The Secret To Retiring A MillionaireSubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on May 3rd, 2019
By Devone, McLeod, CFP®, May 3, 2019
Retirement is something that every person has to think about. And while those thoughts should generally generate excitement and anticipation, there are often times where they cause stress and anxiety – especially in terms of questions like, “Do I have enough money to retire?” or “Can I still afford to live the lifestyle that I want with just my retirement funds?”
These are valid questions, and certainly questions that require some answers. So, today we’re going to talk about retirement in two different phases, providing a realistic example of how someone with modest income can potentially retire a millionaire by starting early and remaining disciplined.
Let’s take a look at the first phase of retirement down below:
Phase 1: The Accumulation Phase
The Accumulation Phase typically begins around age 25 and lasts until whenever you plan to retire. Accumulation revolves around systematic saving and tax planning to ensure that you have ample funds to retire with by the time you reach the appropriate age. But before we get into specifics, let’s take a look at an example of how most people deal with retirement:
So, here’s a scenario I call, “The Workplace Retirement Conundrum.” “James” just recently became eligible to receive his 401k benefits. The HR department at his company sends him a welcome email and a letter to his home, along with a title summary, a plan description, and somewhere on page 15, their investment options: 11 lifecycle funds (aka target date funds), and 11 core funds. James begins to ask himself, “what does small cap blend mean?” “what about large cap value?”
What happens from there? What does James do?
As you could probably imagine, the document goes directly into the garbage.
Now, let’s actually discuss the core principles behind The Accumulation Phase. Bob Reby wrote in his book, Wealth Redefined, “the age old question of ‘how much do I need to retire?’ should be replaced with ‘what does financial independence mean to me and how do I achieve it?’”
Here at Reby Advisors, we often find that many of our clients believe that there is a single, generalized target number that every last person in the country requires to retire. However, that’s simply just not the case. The funds t hat you need to retire are completely unique to you, and depend on a number of different factors including your lifestyle, your location, taxes, spend, goals, etc.
Now, let’s bring James back into the picture again.
Let’s suppose James knew about the power of systematic saving. At 25 years old, he makes $50,000 a year and continues to do so for the next 40 years. He won’t gain a pay increase, but he won’t lose his job either. His company gives him a 10% employee contribution each year and a 6% match of his salary, for a total of $8,000 each year with a 7% rate of return, which is a standard market rate of return.
SO, due to the compounding interest of his account, if James contributes all $8,000 a year for the full 40 years, his 401k would accumulate up to $1.597 million by the time that he’s 65 years old. From an investment perspective, the power of systematic saving and compounding interest is quite clear.
Most important when saving systematically is not letting your expenses dictate your savings. Remaining consistent, persistent, and dedicating funds towards saving them first is crucial – in other words, it’s a budget item in the very front of your budget.
The Accumulation Phase Is All About Behavior Management & Tax Planning
Behavior management is the most important concept, as it relates to The Accumulation Phase of retirement. The importance of dollar cost averaging or systematic saving here is absolutely critical towards planning your retirement, especially because we have no insight into how the market is going to perform throughout this phase.
For this very reason, we recommend that our clients put money away for their retirements as if it were a bill – you pay your electric bill every month, right? If you simply paid whatever was left on your paycheck, would you have lights for the whole month? Remaining consistent throughout this phase, controlling your emotions, and staying disciplined will eventually bring you to a fruitful retirement when the time finally comes.
Now, what about the idea that contributing to your 401k saves you money come tax time; is it true or false? In reality, this is very true. Let’s bring James back into the picture again. At $50,000 a year, James is a New Jersey resident. He’s set to pay $9,378 in federal and state taxes and will end up with an income of $40,622. He chooses to invest in his 401k with a $50,000 salary, and a 10% contribution, so his income to be taxed is approximately $45,000. Essentially, James has reduced his taxable income, and now that the tax base is lower, he’s only paying $8,120 in taxes. So, by contributing $5,000 to his retirement account, his 401k, he has reduced his tax liability by $1,000.
Summing It All Up
The Accumulation Phase is the most critical phase of planning for a successful retirement. We looked at a few brief examples from our dear fictional friend, James, and saw how he was able to save over $1.5 million for his retirement between age 25 and 65, all without a single dime added to his steady pay of $50,000 a year. In addition, we saw how James was able to reduce his tax liability for a given year by contributing 10% of his salary to his 401k in that year.
So, what does it all boil down to? The Accumulation Phase is only going to be as good as you make it. In other words, it’s up to you to accumulate the funds, engage in systematic saving and tax planning best practices, build the right temperament to avoid basing your savings on your spending, and remaining disciplined throughout the course of a lifetime to treat your retirement savings as if they were simply another bill that had to be paid each and every month.
Stay tuned for the next article in this series that discusses the second phase of retirement.