How to retire early & rich
Our resident pension doctor Ian Mitchell shows you how to get out of the rat race with some cheese to spare
“I’M TIRED of the rat race and I want to get out as soon as possible.”
It’s a refrain I’m beginning to hear regularly these days. Maybe the strain of becoming a leading European economy has taken too much out of us. There’s normally a follow-up line: “I just can’t see myself turning up at work when I’m sixty five. There’s other stuff I want to do with my life, other aspirations.”
These aspirations are at the heart of what most of us mean when we talk about retiring early. They’re borne of the successes of the tiger generation - those of us who skated up Abraham Maslow’s ‘hierarchy of needs’ without passing ‘go’. Whatever our view of retirement, there’s one thing we all have in common - we don’t mean what our parents meant when we use the word.
Back in pre-boom Ireland you considered yourself fortunate to have a job. It let you earn enough to put food on the table in the house that, if you were very lucky you, might actually own. And you wanted to hang onto that job for as long as you possibly could, because you weren’t terribly confident about what came next. Maslow called that the need for safety; a preoccupation with secure employment and housing, and with keeping it all together. Whether people thought about it that way or not, retirement never became an issue for anyone but the very rich.
But now we all have aspirations, which boil down to two things for many people I advise: to do something other than what they’re doing now, and to do it more quickly than they previously intended. The first thing I tell them is that achieving these goals requires planning.
Back in the days when we were aspiring to live within Maslow’s safety zone, we wanted to keep doing the same thing for as long as possible. So, when pension schemes were first introduced, 65 was selected as the age for retirement because the average life expectancy of a male was 66. The plan was that the more generous employers would provide their staff with one year’s well-earned rest, sandwiched on a fully- funded basis between the shop floor and the afterlife. The boss himself might plan to retire at age 60, allowing for six years of feckless pleasure before the grim reaper came to call. A few hardy souls might defy the odds and survive into their eighth decade, but not enough to trouble the bean counters who fixed the premiums. And so, the required funding rate for the pension scheme wasn’t particularly high. The same actuarial reasoning applied to the State Pension, formulated so people made enough PRSI payments to fund a moderate income for about five years - unless people were truly fortunate.
“Now we all have aspirations, which boil down to two things for most: to do something other than what we’re doing now, and to do it more quickly than we previously intended. The first thing I tell people is that achieving these goals requires planning.”
Since then, of course, two things have happened. First of all, life expectancy has increased, and we all have an idea that we might live beyond 80. And so we might. 84 is now the average male life expectancy, with females expecting to enjoy at least three more Irish summers after the ‘auld fella has passed away. ’
The second major evolution in ‘retirement thinking’ is the notion that it might be fun. The Baby Boomers have experienced the mind-altering power of the Tiger and are now pursuing ‘self- actualisation’. Maslow defines this as having a need to experience creativity, spontaneity and problem-solving. For pension consultants, it’s a hell of a problem to solve.
“This,” you might say, “is all interesting stuff, and I’m sure you’re an erudite pension man and all that, but I don’t want a lecture on why I’m up for quitting the rat race. I just want to know how to do it. Especially as my pension fund has dropped through the floor recently. I want to be out long before I’m sixty five.”
Well the first piece of good news is that it’s not as difficult as you think it might be. You just need to organise a few essential elements of your life into a cohesive plan, and then make sure you stick to it.
LOOK AT WHAT YOU HAVE
Examine closely the provisions you already have in place. By this, I mean that you should look closely at the early retirement regulations in your pension scheme and seek to clarify these with your employer and scheme trustees. This is particularly important if you’re a member of a ‘defined benefit’ occupational pension scheme. In one case, I recently dealt with a woman who wanted to retire two years early at age 63. She was quoted a figure that would bring her post-retirement income down from the ample €63,000 per year that she would have received at age 65 to a mere €22,500.
Fortunately, the trustees of the scheme proved to have a generous nature, and the scheme itself was well-funded, so an acceptable compromise was negotiated. It is, however, much wiser to investigate this fully when you’re formulating your plan.
Also, don’t forget to factor in the State Pension provision, which is now actually quite a significant factor in post-retirement income planning.
SET A DATE
First you need to choose your retirement date and make it a key life target. If you’re
unsure about this target, then you’re probably not going to achieve your goal. Practically speaking, it’s better if you plan your retirement from at least fifteen years out, but you can achieve your goal in ten if you’re determined. If you’re reading this article and you’re over 50, then ‘retiring early’ probably means knocking a year or maybe two at best off the expected age of 65 unless you’re extremely single-minded.
DEFINE ‘RETIRE’
Next, you define what ‘retirement’ means to you. If your retirement plans consist of sitting at home taking it easy, or playing golf in Spain, you’ll need to take a little longer to achieve your goal than if you’d simply like to trade the day job for two or three days of paid work per week. Because many of us will live until we are over 90 years old, an aspiration to ‘retire’ at 55 would mean that we may have only 35 years or so of working to provide enough extra income to survive for an equal period of time. That’s quite an ask, and many people will simply be unable to meet the saving demands necessary to achieve this - quite apart from the fact that we may long to do something in the workforce rather than pottering about the place for decades. ‘Retirement’, and particularly ‘early retirement’, may simply mean a change, rather than a total cessation, in our work.
