You have probably heard about the 80/20 rule before. If you work or have previously worked in a sales organization you might hear that 80% of the sales are generated by 20% of the sales people. In everyday life, you may have heard that 80% of your income goes for 20% of the things you purchase. For example, maybe your house payment and your groceries take about 80% of your pay. And then you get to figure out how to allocate the other 20% of your take home pay for all of the things you need. According to statistics, 80% of the IRS taxes come from 20% of the tax paying people in the United States.
When it comes to retiring early, one of the biggest challenges you face is reallocating the 80/20 rule so that 20% of your income goes to 80% of what you need. If you think of it in those terms, it comes down to a cartoon I saw 20 years ago in the Wall Street Journal where two guys are walking down the street and one says, “I’ve been looking at my nest egg and have come to the conclusion that I either need a smaller nest or a bigger egg.”
So how much do you put aside for retirement? It depends. It depends upon how old you are – are you in your 20s or in your 40s or in your 50s? It depends upon how much you earn. It depends on your job and if you are a professional or if you are a technician or if you are a blue collar worker.
For the sake of example, let’s say you are single, you’re 40, and have some sort of technical job like an Registered Nurse (RN) or Licensed Practical Nurse (LPN) or maybe you work in Information Technology as a server administrator or programmer. For this example, I am going to assume that your place of work does not offer a retirement plan such as a penion or 401k retirement plan. If your workplace offers these retirement plans, so much the better. But let’s assume that your place of employment does not.
People in these jobs make between $30,000 and $75,000. I will assume you make $30,000. If you make $30,000 you will pay 15% in Federal tax. Depending on your state, you might pay no state tax like people who live in Alaska or you might pay 9% like people who live in Oregon. Let’s split the difference and make your state tax 4.5% and using rounding we’ll say your total tax bill is 20%. We are going to assume that the city where you live does not charge a city income tax.
So after taxes, your net is $24,000 which is $30,000 x 80%. That works out to a net income of $2,000 a month. Using our 80/20 rule, you will spend $1600 a month on housing, groceries, and maybe a car payment or since you are single, maybe it includes a date or two out each month. This leaves you with $400 a month for other stuff like medical insurance, saving for a rainy day or your annual vacation, clothes, and maybe some for your retirement.
In this example, if you could save $200 a month for your retirement, it would be $2400 a year. It doesn’t sound like much – but wait! If we use compound interest at 10%, starting with $200 and adding $200 each month, our totals by each year would look like this:
1 : 2734.05
2 : 5533.46
3 : 8626.00
4 : 12042.36
5 : 15816.47
6 : 19985.78
7 : 24591.66
8 : 29679.85
9 : 35300.83
10 : 41510.40
11 : 48370.19
12 : 55948.30
13 : 64319.93
14 : 73568.18
15 : 83784.85
16 : 95071.33
17 : 107539.66
18 : 121313.58
19 : 136529.81
20 : 153339.38
(It’s fun to play with the numbers here:
http://www.math.com/students/calculators/source/compound.htm)
The purpose of this exercise is to show that even starting at age 40 and with only $200 a month, you can reach $153,000 by the time you are 60. Is that enough for you to retire early? I don’t know your particular situation. Everyone is unique. But the sooner you start the better off you will be.
The next thing to take a look at is how to set aside money each month into a plan. We’ll cover that soon. Leave me a comment if you would like more inforation.
Jeremiah John
TER