 401k before the age of 59.5.
We wrote about it here:
https://www.millennial-revolution.com/invest/let-government-fund-retirement/
I live in Chicago and agree with the other locals; that car alone will hurt you. City taxes, insurance, parking, etc. If you’re living in the City, between Uber, Lyft and the L, you’re throwing away over $1.5k a year I’m guessing. If you just really want or need your car, enjoy it (I also have a Mazada 3 and love it to death) but know the total cost of ownership is higher than you might realize.
On a related note, maybe some of us should do a Chicago meet up one day since it looks like there are a couple of us here. Reply if anyone is interested.
A Chicago meet up sounds great! Would love to discuss with like minded people. Anyone else interested?
Former personal finance blogger (Punch debt in the face) and current federal employee here. I think there are a few things making the numbers whacky.
1. RB 45 does not earn 1% + 5% TSP matching. She earns 1% regardless of wether she contributes, or a max of 5 total % if she contributes at least that much. So 5% of her salary is matched, not 6% (which pushes the retirement timeline out a bit further.
2. As a federal employee she is paid bi-weekly. If she’s like me, her monthly income number is probably based around two paychecks a month since that is accurate ten months of the year, but she very well may have forgot the two “three paycheck months” that come around. If so, her actual monthly income would be pushed a couple hundred dollars a month higher.
3. As a federal employee she will have access to some pension income (assuming she stays with Uncle Sam) when she reaches her minimum retirement age (probably 62). So her early retirement fund will get a welcome boost a couple decades after she is eligible to early retire.
The blogger formerly known as Debt Ninja
Yes – Chicago meet up sounds great! I am interested.
Anyone who is interested can email me at sea@seandersonlaw.com
I will coordinate something for October or early November.
I think this is great! I have only one hope and that is that your BF is on the same page as you financially! I’ve seen so many couples refuse to talk about finances before they start living together and it can be a rude awakening! I hope you guys have had the money talk!