Declaration of financial independence?

Posted on by FIRE v London

Over the new year break I found myself really enjoying the blog post by {indeedably} in which he breaks down his assets and income.

He has an unusual way of looking at his state of financial dependence, as shown by his image below:

i-own-buying-control-of-my-time-e1535807204287

His core point is that his level of financial independence depends on

  1. the amount of his expenses – some of which are ‘wants’ rather than ‘needs’,
  2. the level of investment income he can expect and
  3. how much ‘time he wants to sell’ (i.e. paid work he wants to do). He isn’t fully independent, but only ‘sells’ about half his time.

One thing that shows up clearly in {indeedably}’s graph is that investing can be expensive. In his case, a significant portion of his assets are property, and as a result his investing expenses appear to include a) mortgage costs b) property management and c) property maintenance – among other things.  I think they will also include his investment fund expenses/fees too.

Putting on {indeedably}’s glasses

I spent a few hours bashing my expense tracking data into a similar format to {indeedably} and now can view my cashflows on a broadly comparable basis.

I needed to make quite a few adjustments to my core expense tracking data for this analysis:

  • Employment income (‘selling time’) needs to be recorded Gross, with any associated PAYE taxes / deductions recorded as ‘tax’.
  • Property rental income also needs to be recorded Gross, with then any estate agent commissions/etc itemised as ‘investing expenses’.
  • Any dividends received net of withholding tax need to be broken out likewise.  I have probably missed a few of these, so my Dividend income and Tax payments are probably both a bit lower than reality.

Moroever, there is a slight complication with {indeedably}’s approach, which is that one of the outflows – taxes – is not independent of inflows, in that taxes increase with the amount of ‘selling time’. I think it would be legitimate to show ‘selling time’ as a net (of tax) inflow, and a zero outflow, though for this blog’s purposes I am sticking to the original script.

I want to know to what extent I am ‘financially independent’.  To this end I want to know whether my investment income covers all my costs by itself, without me ‘selling any time’. If I don’t ‘sell time’ then my income tax bill falls, and which is fairly hard to visualise in {indeedably}’s treatment. As a result I have made a slight modification to {indeedably}’s approach by estimating how much of my tax bill is accounted by my paid work, which I show as ‘tax (time)’. The rest of my tax bill is then shown as ‘tax (other)’ (which is mostly taxes on investment income, but also includes council tax).  I assume, incidentally, that all my ‘selling of time’ is incremental, i.e. on the highest tax rate, and that my personal (tax-free) allowance is swallowed by investment income.

Here is where I got to, mimicking {indeedably}’s approach (and his bizarre colour scheme!).

Warren Buffett would not approve

Hooray – I can retire!

You can see that I was, in 2018, ‘almost exactly’ financially independent – with the exception of a one-off project I invested in, my rent and dividends almost exactly covered my outgoings including non-PAYE taxes. In fact my ‘wants’ includes some quite sizeable charity donations. Without these voluntary donations, I’d have had a surplus without earning a penny.

This analysis confirms what I have known for a little while; that in current market conditions and under current circumstances, I don’t need to work for money.

What I don’t yet have complete confidence that I can maintain this level of independence indefinitely. I may only be half way through my life, and my circumstances, and market conditions, and tax rates, may change dramatically in the next half. If everything went t*ts up, would my money be able to do enough work to keep me and Mrs FvL in the lifestyle to which I/we have become accustomed? I need more confidence on that front.

As with my last blog post about the low tax country that is the UK, this lens reveals how taxes I can’t really avoid (on unearned income) are lower than taxes on my working time (which is a choice for me, thanks be to providence).

Why don’t I feel like I have enough money?

Something about the analysis above isn’t adding up for me. While the figures suggest I am close to the holy grail of ‘abundance’, it doesn’t feel like that in practice.

For starters, as regular readers will know, I would rather fast for 40 days than withdraw funds from my ISAs. Likewise, the income I show above includes investment income from my pension, which I can’t access for many years yet. So a significant chunk of my dividend income isn’t available for daily spending needs/housing/wants. Some of my investing expenses do sit within my ISAs/pension, but a disproportionate amount (i.e. the housing-related ones) are in my unsheltered world.

My ISA fetish goes so far that, for me to feel truly comfy, I want my unsheltered assets to be throwing off enough spare cash, after paying for my housing, needs and wants, to fully fund the maximum possible ISA annual contribution. That means, between me and Mrs FvL, I need a £40k surplus between ‘inflows’ and ‘outflows’, in my unsheltered accounts alone. I am at least a million pounds short of reaching that point.

Could I reconfigure?

