Reader William recently wrote to Mr. Everyday Dollar with some great questions. I’ve answered them and thought it would be great to share with all my readers. And if you feel you would be a good case study or are facing an interesting financial dilemma feel free to contact me.
William has been working for about 21 years and has no debt, has accumulated a nest egg of about $945,000 which sits in both a 401(k) and IRA as well as a taxable brokerage account. His house is paid for and is worth around $150,000. His car is paid for and is worth around $3,000.
First off, I’d like to point out that this is awesome! He is a Mr. Everyday Dollar – being frugal, being conscious with his everyday spending, paying off his house, not carrying a car loan, saving and investing year in and year out – being financially responsible and disciplined.
This, my friends, is how you build wealth. William is a perfect example how an everyday guy can build a Walk Away Money Pile (WAMP (I just made that up and I’m going to start using it a lot now!)) and position oneself to retire early.
Williams main concerns were about healthcare, investment strategies and when to quit his job.
Once William quits his job he will not have access to company sponsored healthcare coverage. Many of us working folk in the US participate in this kind of health coverage. And many older working folks keep working just to have the corporate healthcare coverage, my mother is one of these people. You quit the job, your coverage quits.
Your option is to either go without health insurance, which means a major medical issue could wipe you out financially, getting on your spouses’s company sponsored healthcare coverage, or self-insure.
William is single so self insure it will be. Self insuring is not as bad as people make out. I don’t understand why everyone thinks it is so darn expensive. Go to eHealthInsurance and check it out for yourself!
I ran a quote for myself (age 33) and chose a plan that was Health Savings Account (HSA) eligible. You can do this by clicking Additional Features and choosing HSA Eligible. Sorting by price I found that the cheapest plans are the High Deductible Health Plans commonly called HDHPs:
- The cheapest plan rang in at $40.33/mo with a deductible of $5,000 and 0% coinsurance (pay nothing after deductible).
- The second cheapest plan rang in at $45.97/mo with a deductible of $3,500 and 20% coinsurance.
So what if I was around William’s age, say 43. How much would that cost me per month?
- The cheapest plan rang in at $64.03/mo with a deductible of $5,000 and 0% coinsurance (pay nothing after deductible).
- The second cheapest plan clocked in at $72.99/mo with a deductible of $3,500 and 20% coinsurance.
Either of these are a good choice for William. The worst case scenario is if he had major medical issues every year he would be paying either $3,500 or $5,000 a year with one of these plans. Likely? Probably not but it depends on your health.
Why did we pick a healthcare plan that was HSA eligible? For a few reasons. By using an HDHP we can put money into the HSA to cover the deductible, if needed. This makes more sense than to pay the deductible straight out of your pocket because money that you put into your HSA is:
- Tax deductible! For singles, the maximum HSA contribution for 2012 is $3,100. For someone in the 25% tax bracket this reduces taxes by $750!
- Grows tax free from year to year.
- Can be invested just like with an IRA! If you want you can invest your HSA dollars in stocks, bonds, mutual funds and CDs. This is awesome.
The other nice thing about an HSA is that if you decide to switch health plans you can keep the same HSA.
Finally – to make a gross generalization about Americans – we eat poorly, don’t exercise and some of us smoke and drink to excess. Which leads to getting fat. Which leads to chronic health problems. Eat well. Exercise. You will have less medical problems and less medical problems means less dollars coming out of your pocket.
Remember, becoming financially independent is a lifestyle and to be able to support that lifestyle once you obtain it, you need to have a healthy body and have developed healthy habits. Onward!
Early retirement investment strategy
Here’s what William’s tax deferred portfolio looks like:
|401(k)||Stock Mutual Funds||$105,000|
|401(k)||Bond Mutual Funds||$190,000|
And here’s his taxable brokerage account:
|Brokerage||Taxable Municipal Bonds||$450,000|
The interest income from his brokerage account is currently $33,500 per year and his real world return is around 6.7%. There’s varying opinion on what percentage is safe to use when figuring a rate of return when calculating interest income from a WAMP. Depending on your risk appetite I say on the low end 5% and the high end 10%.
I think 10% is possible if you are actively managing your money and successfully use a blend of stocks, stock options, bonds, REITs, MLPs and rental property. Can most people year in and year out get a 10% return? Probably not. That’s why a safe number to use is 5%.
William is mainly collecting income from his taxable muni bonds. One thing to keep in mind is if a higher yield is possible with tax-free bonds. In order to figure this out there’s a simple calculation and we’ll use the 25% tax bracket:
- After Tax Yield = Taxable Interest Rate × (1 – Tax Rate)
- 6.7 x (1-.25) = 5.025%
To make the equivalent 6.7% return with tax free bonds William would have to find one with a yield of 5.025%.
His 401(k) and IRA are healthy and should grow steadily until he reaches “real retirement”. At that point, it will provide a good cushion. Plus, he should be able to receive some Social Security dollars. Personally, I don’t even count on Social Security when figuring out my retirement. If it’s still around when I become eligible I will consider it a bonus.
Here’s his current expenses:
He is spending around $1,445/mo without medical. Extrapolate this out and he is spending $17,340/yr. As we learned earlier he will need healthcare which will add around $75/mo. Adding that plus an HSA contribution of $3,100/yr brings his yearly expense total to $21,340. This is well under the $33,500 per year his brokerage account is throwing off.
Even after taxes – 15% up to $33,350 and 25% up to $85,650 – he is successfully living off his WAMP with around $7,000 extra.
And of course, he could bring his expenses down further to have a larger margin than $7,000. He admits he eats out a lot so making cuts there is one possibility. It doesn’t mean he shouldn’t eat out anymore if he enjoys it but maybe he eats out only twice a week rather than three times. Or he eats a snack at home before he goes out, then orders only an appetizer and a beer at the restaurant.
Maybe when he quits he decides to get rid of his car which eliminates car insurance and gas expenses; if there is decent public transportation this may be an option.
Lastly, he didn’t figure in any home and car maintenance costs. He figures he needs to put in around $20,000 of work into his house. If he quits his job perhaps he can take on this work himself and save a good chunk of dollars. He’ll have all the time in the world to do it!
When to quit
Now, this is up to William. I think about the day that my WAMP is right where I want it to be and I’ll be ready to leave the workforce. Most people would say they wouldn’t think twice about the opportunity to tell their boss they’re quitting! But for me I know I’ll have this little Mr. Everyday Dollar on my shoulder saying:
“Do you have enough money? Are you sure? Is it enough to get you to “real retirement”? What about healthcare? Inflation? Did you think of that? Oh my god, you’re crazy! Why would you leave this comfortable well paying job? Don’t do it! Is this going to work? What if you run out of money faster than you thought? What if you can’t generate enough income? Haha! You should have stayed in that job! You’ll so regret quitting!”
But then I’ll take a deep breath, realize I’ve set myself up for success and I’ll make it work. It’s a leap of faith to retire early but what we can do is to have enough data on our finances to support our decision that it is feasible. People before us have done it successfully. You can too!
And you can always go back to work.