Today’s case is from a couple from Victoria. They are on their way to FI but don’t have any plans to retire once they get there. Instead, they want to move to part-time work asap. How much they can reduce their income right now without jeopardising their goals?
Meet Tim (32) and Nikki (27), a couple from outer southeast Melbourne. Tim works in software consulting and as a lecturer on a casual, part-time basis. Nikki is a doctor. They are planning to have kids in the next 5 years.
Tim and Nikki are working towards FI but they also love the work they do and therefore intend to do some form of it well into the future. They find the idea of traditional retirement boring. Instead, they would like to explore their options and are considering semi-retirement. Semi-retirement would allow them to start working part-time sooner rather than later. Nikki also plans on taking a few years off work when they have kids.
Tim was brought up in a relatively frugal family. The frugality stuck with him in his adult life and he considers it his “superpower”. He realises that many people require much more than he does to be happy and enjoy spending money. In contrast, spending money causes Tim mental discomfort. About 10 years ago Tim started exploring the financial world. Like many, he started off by trading the stock market but soon realised that trading was a trap and got out. Fortunately, his portfolio only suffered a 3% loss.
One day Tim had an epiphany regarding his finances. He realised that the question he should be asking is not “How much money can I make in my life?” but rather “How much money is enough?”. It wasn’t until late 2018 that he discovered the FIRE community and found others with the same way of thinking about money. This motivated him even more and he started making a plan to reach FI. Since then Tim and Nikki have built an ETF portfolio. They also bought their PPOR and have a comfortable amount of savings sitting in their offset account.
Tim and Nikki would like to reach Flamingo FI and have a paid-off house before having kids. They could then use Tim’s income to sustain themselves and don’t depend on Nikki’s salary. Eventually, they would like to reach FI within the next 15 years.
Tim would like to know how much they can reduce their income right now without jeopardising their FI goals. Let’s find out!
Let’s have a look at the Tim and Nikki’s numbers:
Tim’s income (casual): about 78,000 (gross) = $60,000 (net)
Nikki’s salary: 160,000 (gross) = $110,000 (net)
Total after-tax income per year: $170,000
Annual employer Super contributions:
Tim – variable, we’ll use $7,410 (gross) = $6,300 net (after Super tax – 15%)
Nikki – $15200 (gross) = $12,920 net (after Super tax – 15%)
Total after-tax income (incl. Super) per year: $189,220
Super: $78,000 (combined)
Cash: $100,000 (offset account) + $35,000 (separate savings account)
Home loan of $200,000 at 3.15% (PPOR value: $510,000)
Goal 1: A paid-off house in 5 years
One major goal for Tim and Nikki is to pay off their house in the next 5 years. They currently have $100,000 sitting in their offset account. Investing this money will speed up their journey to Flamingo FI and eventually FI. However, if a paid-off house is a priority, it would make sense to use that $100,000 towards the mortgage. This leaves them with another $100,000 to pay off. If they continue with their current monthly mortgage payments, the house will be paid off in just under 7 years. In order to be mortgage-free in exactly 5 years they will have to increase their repayments to $1820 per month:
Goal 2: Flamingo FI in 5 years, FIRE in 15
Eventually, Tim and Nikki want to be able to withdraw $40,000 per year from their portfolio. According to the 4% rule, their FI number is $1,000,000 ($40,000 x 25) and their Flamingo FI number is $500,000.
A note on the numbers: In the calculations below I’ll leave out the $100,000 in their offset account that they will put towards the mortgage. I’ll also exclude the $35,000 in their separate savings account as it sounds like this is their emergency fund. This leaves us with $208,000 in investments (ETFs and Super). Their expenses in the first 5 years are now $59,160 because of the higher mortgage repayments. I have assumed annual future expenses of $40,000 to keep things simple. It’s close to what they are currently spending and aligns with the ASFA numbers for a “modest” retirement. All the calculations assume a 7% inflation-adjusted return per annum.
Tim wants to know how much they can reduce their income and still hit their milestones. The answer: In order to reach Flamingo FI and pay their house off in the next 5 years they need an annual income of about $100,000 after tax. That is just over half of what they are currently making!
Once they reach Flamingo FI they can semi-retire and wait while their nest egg compounds. Normally we assume that it takes about 10 years for someone’s Flamingo FI nest egg to turn into their FI nest egg (assuming a 7% inflation-adjusted annual return). However, Tim has made it clear that he will continue working in his current capacity in semi-retirement. This means that even if Nikki stops working completely once they have kids, they will still make around $60,000 per year and will be able to save $20,000 of that plus Super. They will consequently reach FI faster – 12 years from now and 7 years from the time they hit Flamingo FI:
Here is what this option would look like:
Alternatively, they could continue earning their current salaries for a little while longer and reach Flamingo FI in only 2 years:
This approach would allow them to downshift significantly after just 2 years. They still need to pay off the mortgage after they reach Flamingo FI in this scenario, so they would need to earn around $60,000 after tax for 3 years. After that, they could theoretically earn as little as $40,000 until they hit their FI number and work becomes completely optional.
This is what Option B would look like from an earned income perspective:
The two scenarios above are just two examples of how Tim and Nikki could reach their 5/15 year goals.
Of course, they could also keep working in their current capacity, reach full FI and have a paid-off house after 5 years. But given that both are happy to continue working part-time it is not necessary for them to “waste” 5 precious years of their lives.
Or they could look into debt recycling. I find that this is a common theme on Australian FI blogs at the moment – as soon as someone mentions wanting to pay off their home someone else will suggest debt recycling. But why put your home at risk, worry about moving interest rates and bad investment returns?
It’s not all about what makes the most sense in a spreadsheet. After all, Tim wants to know “how much is enough” and not how much he could potentially make.
Tim wants to continue working in the same capacity and Nikki will likely also work at least part-time, even if she takes a few years off when they have kids. In reality, it is very unlikely that they will ever earn as little as I assumed in the two scenarios we explored above. They likely won’t pull the FIRE trigger until later in life, so their nest egg will continue compounding for many years.
One thing I did not take into consideration in the calculations is the fact that their expenses will probably increase quite a bit once they have kids. This is a big factor if one plans to withdraw funds from a nest egg while raising kids but not a problem at all during semi-retirement when it is easy to earn little more when necessary.
If I were Tim and Nikki I would downshift a little now (Option A), pay off the house in the next 5 years and then enjoy semi-retirement. They could even supplement their semi-retirement income by withdrawing a small amount each year once they hit their FI number (to pay for their kids’ school fees for example). This way they could enjoy the best out of both worlds and once they are ready to properly retire they will have created a very, very comfortable nest egg to support them.
The future is looking bright for Tim and Nikki!
P.S.: What are your thoughts on Tim and Nikki’s situation? What would you do if you were them?
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