A common myth is that house equity is required in order for a low-to-middle-income person to become financially independent and retire early. Read below to find out how those living on modest incomes and in rented dwellings can follow some simple guidelines to achieve financial independence.
The below guide applies to a couple both working toward the early retirement. Note that if any children are brought into the picture, an extra $4,000 per year (or $1.90 per hour fulltime for 52 weeks) per child is required in order to maintain adherence to this guide toward early retirement[1]. This number does not include college. However, a prepaid college account can be established for each child for a fraction of actual college costs.
Why is it easier to save money renting than buying a home?
Home ownership has a multitude of expenses over renting, such as maintenance, repairs, property taxes, assessments, higher utility costs, and the list goes on. By the time the average home buyer pays off his mortgage, he has paid for the house two or three times because of accumulated interest on the mortgage, according to mortgage rates before the U.S. economy fell in 2008[2]. Renting an apartment in a multi-unit building can provide the building owner with property-tax advantages. Separate dwellings would be taxed many times that of the single building[3]. All building-related costs (i.e., new roof, maintenance) are shared by everyone in the apartment complex[3]. Unless one lives in an exclusive area, rent payments are often less than mortgage payments.
How can one achieve financial independence while renting, and living on a low-to-middle income?
Readers, put yourself in the shoes of the example persons used herein, and you can accomplish the same success. Thirty years ago, “Charlie” and his wife, both at age 30, bought a $125,000 home on a fixed 6%, 30-year mortgage loan. After 30 years, they actually paid $269,640 because of interest[2]. In addition, they had $13,300 in annual home-related expenses (current dollars, $4,265 thirty years ago[4]) as follows (in current dollars): $5,000 in property taxes, $2,000 insurance, $1,000 for lawn maintenance, $1,800 in utilities, and an average cost of $3,500 annually in home maintenance and repairs which includes the average cost of replacing the roof, furnace, carpeting, and appliances during the 30-year mortgage period. At the end of 30 years, Charlie and his wife paid out $517,241 for their home and its related expenses. This comes out to $1,437 every single month for 30 years.
Had they rented instead, for $1,000 per month (current dollars, $321 thirty years ago[4]) during the 30 years, it would have cost them $216,039, a savings of $301,202 by renting in lieu of owning, or $837 per month for 30 years. If someone had invested that same monthly savings of $837 in a 6%-minimum-yield indexed annuity with monthly compounded interest, they would have a cash mountain of $905,474 after 30 years! [5]
The lower cost of renting would have allowed Charlie and his wife to build up a savings. Let’s say that 30 years ago both Charlie and his wife held 40-hour-per-week jobs making an hourly wage of $4.50[6]. Their combined annual income at that time was $18,720, or $1,560 each month. The lower tax-base 30 years ago left them with $1,404 in take-home pay each month[7]. Thirty years ago, their current-dollar $1,000 per month apartment was only $321[4]. Thus, after paying their rent, average 2 car payments, groceries, average apartment utilities, and average miscellaneous expenses, Charlie and his wife would have had $904 each month left over as uncommitted spending cash.
If they would have put $475 per month (incrementing the monthly contributions by $50 each year) into an indexed annuity that paid a very conservative 6% annually (with monthly compounding interest), then after 30 years they would have had over one million dollars ($1,024,181) in cash[5] which would have provided them with annual interest (6%) earnings of $61,347, which was more than their combined gross wages! Two years later at (62), now qualifying for early Social Security earnings, their annual income would have risen to $89,347[8].
Instead of settling for a static income that never increases (except for Social Security), they could live on 4.75%, or $48,650, and re-invest the remaining 1.25%, making no further monthly wage-earned contributions to their savings. Not counting any Social Security earnings, their annual interest earnings would increase to $68,746 by age 65; $77,867 by 70; $88,198 by 75, and $145,170 by age 90. Social Security would be an additional $28,000 to $32,000. Essentially, their savings would approximately double every 25 years, helping to offset the cost of living.
However, if they decided to retire after 20 years of saving (age 50), then instead of $61,347 each year, they would make $24,490 from their 6% annuity. And if they wanted to retire after 15 years of investing (age 45), they would make $13,882 annually, not a huge amount. [5]
Retiring early with a more comfortable lifestyle, after 20 to 30 years would have required starting at a more aggressive, but possible, monthly contribution of $750 from the $904 after-taxes-and-expenses (spending cash) they had to play with. Any children added to this picture would have necessitated an additional $1.90 per hour earnings (or 95 cents per hour, per person)[1]. Starting at $750 per month, using the same investment plan as above, they would have been able to retire to part-time at age 40 with about $10,000 per year, or at 45 with $18,830 and a nest egg of $313,834, or at 50, with $538,178 with annual interest earnings of $32,291. Waiting to retire until age 60 would have provided them with a cash reserve of $1,309,163, yielding a 6% annual earnings of $78,550. [5]
If they opted to live on 4.75% of their total cash instead of 6%, re-investing that 1.25% would cause their savings to double approximately every 25 years, helping to offset inflation. Thus, starting monthly contributions of $750 thirty years ago, by the time they are 45 (in 15 years), they would have an annual interest-income of $14,907, and at 50 an annual living of $25,563, which would continually increase due to the re-investment of 1.25% annually. [5]
Here is the big question: After early retirement, could they still afford to buy land, build a home, and pay for medical insurance? The answer is YES. Let’s assume they retired at age 50 on $25,563 per year.
