Alright, questions from readers! The first set of questions come from Laura:
1.) How in the world do you live on $1,500 a month? (I thought I read that you pulled $18k from your $457.)
At this point, we don’t live on $1,500 a month ($18,000 a year). Our goal this year is to live on $51,750…I’ll explain that figure later in my answer to question #4. The $18,000 figure (actually $18,375) is the amount that we are pulling from our IRA accounts using the substantially equal periodic payments (72T) provision of the tax code. We started doing this in January of 2013 and we will continue taking these withdrawals until we turn 59.5.
Let’s look at the numbers: $51,750 – $18,375 = $33,375. To get to our $51,750 figure we withdraw $33,375 from our 457 accounts. For income, we withdraw from our 457 accounts as needed; however, we will make sure that we will not surpass $52,000. When you pull from a 457 account, be aware that there is a 20% withholding required by law, so budget accordingly. We receive our IRA distributions without any taxes withheld.
2. Are you pulling principal or just interest?
At this point all of our withdrawals are from principal. Our 457 accounts are invested in fixed accounts earning 2%, and our IRA withdrawals are from money market accounts earning next to nothing. While the thought of burning principal frightens most people, my wife and I aren’t worried about this practice. Why not? First, we need to access this money for daily living expenses; this stream of income pays for our mortgage, food, utilities, etc. Second, this steam of income allows us to save most (or all) of our job related income. For example, if we take a job in 2014, we will save all of our money in 457, 403b, IRA, HSA and ESA accounts (in that order). Poof…a lot of money magically disappears into our savings…legally! Any excess money from job related income will be applied to our mortgage. We are able to pay ourselves to the extreme since we already have a stream of income that covers our expenses. (It looks like for 2013 that we will save $78,480: 457-$33,070, 403b-$24,660, IRA-$12,000, HSA-$6,450, ESA-$2,000, GA529-$300.)
3. How did you save up enough to live off of your 457? Was it over the course of your 30-year career? Or more rapid?
Our current financial situation is certainly not the result of 30 years of prudent and responsible planning. As you see from answer #2, our money is in two main accounts: IRAs and 457 accounts. Our IRAs contain most of our 403b contributions over the years. Because our 403b choices are almost always variable annuities, we roll our money over to our Vanguard IRAs as soon as we change our jobs. This allows us to access cost-effective investment choices. Because the 403b world is a minefield of fee-bloated annuity products, we sometimes have to quit our jobs to move our money. Contrary to popular belief, some winners do quit and some quitters do win.
Beginning in 2003, my wife and I have fully funded both our 403b and IRA accounts. Some years we also fully funded our 457 accounts also. Since 2003, the least we saved in a year was $30,000 and the most was $91,000. It is fair to say that we have been aggressive savers since 2003. We certainly have come a long way since 1997–the year of we got married. At ages 33 and 30, we both had $20,000 in student loans from graduate school, and our cars were kaput. Our net worth was -$40,000! Today, a mere 16 years later, we have a net worth of over $800,000 and we have qualified for our teaching pensions.
The good news is that we were able to recover from poor planning and numerous financial mistakes through sheer hardcore savings. Of course, we kept our debt and lifestyle in check as we grew our net worth. Pay raises, supplements and “found” money are not for consumption; they are for savings and investing!
Finally, we did accelerate our savings during our three years in Echols County, Georgia where we fully funded every retirement account available to us. Read all about it here.
4. If I do the same, how much can I expect to pay to the government in addition to fed income tax (like social security)? I’m trying to do a budget.
I have to confess that I hate budgeting…it scrambles my mind. What we do is limit our spending to either our “free money” or our “free money + the 10% bracket”. We determine our free money by adding the following: Standard Deduction + Personal Exemptions + Tax Credits
In our case that results in $12,200 (married S.D.) + $11,700 (3 * P.E. of $3,700) = $23,900. That means that we can earn $23,900 before we owe any federal income taxes. But wait, you also have to add in any tax credits. In our case we qualify for a $1,000 child tax credit which means that our next $10,000 of income after the $23,900 figure is also tax free since the credit cancels out the tax obligation.
