Is our rat going to escape the race?
Welcome to part II of the financial independence planning series!
If you missed part one in which we discussed the benefits of having such a plan, you can read at your leisure right here
First of all I would like to apologize for the lack of posts on this series since I posted that first one. However I have not been resting on my laurels! You see it turns out this whole financial independence planning business can be quite a bit more complicated than you first think. The good news however, is that your old buddy theFIREstarter has been beavering away for the last few weeks, creating many, many spreadsheets (oh… the spreadsheets!), going over the fine details, checking the figures, and generally having a bit of a fun geeky time. After all of that, I can now present to you the concepts and calculations you need to do in their simplest form, and explain to you some mistakes some people might make along the way (mainly because I made most of them already, before finally finding the correct answer!). This should save you a lot of time and maybe even save some of the precious follicles on your as well. And to the spreadsheet lovers out there… “don’t touch that mouse!”. I will include links to all my spreadsheets as well if you want to get all geeky with me!
Meet theFIRErat!
I find that the best way to understand anything is to look at real working examples, and funky financial equations are no different. So to keep things as simple as possible I am going to use a test case with a base set of figures, much like the mathematical maestro the madFIentist does in his Lab Rat and Assumptions post. My lab rat, who I’ve christened oh so originally theFIRErat, is using very similar numbers but his* situation will obviously be quite different as he lives in the UK. Aside from that initial hugely silly mistake of choosing such a rainy place to live, he is doing ok for himself and is hitting the following financial numbers each year, denoted in good old Great British pound sterling of course:
- Salary: £50,000
- Employee Pension Contributions: £2,000
- Employer Match Pension Contributions: 4% match = £2,000
- SIPP* Contributions: £20,000
- He therefore banks a total of £24,000 into retirement accounts per year
- His (after tax and employee pension) take home pay is £34,763
- He has just bought a house and makes £5,000 per year worth of principle payments and £4,073 worth of interest
- His expenses are £20,073 including his mortgage payments
- His non-mortgage living expenses are therefore £11,000, which I feel is more than enough to live a pretty extravagant lifestyle
- He is 30, and single ( 🙁 )
*A SIPP is a Self-Invested Personal Pension that allows you to effectively save your salary pre-tax (you actually get tax rebated on contributions made, but the overall effect is as if you’d made the contribution pre-tax, like your employee contribution retirement scheme). For any USA peeps reading it is very similar to a Traditional IRA.
All calculations and figures ignore inflation where possible (maybe ignore is the wrong word, but you get the gist). This means any estimated interest rates or investment returns are real returns – after inflation has been accounted for. All future £ amounts are therefore in todays money, so for example if you see a £10,000 we are discussing, or in a spread sheet, relating to a time of 10 years in the future, the inflation adjusted amount would be £13,439 (1.03^10 * £10,000). You don’t have to do that calculation every time of course, and in fact dealing with real returns and non-inflation adjusted figures not only make the calculations tidier, it also makes it much easier for us to weigh up what future amounts of money are actually worth to theFIRErat.
Ok so now we have our lab rat and his financial figures to plug into our calculations, we are all set to crack on with the rest of it! You’ll have to wait until next time to see my spreadsheets I’m afraid people though!
Do you think my assumptions here are realistic? Have I missed any key figures out you’d like to see an estimation for? Let me know in the comments and I can add them to the test post if possible!
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*yes, I decided it is going to be a him, any problems call my lawyer**
**I haven’t got a lawyer so be prepared to wait a long time for the phone to ring Back ↑
Discussion (11) ¬
Looking forward to the spreadsheets to see what I missed in my own. And of course be a financial voyeur. I only accounted for taxable account savings since the plan is to retire much earlier than I can withdraw the retirement funds so there’s more to the equation but it’s a good start.
Cheers JC! You got a link to yours… no problem with you posting it here? (Or are they “offline”?)
I’m going to look at various scenarios for theFIRErat to see how his path to early retirement gets affected, one of which is taxable accounts vs tax advantaged ones.
I noticed the other day I was getting quite a lot of traffic from your site by the way and then noticed I am on your blog roll… so thanks very much for that and for reading!
