Recently I was talking to a buddy of mine about something I was reviewing already, my retirement number. After I made this post, I had a comment that made me question my basic model on taxes, so I decided to enhance it and post here.
The starting point is how to look at it. There are two ways that I consider how to get to my number. First, one could consider our actual spending. The other option is to consider how much we have minus savings or expenses that we would not make in retirement. Figure out those numbers for an annual basis, multiply by 25, and there you go.
Let’s start with the budget option. Our monthly budget includes a lot of things:
- plan on having this paid off before retirement
- expect that this money will go to retirement healthcare costs
- I hope it will be less than this, but this is my piece of mind
- healthcare co-pays
- this will likely be added to the healthcare costs when our companies are not subsidizing it
- Insurance (cars, home, etc)
- Car payment
- we hope to only have 1 car payment or less at any time
- this is my fudge factor to cover trips, clothes, furniture, yard maintenance, etc
- oil (our home is not far from a natural gas line but the utility has no plans to bring the main to our street)
- septic and well maintenance
- these vary by year but there are some regular maintenance costs to keep them all going
That budget annualized is the basis for one option. I’ll call that annual budget.
The next option is to consider not our actual spending but simply what we earn minus what we won’t have to pay for in retirement.
- 401k / IRA contributions
- College savings contributions
- Extra mortgage payments
- Extra non-retirement account savings
That is all I am subtracting from our income, and there is a gap between this number and our budget. I do not budget to the last dollar, and we use those dollars for home improvement, vacations, extra non-retirement account investing, and of course mortgage payments. I am not suggesting you do this, I am just explaining our way that works for us. In our case, we have separate accounts for everything, aside from one joint savings and checking account which we use to fund most, if not all bills. While I know there is no legal need for this as once you are married, all funds are joint, as far as I know anyway, but it helps keep the family finances from being a source of arguments for to very independent people.
When I annualized those numbers, and subtract them from my income, I now have my true living number. Did you see what I haven’t mentioned yet? Those numbers are almost all after tax. To that end, I need to apply taxes to those numbers. I didn’t apply that to my other number either. For your IRA, 401k, etc accounts some you pay taxes on the money contributed, and some you do not. That is something you can account for in the next section.
Taxes make the numbers a bit more complicated, but it’s really not that bad. The 2019 Federal income tax brackets are here. So for the true living number, have to divide our non retirement income chunk by 1 minus the tax rate for the brackets those taxes will be in. That gives you the income to fund those numbers. I do the same for Social Security, but for those who make more than $132,900 (for Tax Year 2019), do remember to stop there. Medicare tax is 1.45% on all of your salary, so that will be on all of it. I do the same income we wont have divided by 1 – the percent. That does not account for the standard deduction, or your itemized if you do that. All that does is perhaps adjust the bracket that this money is, and it’s federal income tax.
I am not including state here, but you can if you want. Some states, like good old NY, have rather non trivial state taxes, and NYC adds a significant one as well. For this calculation, for those numbers, they are worth applying as well. The result, in our case, is a true income number. Some states use the Federal adjusted gross income, and some states do it other ways. I suggest you look at your state, or the state you wish to retire to. There is a reason why folks retire to Florida! We won’t retire there, but this math will be a factor in our decision as to where to move. It’s always possible we retire to a low cost area of NY, say too far north of the commute to NYC, but south enough of the other cities. CT, NJ, and other states are a possibility, but I doubt it.
Going back to the annual budget option, it’s a bit simpler. We don’t have to add the Social Security tax nor medicare. Remember, though, if you plan on working in retirement, you will. The SSA has lots of good documentation on this, and it’s also wise to expect that things may change in a longer retirement. Laws always change a bit, don’t they. I found this site to have a lot of good information on what and what is not taxed, but of course, when you get close, I suggest talking to an expert, which I am not. I do plan on talking to someone when we get close to retiring.
When we look at that annual budget number and then look at the tax brackets. the taxes should be added to your income for the income in that bracket. Be sure to subtract the standard deduction, or again what you think your itemized will be. I used the standard deduction.
In both cases I end up with a spending plus income taxes number. Now you might say, but what about the fact that Roth accounts are tax free earnings, and traditional are taxed only on the earnings. Yes, that is true. If you want you can make this number more accurate by accounting for that. I choose not to because I want to over estimate what I need. That is my comfort factor. Still, it is a good idea to include if you are looking to make this more accurate.
The tax adjusted number for annual spending is what I use as the basis for my retirement number. One is smaller than the other, and I would likely prefer more, but knowing this, gives me a good idea
I would love to hear about your model, if you like mine, or think it’s insufficient.