Yes, one can buy land, build a new home, and live well on annual earnings of $25,563 (which continuously grows). Here’s how:
The best place for a retiree to buy land and build a home is southeastern South Dakota (outside of Sioux Falls) where land is cheap, personal income tax is zero, and the cost of living is lower than that of most of the U.S[9]. Land can be purchased for $399 to $2,500 an acre, depending on how developed it is[10]. Wooded land would provide free firewood. A 16 by 24-foot cabin with a 3/4 loft and a prairie-style porch can be built, new, for $14,000 such as the one in the above photo by Weaver Storage Barns in Sugarcreek, Ohio[11] or a similar company in South Dakota. Another $9,000 would be required to finish the interior with insulation, walls, plumbing, and electrical (no carpeting-wooden floors). Add 5 acres of mostly-wooded land for $2,500[10]. Monthly payments on the $25,500 loan required to pay for the cabin and land would be $252 monthly for 10 years, with a 3.5% interest rate, which is possible at the time of this writing (2011)[12]. If it is necessary to drill a water well and build a septic system, then the loan amount would need to increase to $35,500[13], and monthly payments would be $351 for 10 years.
How can a couple pay for medical insurance on $25,563 per year?
A private, personal medical insurance plan does not have to be expensive, contrary to popular belief. Medical insurance (catastrophic) can be bought for $240 per month (family rate) from GoldenRule.com, a United Healthcare provider. [14] Adherence to the healthy-living guidelines at www.WellBeyond100.com/HeartDisease.aspx slash the possibility of actually having to use the medical insurance to about 1/50[15].
Bottom line: after paying taxes and all common, average living expenses out of an annual income of $25,563, how much is actually left to live on?
Here’s the encouraging news. At 50, earning an interest income of $25,563 annually (which will double in 25 years)[5], monthly loan payments of $351 for land, water well, septic, and a home are a piece of cake. Total taxes and expenses for living in southeastern South Dakota are as follows: federal tax costs ($2,975[7)], zero state and city taxes, property taxes ($562)[16], health insurance at $2,880 per year[14], average utility cost for a 16 x 24 cabin with wood stove ($660), average car payment ($4,679), and food/clothing cost ($3,000, includes once-per-week restaurant dining). Thus, total annual expenses sum to $14,752. Subtract that from the early-retirement income of $25,563 per year, and the result is an extra $10,811 per year ($901 per month) in uncommitted spending cash after all taxes and obligations have been paid for.
After 4 years, at 54 years of age, the car payment goes away, bumping up the monthly amount of uncommitted spending cash by $390, to a total of $1,291 in uncommitted spending money.
More good news: Their annual interest earnings of $25,563 have increased by $1,310, to $26,873, due to the 1.25% annually-continuous growth (compounded monthly), bringing them up to $1,400 in uncommitted monthly spending cash. However, a “car and home repair/maintenance fund” of $400 per month should be started at this point.
After 10 years of retirement, at age 60, the 10-year home loan is paid off, freeing up another $351 per month.
Even more good news: at the 10-year-retirement mark, at age 60, their annual interest earnings have increased to $28,965 from the original $25,563 on which they had begun their retirement, due to the 1.25% annual continuous growth of their savings (compounded monthly), which has now climbed to $609,797. Monthly uncommitted spending money has now grown to $1,574 (minus the recommended $400 being put away for repairs, maintenance, and a future new car).
After 10 years, with all loans paid off, Charlie and his wife have nearly $19,000 per year in uncommitted spending cash, after taxes, medical insurance, and all living expenses have been paid.
And yet more good news! In 2 more years, at 62, they both qualify for early Social Security benefits, adding a minimum amount of $28,000 to their annual earnings[8].
Thus, at 62, they are now living on an annual income of $56,965, with an amazing amount of monthly uncommitted spending money: $3,907, or $46,884 per year. At this point, they could opt to sink more of their income into their capital savings (now at $625,226), or simply spend it as desired.
This is financial independence. Financial independence is not just for the wealthy. Anyone with perseverance who is able and willing to work can do it.
Sources:
[1] Funds needed to raise a child: New York Times, August 5, 2009
[2] Mortgage tables: www.CreditFederal.com/mortgage-calculator.html
[3] Wikipedia capitalization rates: en.wikipedia.org/wiki/Capitalization_rate
[4] Current-day dollar comparison: www.measuringworth.com/uscompare/
[5] Compound interest calculator: www.MoneyChimp.com
[6] Min. wage tables: www.infoplease.com/ipa/A0774473.html
[7] Federal tax rates in 1981: www.cbo.gov/publications/collections/tax/2009/effective_rates.pdf
[8] US Social Sec. Administration: www.socialsecurity.gov
[9] S. Dakota Dept. of Revenue: www.state.sd.us/drr2/
[10] Cost of land in S. Dakota: www.cheaplandinamerica.com
[11] Weaver Storage Barns, Sugarcreek, OH: www.WeaverBarns.com
[12] 2011 mortgage interest rates: www.lowermybills.com
[13] Well and septic installation: www.yelp.com/biz/j-miller-and-son-excavating-berlin
[14] Medical insurance rates: www.GoldenRule.com
[15] Healthy Living: www.WellBeyond100.com/HeartDisease.aspx
[16] Property tax rates: http://www2.brandonsd.mb.ca/crocus/wp-content/uploads/2011/09/Sr4-Math-Guide-07-Municipal-Government-Finance.pdf