Glad that you’re getting some traffic from my neck of the internet woods. I need to get it updated and converted to Google docs. I’ll try and work on that and get a post about it soon. There’s way too many ideas and way too little time to get everything done.
This is so true! I was just complaining to Mrs TFS that there are not enough hours in the day… I expect the same will be true even once one is FI anyway though 🙂
Will look out for your post! Cheers again!
Hi. By putting all that cash into SIPPs you’re effectively condemning your 30-year old rat to a further 25 years of wage slavery – it’s locking up £500k of investment capital which can’t be touched until he’s 55 !
However, with those high rates of savings and low expenditures, I’d expect your rat to be able to reach FI well before that age. Imagine him diligently saving £20k a year for say the first 15 years and then being unable to take it easy – although it appears that he’s already worth £300k, he needs to continue earning because he can’t touch any of his own ‘savings’ for another ten years…
However, if that £300k was all held outside of a SIPP, he could already be safely withdrawing enough cash to cover all his expenses, and probably for the rest of his life.
So, at only 30 years of age now, he should be maxing out the ISA every year before even thinking about saving anywhere else – when he’s much, much closer to 55, he can always begin to drip cash over into the SIPP to get any available tax benefits.
Pensions should be seen as a one-way bet – as soon as cash is paid into a retirement account, you can’t get it out early. That’s fine for a 30-year old putting say £2k a year in a SIPP, but not for a sum like £20k a year.
http://eaglesfeartoperch.blogspot.co.uk/2012/10/isa-isa-baby.html
Hi EFTP!
Well sir, you have just created the perfect spoiler for some of the topics I am planning to cover over the next few posts… 🙂 but you are of course completely spot on with your comment.
I just wanted to establish a baseline set of figures on which we could run a few different scenarios through after, to show how different variables will affect his path to FI.
Whether I started out the baseline figures with him saving all of his savings into an ISA, all into a SIPP (or even all into taxable accounts) does not really matter. As you mentioned the optimal solution is no doubt to save a bit in both, but I wanted to keep the first set of figures as simple as possible as a base point to jump off from. The big question is how much to save in both types of account for most people to make it most optimal, depending on various factors, which I hope to answer as well.
Hope that makes sense and thanks again for the insightful comments! 🙂
Hi TFS.
Sorry if I’m jumping ahead of your future posts ! Look forward to reading them.
The fact is, even though I’m a relatively old fogey, I only created my first ‘Plan’ at the end of last March after a lifetime of just drifting along, financially speaking, although I did manage to save and invest a little on the way. Getting older tends to focus your mind since the years remaining in which to make substantial additions to the savings pot are rapidly decreasing !
I’m intending to post in early April with my first annual review against the ‘master plan’…
Hi DM,
Not at all… I’m glad that someone is paying such close attention to my posts 🙂
From what I’ve read of your blog so far your have everything ticking along nicely. I guess it doesn’t matter what age you start at, as long as you don’t leave it too late.
(Sorry for calling you EFTP before by the way, that was obviously just the acronym of your blog name!)
wow – on 50k salary you’re making 20k pa contributions to your SIPP? that’s a healthy 40% right there. AND you’re paying off a mortgage too. That’s mustachian!
I’m a little (ahem!) older and still haven’t balanced the expenditure side of the equation properly – the more I read (and I only started reading FI blogs 5 months ago) the more I realise that this is a hugely powerful lever – especially for us older folks who won’t reap the full goodness of compounding
Hi Mr Squirrel!
Umm…. I should point out that the rat is NOT actually me. The only thing really similar is roughly our age, and roughly the gross income. Sorry… I thought I’d made that clear in the post but will have a read over and make it more clear if necessary. Saying that, I think we are easily hitting a 50% savings rate right now but I will be putting down some hard figures in a future post seeing as last time I did them, they were a bit wishy washy.
That is so true about the expenses side of your balance sheet. I don’t really think anyone thinks about this, who hasn’t read a book or blog about how FI or early retirement / retirement actually works.
I can bet you most of my friends, even the high earners, definitely do not think about it at least!