Rule #16 Plan on Financial Independence without CPP

(Note: FYI, this post is mostly relevant in Canada as it talks about the Canada Pension Plan. I am not familiar with other government run pension plans in other countries but I would bet many of the points I raise here are similar.)

I generally don't trust that the government will do what is in my best interest.  I am usually skeptical of any incentive that they offer us as citizens and taxpayers, and I usually challenge whether whatever they are "offering" is truly good for me and my family or not.  I value my freedom and don't take kindly to being coerced or forced into doing things I don't like or want.  An example of this is the Canada Pension Plan.

The Canada Pension Plan takes 4.95% of your first $42000 of earned income and sends it to a government office to manage your money for you.  Thats about $2000 a year.  If I am an employee, I am required to pay into it annually. I am not permitted to opt out of it.  To us, this a bad deal.  The other kick in the teeth is that your employer has to match your contribution... so there is about $4000 per year being funnelled into the CPP each year per employee making over $42K.  But Ryan, why wouldn't you want a government managed pension?  The government has decided to look after you, isn't that a good thing?  No, it isn't.  Not for us.  I would rather manage that money myself.

The maximum amount that CPP pays you if you were to retire in 2012 in before-tax dollars is $986.67 monthly. Not much, eh?  You have to be aged 65 and have worked 40 or more of those years, while maxing out the contributions, in order to qualify for the max pension.  If you didn't make the max contribution, your amount goes down. If you take your benefits early at age 60, your amount goes down.  If you didn't work 40 years or more, for whatever reason, your amount goes down.  Now me, I went to Graduate School so I didn't start working 'til I was 28.  I've also taken two Leave of Absences to be with our boys when they were born.... So fat chance I'm going to get the full $987.  My wife always planned to take some time off and raise our kids so odds of her making that maxed amount is also nil.

There are some other reasons why I am not a fan of the CPP.  If you are single and you die before you are old enough to collect a pension - age 60 I believe for a reduced amount for example - no residual value is left to your estate or your heirs.  If you die the day after your first pension cheque, your surviving spouse may, from what I understand, get up to 60% of it, but if you have no spouse or they have already died, poof your pension is gone.  Again, there is no residual value to pass on to your heirs.  Its essentially an insurance plan that the government forces you to pay into... and not a very good one at that.  You will have paid into if for all those years and gotten very little or none of it back if you expire early.  I can think of a better way to use my own $2000 per year AND have some residual value left over.  Remember Mr Gunter?

When I look at the CPP, I see it as a retirement savings vehicle for people who are not savers.... and to some extent another example of the government encouraging people not to take responsibility for their own well-being.... Or, as in our case, the government not letting people take care of themselves.

When we started planning our finances years ago, we looked at the above CPP conditions and said to ourselves "These are way too restrictive!" For one, we won't be working 40+ years.  If one or both of us want to take a few years off here or there, that small amount gets smaller and smaller.  Then we said "Do we really want to work continuously 'til we are 65" The answer to this was a resounding "No."  Its not to say that we won't work 'til 65... or even beyond... It was that we would be required to work that long because the government would be holding this carrot over us to make us continue to work.  "Screw That!"  So our plan is to make sure that we can look after our monthly liabilities without relying on the government managed CPP. We plan to stop working when we want, if we want.... not because we were forced to work until a certain age. When making up our master plan, CPP doesn't even factor into it.

So our solution is that we plan our finances as if there will be nothing in CPP for us when we get there. If there is anything for us in CPP we would take any benefits into a system that we were forced to pay into, regardless or how poorly it fits for us.  Based on our plans we expect to be just loose change.

Rule #14 Live on one salary.

I'd like to live as a poor man with lots of money.  ~ Pablo Picasso

This post is mainly relevant for couples working towards saving or paying down debt. We live on only one salary when we have two coming in. If you are not part of a couple, I would still recommend living well below your means if you can.

So if you are following along, you've probably guessed that we are very aggressive savers. When we started our careers 14 years ago, we were living in a small one bedroom apartment. I was in Grad School TAing Undergraduate classes and Kim was working an entry level front line position at a Social Services Agency.  We werent making very much money but we were very happy.  Our lives were simple and we didn't define happiness by how much stuff we had.  Pretty much all of my TA income was going to servicing and paying down our Student debt, and we were living on Kim's small salary.  We have always believed in NOT living beyond our means, and believe certain types of debt are anchors that weigh you down, so becoming debt free was a priority for us.  By the time I was done Graduate School in 2002 and had only worked about 3 years, we had tackled $58000 in joint student debt and were debt free.  I had entered my "adult" career phase and began making a fairly decent salary in 2002.  After out debt was paid off, we began saving every dollar of my take home pay.  Its amazing how much you can save if you don't let the cost of your lifestyle creep up as your income goes up.  We were still living a lifestyle that was paid for with only one salary.

