Financial Planning When You Rent

Retirement Savings Needs of Renters -- prior to any financial planning improvements

Fran and Fred Frugal, both age 30, are a married working couple with $100,000 in combined annual earned income. In this baseline projection scenario, they plan always to rent, will not have children, will retire at age 65, will not use any tax-deferred investments, and will pay average investment costs. In this "baseline" case, Fran and Fran have NOT adopted many of the lifetime financial planning practices that make it easier to achieve financial success in life.

Lifetime investment assets of renters -- with investment cost improvements

Fran and Fred Frugal, both age 30, are a married working couple with $100,000 in combined annual earned income. They want to understand how valuable different personal finance strategies could be to their lifetime finances and their retirement security. This "what-if" projection changes their baseline case. In particular, they have decided to analyze the lifetime benefits of reducing their investment costs.

Pre-retirement Savings Rates for Renters -- with and without investment cost improvements

Fran and Fred decided to commit to a significant reduction in their lifetime investment costs. They intend to pay investment costs that would be typical of a passive, broad market, index investment strategy that is also managed to have very low costs. What Fran and Fred do not waste on unproductive investment costs flows back to them in terms of higher returns on their investment assets. Higher net returns reduce their savings requirements dramatically. In effect, it is much easier for Fran and Fred to find their own low cost investments while adopting a passive, broad market index investment strategy.

Early Retirement for Renters -- due to investment cost improvements and higher savings rates

When Fran and Fred adopt what they consider to be lower, more reasonable investment costs, their projected lifetime finances improve dramatically. Therefore, in this scenario Fran and Fred want to understand better their early retirement options. However, Fran and Fred think that $53,050 per year is enough to live on in "real dollar" or constant purchasing power dollars throughout their lives. Therefore, instead of spending more and both working until age 65, they want to test how much earlier they could retire while having a level $53,050 annual real dollar expenditure rate across their lives.

Benefits of Traditional IRA Contributions for Renters

How much longer could Fran and Fred's retirement assets last, if they used traditional tax-advantaged retirement accounts? To find out the answer to this question, Fran and Fred modeled their lifetime cash, bond, and stock fund assets in both taxable accounts and in tax-deferred IRA accounts. In this article, Fran and Fred evaluate making 100% of their maximum available traditional IRA contributions, during their working years. Instead of their assets running out at age 95 in the "no IRA" scenario above, their assets are projected to last until they are both at least age 100. Furthermore, at age 100 they are projected still to have about $98,000 in remaining assets -- mostly in tax-advantaged accounts, which would cover their living expenses for almost another two years, until age 102 for both.

Roth IRA Contributions versus Traditional IRA Contributions for Renters

What if Fran and Fred make 100% of their annual IRA contributions into Roth IRA accounts rather than into traditional IRA accounts? To find out the answer to this question, Fran and Fred modeled their lifetime cash, bond, and stock fund assets in both taxable and tax-deferred IRA accounts. Contributions to traditional style accounts allow for a reduction in current income to the extent permitted by the tax laws. Assets grow tax free until they are taxed in retirement either: due to withdrawals to cover necessary living or tax expenses or due to mandatory withdrawals that would force income tax recognition in retirement. In contrast, Roth IRA contributions do not reduce current taxable income, but the appreciation on Roth IRA assets are not taxed when withdrawn in retirement. In effect, Fran and Fred are testing whether paying taxes now or later would have a higher or lower lifetime value. For the majority of people, making traditional IRA contributions tends to be more advantageous than making Roth IRA contributions. Fran and Fred are typical of the majority of people. For them, making Roth IRA contributions are less advantageous than making traditional IRA contributions across their working years.