In theory, I could rapidly optimise my situation. I could:

  • Swap my previous home for a low-cost public securities. My old home is tying up well over £1m of capital, is only yielding around 2.8% gross, is probably declining in market value, and has costs amounting to around 20% of income. In its favour, my taxes are low – about 10% of income. But if I swapped it for ETFs, I’d expect yields of over 3%, and costs of about 5% of income. Taxes might rise a little. But my inflows would rise, my outflows would fall. And I’d expect market values to rise.
  • Cull my private bank. I have around £1m invested with my private bank, in a global market tracker that I pay about 100bps for. And I pay additional banking fees. If I cancelled the account, I could save around over £10k p.a., on my outflows.
  • Move abroad. Apparently if I relocated to Portugal/similar, but left my funds outside Portugal and didn’t remit them, my investment taxes would drop. No thanks. I like London. And reducing my tax rates below the current level feels unsustainable.
  • Get a proper job. My earned income at the moment is below my market rate. I could increase my inflows, albeit with an increase in my tax outflows. Somehow this goes against the grain of FIREing myself, don’t you think?
  • Chase yields. I could tilt towards High Yield portfolios/similar, to juice my yield. In my (becoming extensive) experience, this robs the long term Peter to pay the short term Paul.
  • Spend less on Wants. I pig out too much. Metaphorically speaking, you understand. I could rein back. In theory. But in practice, life feels short. I’d rather start on the rest of this list.

None of the above are easy for me to do, psychologically or otherwise. In the meantime, I shall instead slowly optimise my investment expenses, do my best to have a positive net savings rate (to grow both my sheltered and unsheltered funds), improve my investing skills, and monitor things pretty carefully – with the help of a public blog. Thank you, readers/commenters, for playing your part.

21 thoughts on “Declaration of financial independence?”

  1. My (then) 5 year old son was very proud of that colour scheme! I do concede he was somewhat constrained by his limited set of working colouring pens when I was sketching out the idea for the chart. Now that it is internet famous, I’ll have to reward him with a new set.

    Some clarifications that may help decipher my chart:

    The cash flows displayed are those accessible to me today. Therefore it doesn’t include cash flows from age-restricted pensions, nor potential future social security benefits that may be available in the form of state pensions. The chart helps me to figure out the balance between my summer semi-retirement stints and winter working hibernations.

    Dividend income is broken down into taxable or tax-advantaged sections. Many of my ISA holdings don’t pay dividends, so on the chart all you see is the narrow dark stripe below “selling time”.

    The analysis sheet that sits behind this chart does tie income to related expenses including tax, which allows filtering by income category, asset class, and/or investment account. This is important because generally I prefer not to invest in things that leave me out of pocket. There are rare exceptions of course!

    For mine, I think it is important to analyse selling time as being gross of tax. As your UK taxes post ably demonstrated, tax is an expense that can be managed and minimised, like any other. If I used a net basis I would likely fall into the common trap of accepting whatever taxes I am charged and never thinking about how I may minimise them.

    This chart is a simple tool for looking at current cashflows. It does not provide a holistic view of a person’s life long cash flow profile.

    Including age-restricted pensions then it paints an over-flattering picture of your actually cash flow today.

    Conversely ignoring those pensions may mean you sell more time than you actually need to today, as you ignore the fact you’ll have additional income later.

    I find it a useful tool to visualise my current cash flow position, but one that shouldn’t be used in isolation.

    Liked by 1 person

    1. Very helpful comments, thank you.

      Unlike you, my ‘inflows’ include age-restricted flows like SIPP dividends. I take the view that while I won’t need them (and can’t access them) until I am aged X, I want to know where i would be, if I reached age X tomorrow.

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  2. Your “need” to keep funding your ISAs seems bizarre. Its money you refuse to spend, its not IHT efficient, and forces a £40k household saving rate.

    In block terms, I’d say FIRE is when you sell some of your time to manage investments, but don’t sell it for a job (p2p is proving a time sink for me, I’m getting out). At that point you want to match income and expenditure (with a surplus for rainy days), minimising tax.

    Don’t ignore the tax advantages of unsheltered equity. On 3.5% dividends alone, that means less than £330k unsheltered or for property earning 5%, £230k. And you get the CGT free too. That’s quite a big buffer that doesn’t need to be in an ISA until you start drawing pensions.

    But you might as well continue to fund ISAs at £20k pa, so when pensions available you can refresh the buffer with the lump sums or pension income. Better for equity total return to occur outside a pension (23k allowances, 7.5 or 10% tax) than inside a pension (11.5k allowance at 20% or worse with LTA breaches), and you’d not want to be a higher rate pensioner.

    But you have to weigh that against the 40% IHT on the ISAs, so perhaps its better to keep the pension plump. ISAs are better than unsheltered, but not always better than pensions. You need a plan to spend those ISAs before you die!

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    1. I accept that my compulsion to preserve my ISA funds is not wholly rational. But, as @monevator observes below, it is the ‘use or lose’ that is scary.

      I hope and intend that, God willing, the ISA tax break will be worth literally millions to me. My household ISA pots already amount to around £500k, and produce £15k-£20k of tax free income already. A £1m pot, producing £30k-£45k income, is avoiding £10k+ tax per year.

      It must be sensible to use/spend unsheltered funds, including capital, rather than withdraw funds from my tax-free-for-life ISA. No?

      I am not that into avoiding IHT. In fact I very much like IHT – I would much rather the dead pay tax than the living. I expect to leave more than enough to go around and am happy to defer my dues until I no longer need the funds.