DO THE MATH
Set a clear budget to achieve your goal. How much more income will you need to save in order to take an early retirement? The good news is that it may not be as much as you think. Let’s take as an example Alan and Deirdre, a couple in their early 40s earning €120,000 per annum between them. They are both in occupational pension schemes which, at age 55, would provide them with a joint income of €28,000 each year in today’s money. However, if they worked until 65, this would rise to €45,000, and they would also receive joint state provision of around €21,000 - again in today’s money, as they are both in full-time employment. Additionally, their spending needs would be significantly lower at 65 as their mortgage costs (currently €25,000 per annum including mortgage protection insurance), pension premiums (currently €7,500 per annum net of tax relief),
and travel costs for work (currently €1 ,500 per annum) would no longer need to be paid. Add to that the fact that their children should be up and self- sufficient by then (saving them, they calculate, around €18,000 per annum) and they are projecting a pre-tax reduction in their outgoings of around €63,500. Thus, they would be comfortable on the total pension income of around €66,000 that they expect to receive at age 65.
But they are determined to retire when Alan is 55. On a Paris mini-break last spring, they had an epiphany. “Let’s change our lives,” they said. “We need to get out of the rat race early.” The target for Alan and Deirdre is straightforward enough. They need to clear off their outstanding mortgage of €350,000 by age 55 to reduce their expenditure by €25,000 per annum and build up a pension fund capable of generating an extra €17,000 a year at age 65. Oh, and they’ll need to put themselves in a position to generate around €40,000 each year in the 10 years between retiring at 55 and drawing this extra €17,000 (plus their State Pensions) at 65. To achieve this, they need to do two things. Firstly, they have to put an additional €400,000 or so in their pension fund. They also need to increase their mortgage payment by roughly €700 per month (€8,500 a year net of tax) in order to knock seven years off their mortgage term to clear it by Alan’s 55th birthday.
Aside from this, they should try to save enough to create a significant ‘parachute fund’ to ensure they have the wherewithal to survive any financial emergency that may arise after retirement. In our first discussions, we agreed on a figure of €200,000. And so the budget goals were set.
PLAN TO HIT THE TARGET
Next, work on a plan to achieve the goals. After several meetings with their pension adviser, plenty of plan redrafts and a few late night arguments, Alan and Deirdre agreed on the following steps:
They would increase their mortgage payments by €700 per month immediately, and fix the rate of interest for five years. This allows them to budget accurately for mortgage costs and ensure that the loan is paid off when Alan is 55. In order to find the money Alan decided that he would sell his car and use a bicycle to go to and from work. This saved the couple around €400 per month on car payments, tax and insurance, and another €75 per month on Alan’s gym membership! He wasn’t going there much anyway, and the cycling will be much better for him.
They also pledged to boost their Additional Voluntary Contributions (AVC) into their company pension schemes as far as possible. These AVC payments qualify for tax relief at an individual’s marginal rate. This means that putting away €10,000 only costs Alan and Deirdre €5,700, as both are in the 41 per cent tax band and will also save on the two per cent health levy. At their age, they could contribute up to 25 per cent of their salary, minus the €7,500 annual contributions they are required to make into their company pension schemes. The total annual cost of this works out at €9,600 after tax, which results in roughly €16,800 going into their AVC fund every year. This money, if indexed to inflation, would produce an additional fund of around €350,000 at age 55, assuming an annual growth of four per cent (the average pension fund growth for the last 10 years). If it’s left invested, the stash would grow to around €450,000 by age 65. Alan and Deirdre, though, felt that this was too high a figure for them to find. After much discussion, they settled on saving an additional €5,000 after tax each year, targeting a figure of around €170,000 at age 55, which would grow to around €225,000 by age 65. They are going to reduce their spending on holidays by half to make this payment affordable.
Realising that even this huge additional financial input of around €1, 120 per month into retirement preparation will leave them more than €325,000 shy of their target, Alan & Deirdre began to reassess their living situation. Their house is currently worth around €1,100,000 and is suitable for their current needs. But they do know that, in later life, they could release equity from it - either by moving from Clontarf to purchase a similar property outside Dublin, or by moving to a smaller property within Clontarf. Currently, they disagree over which option to take, with Deirdre favouring a move back to her roots in West Cork. However, they have thirteen years to reach a compromise.
Only two other issues need to be dealt with. One is the small matter of ensuring that their fund is immune from the vagaries of an increasingly unstable worldwide financial market as they pursue their goal. Alan and Deirdre are prepared to pay a big short- term lifestyle price to achieve their long-term objective, so they don’t want some over - ambitious fund manager screwing things up on them. After much debate, they decided to work with a fee-based pension adviser (rather than one receiving a commission) and to adopt a highly cautious investment approach. Their adviser is providing them with regular information regarding fund performance though, for the moment, they are investing their pension contributions in a cash fund until markets settle.
The last remaining issue was working out how to fund an annual income of €40,000 in the years between their early ‘retirement’ and 65, when their pensions kick in. Already they have plans. Deirdre is hoping to take a course in teaching English as a foreign language, while Alan is hoping to hone his IT skills to the point where he can offer part-time consultancy to his current employer. Both would be prepared to work for up to 10 hours per week in retirement and feel that this would give them ample opportunity to earn the €40,000 they will need.
STICKING TO THE PLAN
Of course making the plan is one thing. Sticking to it is another. As you’ve probably seen from the case study, big lifestyle changes are required to achieve the ‘self-actualisation’ dream. There’ll be cold wet days some November, for example, when Alan regrets selling his car! But if we’re on a fixed or limited income, then we have to take radical steps if we have a vision for quitting the rat race. And a good pension adviser will prove invaluable. You’ll need her or him to make the calculations for you on a regular basis (every six months is a good rule of thumb) just to ensure that there are no nasty surprises on the journey. Best of luck!
Published in: You & Your Money, May 2008