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Our Next 5 Years of Expenses

January 19, 2021 by Lazy Man 2 Comments

expenses

Today I wanted to look at our next several years of expenses. Most people are probably fine with looking at one year of expenses. However, we have two Big Financial Events (BFEs) colliding that will drastically change our financial picture. In 6-7 years, we’ll finish paying off our primary mortgage and two investment property mortgages. Around the same time, the kids will be graduating from their expensive private school. That may translate to ditching $50,000 in investment expenses while adding $25,000 in income.

That’s a great BFE down the line, but we have to get there first. So let’s look at where our money goes until the BFE.

[Note: You might be asking, “Why did you choose 5 years in the title?” Well, choosing 6-7 years just looks weird. I think there’s more value in people looking at 5-year chunks anyway.]

Expense 1: Kids’ School

Currently the kids go to private school. It’s an exceptional school. In one of my kids’ classes, two of the ten kids’ parents are public figures with an estimated net worth of hundreds of millions of dollars. You could call it the best education that money can buy.

We are lucky to get a large military discount. We think it’s a good value even though it is clearly still very expensive at $25,000 a year for the two kids.

I realize it is a great privilege to send your kids to a private school. We’re very frugal in a lot of other areas, so we’re okay with investing in our kids’ education.

School Annual Expense: $25,000

Expense 2: Housing (and Rental Properties)

We have our primary residence and 2 other rental properties on 15-year fixed mortgages. The idea was to front-load the expenses while we were making good money, pay less interest, and not have to worry about mortgages in retirement.

We recently sold one investment property (via a 1031 exchange to limit taxes) and bought another one closer to where we live since it would be easier to manage. The good news is that process reset the mortgage for 20 years so now it is cashflow positive as opposed to the other two slightly negative, cashflow properties. Between maintenance and such, we can probably consider the three investment properties – all in an LLC to be cashflow neutral. In around 6 years, we should be able to bring in around $25,000 in additional income. In the meantime, we don’t have to plan any significant annual expenses due to the income from the tenants. (This could change, so we need to keep an emergency fund for it.)

Our primary house though is a big expense. We have about another 6 years on that mortgage. I’ll round it up to $3000 a month to make it $36,000 a year. In fact, I’ll bump it up a little more to include some maintenance. (I’ll be adding some extra money to pad all the expenses at the end, so let’s not quibble about whether this enough padding for now.)

Housing Annual Expense: $40,000

Expense 3: Transportation

I haven’t looked at our transportation costs in a long, long time. I typically don’t worry about breaking it out, because we do the best we can – there’s no fat to trim. We’ve paid off our cars, but they are 7-8 years old now. We are the type of people to drive our cars into the ground. The timing of paid-off cars is good because we can probably get by without a car payment until the mortgages (noted above are all paid off)

Of course, there’s more to transportation than just the car. I’ll budget another $3,000 for gas, maintenance, insurance, etc.

Transportation Annual Expense: $3,000

Expense 4: Food

Food is like transportation. I don’t typically look at the numbers because I’m frugal with our shopping. Fortunately, we have an American Express card that gives us 6% cashback on groceries. Since we use that card for food religiously, I can look up our annual spending on the card and use that number.

In 2020, we spent $6,253.28 on groceries. In 2019 we spent $5,585.16. So on average, we can expect to spend $6,000 on groceries. However, our 7 and 8-year-old boys will probably eat more, so I better boost this up to $8,000 to be a 6-year average.

Our restaurant spending is a little more difficult. We do have a credit card for that, but for some reason, Chase disables the year-end reports for that one particular card. I added up each month’s statement from 2019 (restaurant spending in 2020 was off due to the pandemic) and found that we spent about $8000 there as well. As we found out in 2020, this is an area we can cut back on if we ever need to.

Food Annual Expense: $16,000

Expense 5: Healthcare

Healthcare is provided by my wife’s work. It comes out of her paycheck, so I don’t notice it. It’s great for now, but my wife will likely retire within the next 6-7 years. It’s a good idea to include this category to plan for that scenario.

We can get Tricare for Life, which is relatively cheap military healthcare. My wife is an expert in healthcare and it’s her main business to know the economics of this stuff. It looks like the deductible is $300 per family with a catastrophic cap of $3000. It seems like most other things are covered in some way.

I have to admit that I don’t understand any of these things. Maybe I should read “Healthcare Plans Explained for Dummies”, but I know this is our best option, it’s cheap, and my wife knows all this.

Healthcare Annual Expense: $1000 (but no more than $3,000 – I think?)

Expense 6: Miscellaneous

I’m adding $15,000 to the final number for things that I’m just too lazy to add up. That can include the kids’ extracurriculars, kids’ camps, house cleaning service, utilities (lowered by our solar power), landscaping, emergencies, entertainment, vacations.

We’re fairly frugal with some of these items. We can stretch our vacation dollar with our Aruba timeshare and stored up airline miles. We can also use numerous military perks in retirement. We can skip some kids’ camps if we have two adults around all day.

