My, How the Little Things Add Up

In a number of prior posts I’ve discussed some ideas for making your retirement savings go further. For the most part, each idea is a modestly good idea, but taken together, they can add up to a great idea. Huge! And that’s today’s task—to put it all together with an example. The results are amazing and heartening.

Consider Wally Cleaver. He’s grown up now. In fact, he’s age 40, with a family and everything. To date, Wally has saved $50,000 in a taxable investment account. Wally has analyzed his many savings options. He thinks of them as creating many different futures—Wally Worlds, if you will. Wally projects how much each additional good idea, layered on top of the others, will add to his annual after-tax retirement spending. All of his projections are shown in real, inflation-adjusted dollars, to keep them meaningful. And all in after-tax dollars, as well, because you can't spend money that goes to the government. The assumptions that went into Wally’s projections are shown in the chart below.

Wally World One. $6,320 per year.
Wally does nothing special and continues to invest his existing savings in an ordinary taxable investment account. He projects that his $50,000 of savings will eventually, at age 65, buy him a retirement of $6,320 per year. A nice start.

Wally World Two. $7,268 per year.
Wally decides to do the hard thing—to forego some spending this year and add $7,500 to his investment account. (In fact, he postpones a planned cross-country trip with his wife and kids to a Disney-esque amusement park.) Giving up some luxuries hurts, but it adds $948 to his annual retirement spending. That’s after-tax and expressed in today’s dollars. Foregoing the pleasures of consumption is the hard part. It gets easier from here.

Wally World Three. $7,950 per year.
Instead of adding $7,500 to his taxable investment account, Wally makes a $10,000 pre-tax elective deferral to his employer’s 401(k) plan. It costs him the same $7,500 as in Wally World Two because he is in the 25% tax bracket. Just by contributing his savings to the right bucket, Wally has increased his future after-tax retirement spending by another $652 per year. Way to go, Wally!

Wally World Four. $8,398 per year.
Wally increases his 401(k) deferral to the maximum $16,500. But he doesn’t decrease his spending by more than the $7,500 of Wally World Two. Rather, as described in February 8’s post, he spends $4,875 from his taxable savings account (shrinking it to $45,125). Because of the tax deduction, it only costs him $4,875 to increase his 401(k) deferral by $6,500. And doing this adds $448 to his retirement spending. Here’s something worth noting: The last two steps combined added more to Wally’s projected retirement spending than did his painful and heroic effort to save $7,500. And they didn’t require any further spending reductions! Oh, happy day! But wait; there’s more!

Wally World Five. $8,722 per year.
Wally has read January 15’s post and decides to make the $16,500 deferral on a Roth basis. The loss of a deduction costs him $4,125 of additional taxes (further reducing his investment account to $41,000). But it has a long-run tax benefit, which increases his projected after-tax retirement spending by an additional $324. Hey. Why not?

Wally World Six. $8,919 per year.
After reading February 15’s post, Wally decides to take another $5,000 out of his investment account (reducing it to $36,000), and use it to open a $5,000 IRA. He has read February 14’s post and has concluded that the contribution won’t be deductible to him, but he finds it to be a worthwhile step nonetheless. In fact, he projects it will add another $197 to his annual retirement spending. And, again, without breaking a sweat.

Wally World Seven. $9,217 per year.
Wally decides to expend some effort to lower his investment costs for his (now three) savings buckets, as described in yesterday’s post. He finds he is able to shave his expenses by a modest 0.1% (10 basis points, in investment world jargon). Wally projects that this modest savings will increase his after-tax retirement spending by another $298 per year. Not a huge amount, but he’ll take it.

Wally World Eight. $9,630 per year.
Wally has read February 12’s post, and decides to do some future spigot planning. When he gets to retirement, instead of spending down his three savings buckets proportionately (as was assumed in prior Worlds), he plans to spend them down in the order that will optimize his annual after-tax spending. He projects that doing this will increase his after-tax spending by another $413. It’s money for nothin’!

Wally World Nine. $10,636 per year.
Wally decides to go further and engage in asset location planning (after reading February 13’s post). He projects that by cleverly allocating his stocks and bonds among his three savings buckets he can increase his retirement spending by another $1,006 per year compared to investing his three savings buckets in the same stock/bond proportion. Cool!

Wally World Ten. $10,967 per year.
What! Yet another world? Yes. Wally has read February 10’s post, and, seeing that he has adjusted gross income of less than $100,000, he realizes he can convert his new $5,000 traditional IRA to a Roth IRA. (And in Wally’s unusual situation, he pays no income tax to do so. The value of his IRA is equal to his after-tax contributions, and he only has to pay income tax on the difference, which is zero.) He projects that this step will increase his retirement spending by another $331. Free money!

Now just look at the aggregate results. Struggling to save $7,500 added $948 per year to Wally’s future retirement security. But just being clever about how he arranges his savings, adds even more: another $3,698. That’s a four-fold increase! Who knew?!