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A Surefire Way to Secure Your Retirement

Category : Personal Finance, Retirement

He is richest who is content with the least, for content is the wealth of nature. — Socrates

Are you on a financial treadmill? I talked to a friend recently, and the conversation made me think about why most Americans depend on social security for their retirement. Social security income represents about 41% of income of elderly. And, 15% of our seniors depend entirely on the social security income.

Friend: I accepted a new position as a director of IT.

me: Congratulations. Where is your new job?

Friend: Chicago. My salary has gone up almost 40%. I will be making over $250K.

Me: Outstanding. You deserve it for your acumen and hard work. What about your house?

Friend: I’m going to sell and take loss as it won’t be feasible for me to manage it remotely.

Me: Have you found an apartment in Chicago yet?

Friend: Well, I found an amazing deal. I am buying over a million dollar house for 900K.

This friend of mine lives in a decent four bedroom house worth about $400K in Atlanta. He is an extremely talented guy. So, I know that he will climb up the corporate ladder, but he certainly is aboard financial treadmill.

If you keep increasing your standard of living as you earn more then financially your are at a standstill. Worse yet,  Uncle Sam loves high earners. You will get taxed at 39.6% marginal rate once you make over 250K.

Most of us dwell more on wealth in terms of realized income. Ironically, most wealthy pay less taxes as they rely on investment income. For most part, long-term capital gain on investment income gets taxed at 15%. Also, investment income is not subject to payroll taxes( 6.2% for Social Security and 1.45% for Medicare). On the contrary, If you add payroll taxes, state income tax, property tax and sales tax then my friend may end up paying over 50% just in taxes from his realized income.

Law of Deferred Gratification

The surefire way to get off the financial treadmill is to keep growing income while maintaining same level of lifestyle. Every extra dollar earned should be invested into a tax deferred asset.

With all the pessimism and worst of economic woes, all of us are making more than we were fifteen years ago.  The only problem that hinders our journey to secure retirement is the fact that — unless we learn to live life of simplicity — increased demand posed by our lifestyle sucks every dollar that we’ve added to our income over the years.

All families struggling to get by on $100,000 a year can look down the street to see a family — somehow — manages to get by on $50,000 a year. Heck, the same family struggling to get by on $100,000 a year somehow survived and thrived once on $50,000 a year.

The point is that you can save money if you can learn to live with simplicity all the while increasing your income to secure your retirement.

The goal is to squirrel away every extra dollar earned into an investment income bucket.

Instead of buying a bigger house and expensive stuff to elevate his lifestyle, if my friend maintains his lifestyle at the previous salary he earned, he can invest extra 40K in tax deferred investments — real estate, tax-exempt municipal bonds and dividend reinvestment.

If we assume that his portfolio grows at modest 6% then within 15 years he can amass over $1 million in assets.

At that point, you can work part-time or retire with income from $1 million. How? Most of us have two major debts — mortgage debt and car loans. If you kept your lifestyle in check, you would have paid off your mortgage in these 15 years all the while your retirement portfolio grew to a cool $1 million. You can easily live off $60,000 from your retirement nest egg with no debt. If you are passionate about golf or touring the world around with your leisure time, you can work part-time to earn 20-30K extra. Keep in mind that once you reach over social security retirement age, you will get a nice check from Uncle Sam to fund your fun activities like golf or cruise to Bahamas.

A Simple Plan to Secure Retirement

Open two savings or checking accounts. One to pay your self first. And another to support your lifestyle.

Here’s the scoop — If you squirrel away every extra penny you make as you grow your income — assuming that you are getting paid more with your experience and skills — you will soon not only be maximizing your 401(k) contribution($16,500 for the current year and $5000 for IRA), but also adding more money to your other tax deferred assets.  The secret key is to assume as if that money never existed, ever to support your lifestyle!

What if you never climbed up the corporate ladder?

If you are one of those average Joe who lacks skills to climb up the corporate ladder then you may not see a sudden income spike like my friend did. You can still amass similar nest egg using the sample principle of living way below your means. The only difference is that you may have to wear your frugal hat religiously than those who make much more than you do.

Most of us start earning money in our 20′s and peak during our 50′s. Save and invest percentage equals to the age group your are in every year. In other words, if you are in 20′s start saving 20% of your salary every year; keep gradually saving 30% once you enter in that age group. You will have to save 50% once you get in your 50′s, but if you’ve made right financial decisions thus far then you should be on the lower spectrum of the debt curve in your 50′s.

So, if you are one of those unlucky average wage earners who never made more than your measly 3% raise every year after getting your first job with 50K salary, you will still have over $1 million as you will be making close to or over six figure in your 50′s.

The gist of this article is to keep same lifestyle all the while increasing your salary to a point where your investment income starts making same money per year or more compare to your earned income. It takes discipline and persistence, but it’s well worth it in the long run.

Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.

– Charles DickensDavid Copperfield, 1849, English novelist (1812 – 1870)

 

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Comments (49)

another great post, Shilpan. My favorite so far.

In fact, people could read and implement only this and do very well. FI is really very simple:

spend less than you earn — invest the difference — avoid debt

do just that and you can’t help but wind up wealthy.

Here’s my own attempt at the concept:http://jlcollinsnh.wordpress.com/2011/06/08/how-i-failed-my-daughter-and-a-simple-path-to-wealth/

Thank you my friend. As you’ve said, personal finance is not a rocket science; it simply needs lots of common sense. :)

Excellent post Shilpan and I hope your friend keeps climbing the ladder because with his lifestyle creep (actually it sounds move like a lifestyle sprint) he will need those big income boosts and bonuses.

I was always in those average Joe type jobs, but by simply increasing my 401(k) contribution by 2-3% each year I was soon at the maximum contribution and never missed the money being sent that way. Personal finance is simple, it’s needing the willpower and dedication to continually implement your plan that makes it seem difficult.