We were informed that our apartment was being turned into condos so we were required to move, so we bought a house in 2002.  It was a very modest house on a very walkable inner city neighbourhood.  It seemed expensive at the time, but today it would be a screaming bargain.  Even though we could have "afforded" to take on a car loan, we chose to do without a car for another 4 years until we had saved enough to pay for it in cash.  My employer paid well so we began living solely on my salary and banked Kim's.  I worked in a boom-bust industry so while I was employed at the time, there was no guarantee that I would always have work, so we established a general rule that when both of us were working, we lived on only one salary and we saved the other, just in case one of us found ourselves without work or income.  We've done that every year since about 2002 unless Kim or I were taking some time off from working either for a Parental Leave or a personal Leave of Absense.  There was never a need to change our lifestyle since we were accumstomed to living on only one salary.  Easy Peasy.  The other great thing that happened is that as we saved and bought cash-flow producing assets, those assets began providing us income as well.  That investment income started small, but over time has compounded to a meaningful amount of income.  Its not easy to live this way if you are accustomed to a high consumption lifestyle, so it wont work if you aren't prepared to make sacrifices now.  If you haven't began keeping up with the Joneses, don't start.  

This "Live on one salary" strategy obviously works when you, as a couple, have two good sources of income.  If you don't have two good sources of pay, then getting two good source of pay is probably a bigger priority.  Once you are at that point, imagine how quickly you could amass a large nest egg if you as a couple saved half of what you brought home. To this day, we bank/invest about 40% of our joint net take-home income. We do not live lavish lifestyles so there is no shock to the system when either Kim or I, or both, are not employed. Since we've been living this way for about a decade, we have built up a substantial financial base as a cushion and we maintain a lifestyle that is somewhat modest compared to others in our age and income cohorts.

I've heard a lot of people say that they couldn't live on just one salary.   I believe most people can do whatever they set out to do, and that most couples choose to live on both salaries.  They have adjusted their consumption and lifestyle level to their joint income level which leaves very little wiggle room if one of the earners loses a job or wants to do something else like go back to school, or start up a business.  You are now trapped in the "I must work to sustain my lifestyle" vortex.  This is fine if it works for you, but don't use it as a crutch for why you can't save.

Rule #6 Forget the Latte, Its the Car/Vacation/Renovation Factor

"Screw giving up your Latte!" - me.

People who have read David Bach's books will be familiar with the Latte Factor.  Its the idea that cutting out small expenditures such as your daily cafe-bought latte, and socking the money away to save and invest, can add up to a really large pot of money further on down the line.  You know, save $5 dollars a day and it adds up quickly.  I don't disagree with this strategy... It intuitively makes sense.  Making your own morning jet-fuel can cost pennies a cup as opposed to paying $3 for a large black coffee at Starbucks.  But if I get some good social interaction while drinking that Starbucks coffee, it might be money well spent, at least thats the way I see it.  After work drinks are another example.  Not having a social life, or eliminating the simple pleasures in life, is not the cure for troubled finances.... And if it is, you probably have an income problem, not a spending problem.

In general, while we agree with the concept of the Latte Factor, we do not subscribe to the practice.  Rather than focus on cutting out the daily small costs, we focus on the bigger things that we can cut out.
If the objective is to save money, people who scrutinize every little purchase, but then drop $5000 on a family vacation, would probably be better off cutting out the vacation if they want to get ahead.  To me this is "not seeing the forest for the trees".  For us, lots of small daily luxuries can be paid for by just cutting out one big one.  Some of the big-ticket items that we have cut out of our lives, while still maintaining our daily coffee or happy hour fix with friends, are a second car, a motorcycle, a second home or cottage, vacations, and cosmetic house renovations.

Imagine how much money you could save if you got rid of your second car, your motorcycle, or that cottage you only go to 3 weeks of the year.  "The kitchen we have now is functional, but dammit I want stainless steel everything... and I'm willing to pay $20000 to get it."  That just sounds silly. Cut back the second car and if you only put away half of what you would typically spend on it, you'll still be saving more than most people do.

Here's mud in your eye... and in your cup!