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!
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!
**I haven’t got a lawyer so be prepared to wait a long time for the phone to ring Back ↑