Steve, my friend surely is a brilliant guy. So, I am confident that he will move up. But, he can also move up quickly on the financial freedom ladder if he can start investing big chuck of his new found wealth.

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Good thoughts, Shilpan. Your friend sounds like one of those high-earning types that don’t take the time to figure out the basics of personal financial management. Even a $400K house in the Atlanta area is above the norm.

Well said my friend. I think he will be fine financially with his income even with the big house, but he can get out the rat race lot sooner by keeping same lifestyle for 5-10 years for sure.

Great post. I really hope your friend reconsiders that big new house and heeds your advice. The other thing about talented people is they don’t realize that it could be difficult to find another job paying what they need to sustain their lifestyle. Say he gets fired, how long will it take him to find another 250k a year job? If the answer is I don’t know, then you need to really think long and hard before you adjust your lifestyle upwards. I’m with you, I would just bank the extra money and aim to have the ability to retire when I want too.

YFS, You summarized all of my thoughts in few sentences. It’s indeed hard to find a job to match same or higher salary level. Also, high lifestyle adds tremendous stress just to maintain it.

this is an excellent point. the higher you go in income the thinner the job pool becomes.

and it’s not just a concern of being fired. He may simply lose interest or become interested in another path.

If his lifestyle matches or, god forbid, exceeds his income he is no more than a gilded slave.

I love how you put it… “If his lifestyle matches or, god forbid, exceeds his income he is no more than a gilded slave.” That needs to be on a shirt or coffee mug somewhere!

I can’t agree more.

thanks! High praise indeed. It’s a line from my manifesto:
http://jlcollinsnh.wordpress.com/manifesto/

Great post! Sounds like your friend is definitely caught up in the rat race or keeping up with the Jones. Although not as flashy, keeping your current lifestyle while increasing income will help you prepare for retirement quicker!

Buck, Key to financial freedom is to not allow emotions to creep in — when cash flow goes up– to spend more. Instead, let that money to work for you like a wise son who can take care of you when you can’t earn.

Really great post.. I would love to hear a follow up a year from now to find out how your friend is doing..

I can’t say that I would behaved entirely differently if the same thing happened to me. Money doesn’t go nearly as far in Chicago as it does in Atlanta..

I recently got a nice raise at work.. certainly not 40%.. but enough to make a difference. We aren’t changing a thing about our lifestyle, and the extra money is a big part of our strategy to help climb out of debt.

Jefferson, Congratulations! I admire your plan to pay off debt first with additional income. I’m sure that soon you will be on the path of financial peace.

Gem of a Tip Shilpan! I did exactly this. I have one of those savings sub-account which I named ‘Frugal’ where I sock away money saved (mail in rebates, cc cash back etc) or earned but not from my work.

Amazing to see how quickly the account starts to swell!

MC, I admire you for your financial acumen. Way to go my friend!

Beautifully written post, Shilpan. It’s great that your friend earned a new position with higher wages. He sounds like a real dynamo who has worked hard, and has applied himself in order to reach his current income status. However, I hope that, at some point, he will follow your example, and become a far better saver. Deferred gratification is not an option. Unless, money is falling freely from the sky and directly into one’s backyard, which of course is very unlikely, we all have to practice delaying gratification for future financial security.

Anthony, delayed gratification indeed works. Think about anything that’s hot today becomes much cheaper to buy later. Latest example is much hyped 3D TV’s. Watch and see how prices fall in few years. :)

It’s amazing how lifestyle inflation derails our ability to build wealth.

But that’s what we strive for though, right? We desire and work to make more money, so in turn we can buy more stuff and live “THE LIFE.”

It is a financial treadmill and a rat race that most will never escape. The only way to escape it is to find contentment.

Jason, I can’t agree with you more. Buying stuff never brings eternal happiness. In fact, it brings more stress in the long run.

Not enough people have deferred gratification. I agree that by increasing income while keeping lifestyle constant, you can definitely make strong strides to getting out of the rat race. That’s very simple, but not easy, which is why reminders like this are so important.

Shawn, message is simple yet hard for most of us as we tend to spend more as we earn more. :)

Excellent post. The old saying goes, it’s not what you make, it’s what you keep. We shall see what happens with the Social Security system in this country. It is not looking too good, so it is more important than ever to invest wisely for retirement.

I agree with your suggestion that it is what you keep that matters most for the happy and peaceful retirement. No one else, including your government, has more interest in your retirement than you do.

This is one part of retirement planning that people often overlook – not letting their lifestyle get out of whack! I can say from personal experience that I have seen my income increase, but we keep our lifestyle modestly consistent. This is why we are now able to max out our 401k’s and IRA’s. Thanks Shilpan!

I’m glad that you are doing well by investing your increases for the future appreciation!

“live below you means” is my daily mantra. It helped me for the last 15 years nicely, i am betting my next 15 on this mantra too ;)

Way to go Alik!

Truly excellent post. Common sense is not so common anymore in the race against the Joneses.

Something I really like about the U.S. is the tax structures one is able to set up. I wish we could take advantage of some of those wealth-building structures in New Zealand!

Thanks,
Jim

Jim, You’ve said it right about common sense. It’s an extinct trait in our society. Apparently, Joneses rule the world with spending money they don’t have.

Great advice Shilpan, easy to remember :)
You have a talent to greatly simplify the things you teach

Thank you Karunesh for the kind words.

[...] @ Street Smart Finance writes A Surefire Way to Secure Your Retirement – Are you on a financial treadmill? I talked to a friend recently, and the conversation made [...]

Great article, Shilpan and very sensible. Love the Dickens quote – very apt.

Mark, I love the Dicken’s quote as well. That quote itself is the key to financial freedom.

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