On the drive home the other day, we got to talking about an unclaimed $35 million lottery ticket in Ontario. After a discussion about people doing crazy things to get a divorce after learning they won the lottery, we moved on to the natural topics of “what would I do” and “retirement.”
We settled on a scenario of ten people splitting the ticket, so $3.5M each.
An important note here is that lottery earnings are not taxable in Canada.
So you’ve got $3.5 million. The next question is “is it enough?”
Enough for what? To resign and be “retired.”
It turns out that many people had never heard of the 4% withdrawal rule, which only slightly surprised me. By no means a hard and fast, nor guaranteed, rule, the 4% withdrawal rule is a rule of thumb that says you can “safely” withdraw 4% of the value of your portfolio each year, without running the risk of depleting the capital.
Thus, with an investment portfolio of $3.5 million, 4% per year gives you $140,000 in gross income. Even better? Investments are preferentially taxed versus employment income.
$140,000 Per Year
Is that enough for you? Would it be more complicated than a simple yes/no?
I think that I would fall into the “more complicated” category. You see, all of us in this group of coworkers earn quite high incomes. With $140,000 rolling in, all on its own, we could bank our entire salaries, growing the nest egg even further.
Plus, regular income continues to generate tax-advantaged savings vehicles, like RRSPs, though their value would be greatly diminished if a portfolio was generating that kind of revenue. It would be best to have some sort of tax professional or at the very least, a tax calculator, to help crunch numbers. However, if you weren’t withdrawing from your portfolio at that rate, it may still be useful to create that tax advantaged space.
For argument’s sake, say you were bringing in 100,000 from a day job. I’ll assume a 35% effective tax rate, so you’re able to add another $65,000 to your nest egg each year you continue working (ignoring RRSPs etc.). A 4% withdrawal rate means that for each additional year you work, you can increase your post-“retirement” income by $2600. That is all assuming that you invest your entire salary and live off of the portfolio in the meantime.
Another way to approach it would be to live off of your day job and assume an 8% growth rate of your portfolio, followed by a 4% withdrawal rate from the point at which you retire. Going one year increases the value of your $3.5M by $280,000. At a 4% withdrawal, that means an additional $11,200 for each year your portfolio sits and grows.
Do You Keep Working?
Fast forward five years, and your portfolio is now worth $5M. If you switch to a 4% withdrawal rate at that point in time, you are looking at a gross income of $205,706, or $65,705 more.
Naturally, this argument can be made at length, at any level of income, but it will all come down to preferences.
Paying off Debt
Just to make sure that we cover all of the basis, if you take your windfall and pay off a bunch of debt, or worse, spend the principle, it will reduce your 4% withdrawal income. Let’s assume you have $250,000 on a mortgage and buy a modest new car at $30,000 (I’m in Canada, don’t forget.) That decision has reduced your income by $11,200 per year. (In magical news, this scenario is exactly equal to delaying your decision to quit your job by one year.)
That amount may in fact be less than you were paying for your mortgage and a potential car payment, so perhaps it is worth it to you? However, you can see that reducing your portfolio has a negative effect on future earnings. If you paid down that debt, then worked for five years like in the last thought, the end result would only be $175,231, which is $30,475 less than the straight “work for five years” scenario. Ten years later, you will have had $304,476 fewer dollars to spend.
It may make sense to pay down debt, but if you spend your lotto winnings up front, it can be extremely costly over time.
Is It Enough for Me?
Would winning $3.5M be sufficient for me to quit my day job?
The answer to that is, “probably.” I am looking to become financially independent as soon as possible. It would probably take us at least a year to figure out a portfolio allocation with which we were happy, and to figure out a lifestyle plan that allowed us to enjoy life without depleting the nest egg. Our magic number to retire is higher than a $3.5M portfolio, so we would want to ensure we were setting ourselves up to achieve all of our goals.
Our early retirement vision includes the ability to take shorter term work contracts to keep ourselves challenged and to supplement our incomes periodically. If I won the lottery, I might seriously consider a PhD again, for example, or perhaps another master’s degree in a related but slightly different field.
What about you?
Have you considered your target portfolio size to retire before? I bet you have considered winning the lottery before! What kind of scenarios do you envision if you win?
Later the discussion on the commute home moved on to teeth knocked out, but I’ll spare you the details on that one. Hockey has some downsides, what can I say.