Tuesday, February 15, 2011

Calculating a Sustainable Lifestyle

Like many Boomers, we realize that there is no way that the assets we have accrued and our investment income will support the retirement lifestyle we desire. We have reduced our run-rate from our big income earning days by over 50% and yet we know that the cuts aren’t deep enough to deal with the rising cost of food, rent, utilities, gasoline, and medical insurance as well as our other expenses, like college. We can only cut back our yearly expenses so much, so we have been looking for a way to calculate the minimum income we need to support the lifestyle we desire. The retirement calculators we have found focus on how fast savings will drain or how many millions of dollars of principal are needed to retire based on various interest earning settings. None of them calculate the income required to support a measurable and well defined lifestyle.

We find the logic of Michael Masterson to be a compelling way to define the income needed to support a given lifestyle. Masterson realized in his twenties that it would be impossible for him to save enough to retire on a normal salary. So, he found ways to make enough money to pay cash for expensive houses and luxury cars and ultimately was able to retire early and dedicate his time to writing short stories. But after a few years, the overhead of his lifestyle because of taxes, utilities, insurance, maintenance, clothing, furniture, and the expenses of keeping up with his neighbors could not be sustained by the huge wealth he had accrued.

According to Masterson, the value of the home determines a family’s expenses because of the pressures of neighbors, expectations, and surrounding businesses ratcheting up costs based on your neighborhood. He claims that it will cost you 40% of the value of your home every year to support the lifestyle that goes with the home and neighborhood. His calculation makes a lot of sense to us and is the first tangible method we have found to calculate the income stream we need to support our lifestyle.

We created a lifestyle calculator using Masterson’s cost of living algorithm to estimate the amount of after-tax income needed to support a lifestyle based on the value of a home.

There are several ways to use the calculator:
  1. You can use the calculator to estimate the after-tax income you need to support the lifestyle based on your home value. You can determine the value of your home by checking zillow.com or the real estate section of your local paper for houses or condos similar to yours that have recently sold in your area. Enter your Current House Value and if you have any debt payments (mortgage, credit cards, etc.), enter your total Yearly Debt payments so that they can be subtracted from your available after tax income. Leave the Yearly Income value at $0 and press CALCULATE. The calculator will display the estimated annual after-tax Income Needed to support your current lifestyle.
  2. You can also use the calculator to estimate how much house you can afford. Enter your after tax Yearly Income and then enter your total Yearly Debt payments (mortgage, credit cards, etc.) if you have any. Leave the Current House Value at $0 and press CALCULATE. The calculator will display the approximate House Value you can afford based on your after tax income.
  3. If you are a renter, you can also use the calculator to estimate the income you need to support your rental home (assuming you rent a condo or house). First determine the current price for the property you are renting (as above #1) and enter that amount as your Current House Value. Next calculate your annual rent and subtract from it the estimated annual costs that rental owner has to cover (property taxes, property insurance, maintenance or home owner fees, etc.) and enter the remaining rent costs as Yearly Debt payments. If you have other debts, then add them to the remaining rent and put that figure in the Yearly Debt payments. Leave the Yearly Income value at $0 and press CALCULATE. The calculator will display the estimated annual after-tax Income Needed to support your current rental lifestyle.

Using Masterson's calculation, a debt-free $200,000 home will cost a couple $80,000 after taxes to pay for its associated lifestyle. Even earning 10% on savings, which is rare these days, would require a nest egg of $1.6 million (taxed at about 50%) to support the lifestyle. Assuming a $24,000 annual social security income, the maximum house affordable is $60,000 and this assumes the house is paid off and that the owners have no other debts. Of the 34,326,000 retired workers currently on social security, the average monthly payout is $1,171.60 or $14,059.20 annually. An after tax income of $14,000 will support the lifestyle associated with a fully paid off home valued at $35,000 assuming no other debt payments for cars or credit cards.

Although it may seem like a strange calculation, we have used the Lifestyle Calculator for various income and house value scenarios we have had in our life and it has held true to our experience of when our lifestyle was above our income and when it was below our income. Interestingly, the amount of income we need as renters right now is also accurate to the amount we are actually spending and it even takes into consideration the reduction in the value of the condo unit since it was last sold based on current listings.

It is clearer to us how our home’s value and the neighborhood in which we choose to live determines the income stream we need to sustain our lifestyle.


Unknown said...


Thanks for discussing an important topic about calculating a sustainable lifestyle that we ignore many times. But we should always have an idea about income required to support a measurable and well defined lifestyle.

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Bobster0007 said...

I would like to be able to live there someday regardless of the challenges. Im sure the costs will be a well worth it.air

Matt said...

You should check out www.mrmoneymustache.com for some ideas on how to live a great retirement with far less spending. The auther managed to retire at 30 using his method so it has some real world testing. Even if you can't be as frugal as the stash I think it's worth a read.

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