Have you received a pay raise, bonus or an inheritance and as a result changed your spending habits? Have you bought things such as expensive items, cars or even a new home because of one of these events? Soon, your lifestyle starts to inflate or creep to where your standard of living resets at this new higher income level. Spending can quickly become unsustainable if your income doesn’t stay at the same pace and continue to rise. Importantly, you’ll need to save substantially more now to continue that lifestyle in retirement than originally planned. From experience, most families continue at near the same spending level if not more in retirement, especially when grandchildren enter the picture!
There isn’t any harm with spending more money if you make more, however you need to also increase your savings for important goals at the same level. For example, if your income is now $250,000 or above, you’ll need to save quite a bit more than the $19,000 401(k) contribution to maintain your lifestyle when you decide to retire. These savings targets increase much more if you want to “make work optional” at an earlier age.
It’s inevitable that your income will rise as you progress through your career, however there are good habits to follow to prepare for the future while still enjoying the “now”:
Prepare and follow a budget
No matter your income level, having a household budget is key to achieving your goals. It allows you to put all your income and expenses on one sheet of paper to determine how much savings you can automate each month. Many households are cash flow “rich” thereby they are best served by figuring out monthly savings targets. This article discusses a budget technique that can be used as a template for your budgeting. It’s especially important to have a cash flow plan for families where cash bonuses and restricted stock make up a large portion of their annual income.
Develop and adhere to a pre-determined plan for extra income
If you receive a bonus, you should have a pre-determined savings allocation for those extra resources. This meaning that of the bonus that you receive after-tax, possibly 25% is allocated to spending (i.e. the fun stuff), 25% to travel and short-term savings, and 50% to long-term savings. That way, you get to spend and enjoy a large portion of your bonus while also saving a large sum towards the future. Too often do people receive a bonus and quickly spend it. Having a pre-determined plan or formula for how to allocate these excess dollars is important as your budget won’t account for this income.
Routinely update your retirement projections
Your financial plan needs to be updated each time your spending level increases as the plan is not going to be successful if it is based on $100,000 of annual spending in retirement when your lifestyle now requires $200,000 a year. Many households attempt to exclude child costs from this figure as they won’t have dependents in retirement, however experience has taught that the spending has been replaced by spending on trips and supporting children and grandchildren.
We suggest reading the book Making Work Optional: Steps to Financial Freedom to learn about how best to prioritize your savings to achieve your long-term goals. Importantly, make sure to read the section about “mistakes to avoid” on your path to financial freedom.
Please contact Merriman if you have any questions about developing a cash flow plan or for any of your other financial planning needs.
If you work at a company like Facebook, Amazon or Microsoft, a large portion of your total income is probably made up of restricted stock units (RSUs). After tackling your savings goals, there might not be a lot left over in your paycheck, so you may be asking yourself the following question:
How do I use my RSUs for income and spending?
At Merriman, we take our clients through a discovery process to learn about goals and lifestyle. Through that process we often discover total income may be made up of more than just a salary. To ensure our clients are hitting all their savings goals for early retirement, vacations and higher education, we need to create a plan for how to use multiple sources of income. For example, we may need to figure out what to do with RSUs, how to effectively use an employee stock purchase plan (ESPP) and how to invest annual bonuses. Mapping out a month-by-month plan helps our clients get organized and feel confident they’re taking the right steps toward saving enough and achieving their goals. Having this peace of mind allows guilt-free spending with the money that’s left over each month.
I recently met with a couple, Scott and Julie, who needed help creating a plan for their monthly cash-flow needs. At first, putting together a monthly budget seemed simple enough, but for Scott and Julie, it became clear it would be more complex because of their different income options. We had to figure out what to do with their income from salary, when to sell RSUs and how to take advantage of their company’s ESPP.
To create a plan that balanced their income vs. expenses, we took a three-step approach.
Step 1: Optimize savings options.
Each contributes $19,000 per year to their 401(k).
Each contributes to their ESPP to take advantage of the discounted share price.
Each makes contributions into their after-tax 401(k) so they can take advantage of the Mega Backdoor Roth. (Note: This is not available at all companies.)
They contribute monthly to a 529 college savings plan for their two kids.
Step 2: Calculate what the income gap is each month.
After they meet their savings goals, pay their taxes and take care of other miscellaneous payroll items, their monthly income from their paychecks equals $10,000.
Their monthly expenses are -$15,000, so this leaves them with a monthly deficit of -$5,000.
Step 3: Sell RSUs and ESPP shares to supplement income.
Below is a spreadsheet that shows a month-by-month cash-flow plan for their “spending bucket,” which is their checking account. Notice we first filled the bucket with $50,000. This initial $50,000 came from the sale of some of their RSUs. At the beginning of each month, you can see the starting amount gradually go down. We refill the bucket every quarter by liquidating more RSUs, and then every six months we sell shares in their ESPP.
We never want the bucket to go to $0, so we make sure there’s a buffer every month. Also, it’s important to note that this spreadsheet does not show what we’re doing with their annual bonuses or remaining RSUs. Without going into too much detail, those excess income amounts could be saved or used for guilt-free spending.
Income from paychecks continue to fill the bucket, and when the amount gets low we refill their spending bucket using the proceeds from selling their RSUs and shares in their ESPP.
Because they’re on track to hit all their savings goals, they can put their annual bonus in their “live fully” bucket and use it for dining out, vacations and other guilt-free spending.
Each year we’ll review how the actual cash flow went. If it turns out spending was a little higher, then we’ll adjust how much of their RSU proceeds are used for cost of living needs. If they spend less than we anticipated, we’ll instead invest more of their RSUs.
The complicated budgeting that we helped Scott and Julie put together is something we’re doing more and more for clients who work in tech. Here at Merriman, we get it. While working 50+ hours a week, it’s tough to find time to ensure you’re efficiently saving in all the right ways. It’s our job to help you keep your financial plan on track and so you can enjoy your life. In other words, our goal is to help you Invest Wisely and Live Fully. Feel free to contact us if you’d like to learn more about how to implement a customized cash-flow strategy that fits your compensation plan.
In this article, we discuss the Smiths’ and the Jones’ different lifestyle spending needs, and the annual savings necessary to maintain their lifestyle in retirement. Let’s walk through the steps these families should take each year to help them stay on track to achieve their goals.
1. Determine the cost of your annual lifestyle spending needs, and how much of that will continue into retirement.
Smiths – They currently earn $150,000 a year. After excluding retirement savings and expenses that wouldn’t continue into retirement, such as the cost of commuting to work, they determine that their annual spending is $90,000.
Joneses – They currently earn $500,000 a year. After backing out retirement savings and expenses that wouldn’t continue into retirement, this couple finds their annual spending is $250,000. This higher spending need is in part due to living in an expensive city and having a mortgage on their home and vacation property. About 10 years ago, this couple’s income was $175,000, with spending needs of $115,000.
Take-away: To determine your lifestyle spending needs, you need to exclude retirement savings and expenses that wouldn’t continue into retirement. Expenses that remain include utilities, taxes, food, entertainment, travel, etc. Many households carry a mortgage for the first 10-15 years into retirement. If you don’t think you’ll pay off your mortgage by the time you retire, make sure to include this housing cost in your spending estimate. You need to be aware of how much your lifestyle spending changes over time to make sure it’s sustainable in retirement. It’s far easier to spend more money than to cut back on your lifestyle. (more…)
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