Wow, that means we can earn $33,900 dollars before we owe any federal income tax. The next
$17,850 $7,850 ($17,850 – $10,000) above our “free money” is taxed at the rate of 10%, so we would owe $785 on that amount. Here are our numbers: $33,900 of free money + $7,850 of 10% tax rate = $41,750. After federal income taxes that results in $40,965 ($41,750 -$785); an effective tax rate of 1.88%…not bad!
I recommend that you first determine your “free money” based on your current tax situation. It’s always good to know how much you can earn before the government demands its cut of the act. From there, add in your 10% bracket. Since our IRA and 457 distributions are subject to federal income tax, we budget our withdrawals to meet our tax goals. As a general rule of thumb, we try to NEVER pay taxes at the 15% rate. You will need to determine how much your state income tax will be. Finally, it is my understanding that social security tax is withheld from wages or self-employment earnings, not from retirement account distributions.
This link will help you understand the concept of “free money.”
Another reader writes:
My husband and i have been talking about doing this very same thing so i was glad to find your article. but I’m very confused. We are teachers in year nine. We don’t take home but about 37k each a year. How in the world did you save so much?
In Dr. Thomas J. Stanley’s book The Millionaire Next Door, the author writes that millionaires know how to play both “offense and defense” when it comes to their personal finances. “Playing offense” means that they know how to generate income and “playing defense” means they know how to live frugally. Educators usually do not have many options to increase their earnings since they get whatever the pay scale dictates. Fortunately, we live and teach in Georgia where educators are paid for their experience AND their highest degrees. (View GA pay scale here.)
In 2006 and 2007, my wife and I both earned our Educational Specialist degrees in Administration and Supervision. Previously, we were paid at the master’s level for our M.B.A. degrees. At a minimum, we knew that we would both receive a $6,000 pay increase as soon as we earned our degrees. That means that together we earn an extra $12,000 every year just for having these degrees. In Georgia, any teacher can study their way to a $6,000 pay raise by simply earning their next degree.
In Georgia each degree (master’s, educational specialist, and doctorate) leads to a pay increase of $6,000. It is possible for two teachers with the same years of work experience to have a pay difference of $18,000 based solely on the highest degree earned differential. If your state allows you to study your way to a pay raise, jump into a cost-effective graduate school program and study until you can’t study anymore! However, DO NOT take on $50,000 of student loan debt for a $6,000 pay raise. We paid about $6,000 each for our Ed.S degrees, so after one year they had already paid for themselves.
Another way I have always played offense (generated more income) is by teaching extended day. Instead of having a planning period, I taught an extra class every year during my seven years at LaGrange High. Why did I do this? For the money! Every semester I taught extended day resulted in a 12.5% pay increase. Since I taught extended day both semesters, I received a 25% pay increase.
While the extra money was great, there is no denying that teaching extended day often made the job really tough. For example, in 2006 I taught extended day, coached basketball and cross-country, finished my Ed.S degree, and finally became a father…those were exhausting times! I remember that in 2006-2007 I earned $72,000 teaching extended day with my new Ed.S degree. It wasn’t always fun, but my wife and I made the hard work pay off by religiously saving and investing our pay increases.
You can also add to you paycheck by coaching a sport or club. If you enjoy the sport or activity, every school seems to need club advisers and assistant coaches. I highly recommend coaching for a non-monetary reason: by coaching the students will see you in a different light and you will become a “real” person in the eyes of many students. I am certain that coaching helped me become a better teacher. (But I still hated those Tuesday night away games during basketball season…coffee please!)
Thank you for your questions and a big thanks for reading my blog. I hope my answers will help someone out there to make better financial decisions. Remember, questions are always welcome.