      You are right about the tax advantages of unsheltered equity, thanks to the dividend allowance, which saves around £1k-£2k of tax per year. Relative to the ISA tax break though it is small beer.

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  4. I share the ISA compulsion problem. It was funny when I was talking to the banker that eventually granted me my long-awaited mega-IO mortgage. I explained to him that I partly wanted it because I couldn’t bare to sell in the ISAs and remove funds, hence why I wanted a chunky mortgage even though in theory I had more cash to spare.

    “Oh I quite understand, I felt exactly the same last year and did the same thing.”

    It’s the fact you can’t get the wrapper back that’s so painful. (Plus I am confident it will eventually be downsized on new contributions.)

    (I had to liquidate a little ISA money anyway. It was as painful as going to blind and sadistic dentist).

    Congrats on your Heisenbergian Cat-like state of Financial Freedom. 😉

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  5. on ‘Swap my previous home for a low-cost public securities’ I think that could well be a good idea. I did the same as the yield was similarly uninspiring the associated costs very lumpy and high relative to income, but really what did it was I didn’t like the hassle-factor. It was a constant worry for me. I’m not a natural landlord, but I know others who are and its no drama for them.

    Another reason to get on and do that is the various reliefs associated with you once living there will taper the longer you leave it. I didn’t end up with any CGT on the sale thanks to those.

    Wasn’t there some other fringe benefit to the private banking? I vaguely remember you mentioning it once? Otherwise that would seem like an easy win?

    Don’t bother moving abroad if you already like where you live. Although I’m very taken with the idea of long breaks abroad over the colder months and taking my work with me, but will have to wait for schools to finish for that to be an option.

    wouldn’t worry about getting a proper job, if current situation is enjoyable then thats worth its weight in gold.

    chasing yield prob never a good thing?

    Spend less on wants – I’m going very FI contrarian on this of late. My current thinking is that its a bad idea for the demographic who are rich and sensible. If there’s stuff you fancy doing, best get ahead and do it – spend the money. I’m really bad at doing this, but half the battle is me realising it and owning up to it.

    I’m also likely to get an IO mortgage for the same reasons as TI this year all going well in the world. I say same reasons, but to know for sure, I’ll have to read his awaited blog-post.

    Liked by 1 person

  6. I do like the simplicity of boiling it all down to an ongoing cashflow basis, although it is possibly a bit too simplistic for long term planning. And importantly, you are financially independent if you make a few tweaks and uncomfortable (to you) decisions, which is an epic place to be – well done. Moreover, you are choosing to work for more luxuries and, it seems to me, as you don’t hate it – sounds like you are winning at life FvL.

    Weirdly I’m more zen than most about withdrawing money from ISAs – probably as over the years I’ve emptied them each time I bought a house…so filling them then emptying them after my taxable runs out doesn’t feel like a big deal to me in the longer term. But who knows, as it becomes more reality than theory, I may also change my mind.

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    1. Thanks Ms Z Y.
      houses are almost tax-free as well so if you money has shuffled out of an ISA into a house then your long term trajectory may not have changed much.

      What you need to remember is that if you, say, took £10k out of an ISA 10 years ago, it would be worth ~£20k now, £40k in 10 years time, and £80k in 20 years’ time. The opportunity cost of removing it is significant.

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  7. Anyone aiming for “fatFI” will find it hard to really define where FI is compared to someone aiming for “leanFI”. The person aiming for “leanFI” is accepting a frugal lifestyle. You can more easily define the income floor that comes from requiring the bare necessities and then add whatever feels right for discretionary spending. If the markets go south, side gig jobs may well be a hedge to investment losses.

    By contrast the whole point of “fatFI” is comfort and affluence. The market going south isn’t going to be offset by a side gig. You really do need to worry about becoming the target of income tax at 70%+, wealth taxes at 1%/annum etc. This make it virtually impossible to really be confident whether you have enough to keep you in the life your accustomed to without the portfolio getting to UHNW type levels. On the positive side, however, you are way beyond the bare necessities; even the worst case scenario, you’ve got “leanFI” nailed a few times over.

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      1. seeing ZXs comment reminded me that the best reason *not* to flog the BTL is to hedge against future property purchases, which he has pointed out a few times in the past. So if you’re thinking of setting kids up in the future that could have a bearing on things..

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    1. Brexit’s impact depends on how tied your investments are to UK markets and GBP. Those who invest largely in world equity index trackers are not affected as much by UK markets and actually see a GBP increase in value of their portfolio when the pound falls.

      So I think the more globally diversified you are, the smaller the effect of Brexit on your investments. In exchange other global developments have a greater effect than if you maintain a home tilt.

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    2. Stefan’s reply covers Brexit really – I am pretty hedged against Brexit, I think.

      If inflation rises then prices of real assets (property, equities) rise. I have a lot of exposure to these and should be OK. In the meantime debt gets eroded away; thus my margin loans would shrink.

      What would be much more impactful for me would be penal wealth/income taxes. If they came in at the level ZX48k above mentions, and bit me (which is a slightly different thing), then I’d seriously consider emigrating.

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