Miscellaneous Annual Expense: $15,000

College Savings

It may seem weird to spend tens of thousands of dollars on a private school for a first grader and save next to nothing for college – yet here we are!

The reality is my wife’s GI bill can effectively cover half of the college expenses for both kids. We have some money already saved for college and a little time for it to double. We’ll ask them to cover some expenses so that they have “skin in the game.” After the BFE in 6-7 years, we’ll have more cash flow for college. Hopefully, they’ll get some grants and scholarships – they better for all we are spending on their education now, right?

In reality, we’ll save more than $0 as we have been doing, but we don’t need to factor this in as a requirement.

College Annual Expense: $0

Final Expenses

Here’s what our expenses look like in a table:

Housing$40,000
Schooling$25,000
Transportation$3,000
Food$16,000
Healthcare$1,000
Misc$15,000
Total$100,000

I’m certainly making that $15,000 Miscellaneous section do a lot of work, but that nice, even $100,000 number is so damn attractive. I definitely let the tail wag the dog to reach that number.

If we presume a 20% effective tax rate we’ll need a pre-tax income of around $125,000 before taxes. That may be a bad assumption of taxes, so it’s a question that I’ll have to ask our tax preparer.

While that $125,000 sounds like a ton of money, after the 6-7 year BFE, it would effectively be closer to $45,000 – with $25,000 of income from the rental properties. That’s a lot more manageable, especially with our other income sources.

Why These Expenses are Important

You may have caught a hint of why I’m going through this analysis. It was originally intended to be part of a bigger article analyzing a bigger question. Expense analysis is a critical factor in determining if you can retire.

Next week, we’ll revisit these numbers in a larger context.

Filed Under: Financial Planning Tagged With: expenses

Retire on $5 Million Dollars?

May 12, 2016 by Lazy Man 3 Comments

I’ve really been digging how Retire by 40 can always find a new spin on financial freedom. Their article from a couple of days is a great example: Can You Retire With 5 Million Dollars?

I would have never thought of that idea. That seems like an absurd amount of money for most people to retire on. It’s almost like asking if anyone would want a million dollars… the answer is going to be “Of course!” I read everything that Joe writes at Retire by 40, but this title made me curious why he picked such a high number.

It’s a very good article, but as Joe writes, “accumulating $5 Million isn’t exactly normal.” You typically need a high paying career (or two) and that typically comes with a lot of lifestyle inflation.

It reminds me of these stories of bankers barely getting by on a million dollars a year. Taxes cut the million to around $600,000, and mortgages in Manhattan and the Hamptons aren’t cheap. Throw in private school for 3 kids at around $40,000 a year each and it’s easy to see that money disappear.

That’s an extreme example, but you get the idea. There comes a point when the question, at least for the 1% (or 0.1%) almost becomes legitimate.

But you (most likely) and I aren’t those people. Joe recommends tracking your expenses (we both use Personal Capital) and using the Rule of 25. That means once you know what you spend in a year you can multiple it by 25 to figure out how much of a nest egg you need to retire. For Joe, the annual number is $55,000 which means he should have a nest egg of $1,375,000. (For math nerds and personal finance junkies this Rule of 25 is just flipping the Rule of 4% on it’s head.)

Now this doesn’t factor a variety of other factors. For example, if you have real estate property (which we do), it might be possible to generate $15,000 a year from that. Suddenly that $55,000 becomes $40,000 making for a more manageable nest egg of $1 million.

You also need to invest the money properly. I find this risk tolerance calculator from FinMason to be a great tool for that.

And while Joe says you probably shouldn’t include your primary residence in the calculation, I think it’s fair to calculate your expenses assuming your mortgage will be paid off. (You are going to have your mortgage paid off in retirement, right?) For many people, that’s their biggest expense. There’s still taxes, insurance, and maintenance on the home, but eliminating the mortgage payment is a big deal.

Personally, it’s been a couple of years since I tried to calculate the numbers. When I eliminated expenses that should eventually go away in retirement (child care/college, mortgage payments, electricity (via paying off our solar panels)), I was surprised how little was left. The bulk of it was car ownership. And by that time, we’ll probably have robot Uber drivers which could make owning a car unnecessary.

The calculation is almost flipped upside down for us as the rental property income should be enough to cover our retirement expenses. Of course those retirement expenses were based on necessary expenses and didn’t include any cushion. They also didn’t factor in any money for fun. That’s why I say the calculation is “almost” flipped.

On the other hand, rental income is only one small part of our overall retirement income plan. If you have enough income coming in, you may not need to draw down on investments at all.

To close this out, the retire on $5 million question isn’t a very good one for almost anyone reading this. Instead it is better to figure out what you can retire on. And while many people believe in getting a big nest egg and drawing down on it, keep an open mind towards other income streams that can continue in retirement.

Filed Under: Retirement Tagged With: expenses, income

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