Allowance 2.0 in Early Retirement // Systems for Financial Success and Peace of Mind

I need to confess something: I am freaked out about being able to live within a budget in early retirement. 

I know we can do it big picture, and our spending these last few years doesn’t have to change much at all to be in line with our early retirement budget, but we’ve always had a huge safety net built into our finances up to this point. If we spent too much one month, no big deal — there was another paycheck coming in at most two weeks, plus there’s the life happens fund for big ticket items like an unexpectedly large federal income tax bill.

But in just over a month, that safety net disappears. There’s no more continual cash flow to pick us back up if we fall down.

Those of you reading who are traditional budgeters might be puzzled by all of this. “How on Earth,” you might wonder, “did you save all this money if you aren’t sure you can live within a budget?!”

And it’s a completely fair question!

The answer is that we did it by artificially constraining our income, automating most of our saving, and underspending on big ticket items like housing. We hid most of our incoming money from ourselves before we had a chance to see or spend it, and we lived on what was left over. Which mostly worked, and when it didn’t, we had that safety net.

But let’s put it another way: we’ve never budgeted. Or, rather, when we did, we sucked at it. We just couldn’t stick to X amount for groceries, Y amount for travel, and Z amount for everything else. And that was incredibly disheartening.

Except we didn’t just throw up our hands and proclaim ourselves bad with money. Instead, we found a different system that worked for us. Which was our particular approach to automation.

Now, with early retirement approaching fast, we’re becoming all the more aware that the system that worked for us during our accumulation years was entirely income-focused. And while that was great up to this point, our draw down strategy isn’t going to give us income every other week anymore. We’ll have dividends a few times a year, sales of shares quarterlyish, and the rental income that will eventually come monthly doesn’t actually become cash flow for another 11+ years. Other income may come from part-time consulting, speaking gigs and the blog, but that’s likely to be unpredictable.

All of which means: We need new systems, both to ensure our financial success in this next chapter of our lives, and to give us peace of mind as we make this huge transition. So let’s dig into what we’ve settled on!

A New Financial Infrastructure for Early Retirement

Some people are naturally super disciplined. (Not us.) Some people thrive with a clear line-item budget. (Not us.) And some people do far better when they operate within a system that makes a lot of the choices and removes decision fatigue for them. (Ding ding ding!)

That’s why we think of our systems as our financial infrastructure. They’re the lane lines and guard rails that keep us from driving off the road, and the power lines that keep us operating smoothly. Or, if you think like I do, the safety net.

In our new world of full financial independence, there are very few limitations on what we can do or how we can operate, and while that’s freeing, it’s also a recipe for failure, or at least a recipe for our failure. We welcome that infrastructure to keep us operating within some orderly system, so long as that system is of our choosing. (It is.)

And here’s what it looks like:

Primary Spending Fund

Making ourselves believe that we have less to spend than we earn has worked well for us to date, so we’re going to continue this habit into retirement, leaving only spendable money in our primary checking account at USAA, which we think of as the primary spending fund. Basically, all expenses should come out of this fund, with a small number of exceptions (keep reading), and it should be the amount that we live within.

Operational rules: Source of funds for all routine expenses.

Transfer Fund

A new account we’ll open is what we’re thinking of as our transfer fund, a secondary checking account at USAA that will be where we park funds after we earn them, if they are not allocated for the current month we’re in. And then we’ll dole those dollars out to our primary spending fund slowly, so it feels more like a regular paycheck.

Operational rules: Holds proceeds from dividends, share sales and other income, with a set amount transferred to the main account each month.

Known Large Expenses Fund

While we own our home free and clear, we know that only stays true so long as we pay our property taxes, and because they are our single biggest annual expense, we prefer to set that money aside so there’s never a question of whether we have it. With each quarterlyish share sale, we’ll deposit approximately a quarter of the amount needed for our annual property tax and other big ticket expenses like insurance bills into our known large expenses fund, so we always know we’re set there.

Operational rules: Only spend on expenses as earmarked.

Life Happens Fund

Plenty of folks say you don’t need special funds in early retirement, but we heartily disagree. If we accidentally spend too much in retirement, we don’t want to be forced to sell shares at a bad market moment or carry credit card debt to get us through to the next cash infusion. And while we have all those contingencies, we don’t want to have to use them. So that’s why we plan to retain our life happens fund. It’s a savings account at USAA, and the money is easy to transfer over if we need it. If you prefer, you can think of this as the “peace of mind fund,” because that’s how we think of it. (Or the “training wheels fund,” as we learn to trust our cash management skills in early retirement.)

Operational rules: Don’t spend it capriciously, but fine to use it if we need it. But then top it back up again at the first opportunity. 

Emergency Fund

Here’s another place where we disagree with a lot of folks. We definitely think you need an emergency fund in early retirement, even though the “emergency” most people are guarding against while working is job loss, and that will no longer be an issue for us. While the experts will tell you that a robust emergency fund while working is six to eight months of expenses, a retirement emergency fund should be based entirely around your own circumstances. The biggest single non-healthcare expense we can envision is total home loss from earthquake, which comes with a deductible that is — by law — tens of thousands of dollars. And although we’re not going to keep that full amount on hand in cash, the fact that that is a possibility tells us that we need more than a few thousand liquid dollars at our disposal at any given time. Another good number to base it on is the out-of-pocket maximum on your health insurance plan, which is often $10,000 or more. Our number will probably evolve over time, but we’re starting out our early retirement with a hearty e-fund.

Operational rules: Not to touch except in true emergencies.

Debit Cards — Maybe

We haven’t used debit cards in years, and hope not to need to in retirement, because travel points. We’re not travel hackers by any means, but we do prefer to get points when we spend money, and have used credit cards exclusively for many years now. That said, in my early days of getting my act together, I insisted we use debit cards so that we could see how much we have at any moment, rather than having the mystery of each other’s credit card accounts and the possibility of overspending. (Yes, I know this is fixable with technology.) But if we feel ourselves getting at all anxious about our spending and cash flow, then we’ll go back to debit cards until we have solid new habits in place.

Operational rules: Use for routine spending on non-planned expenses.

Points Credit Cards

Assuming we can trust ourselves with credit cards, we’ll keep using them for all spending. And if we find we need debit cards to better manage our flow of expenses, then we’ll reserve cards for large planned expenses like airfare and hotel charges.

Operational rules: Use for planned spending like travel expenses (and on unplanned expenses if debit cards aren’t necessary).

Allowances

See below.

Operational rules: Up to each of us to spend how we see fit. No free refills.

New Addition: The Return of the Allowance for Early Retirement

Waaaaaay back, when we first combined finances after we got married, we decided to give ourselves allowances so we could each spend a bit without any fear of scrutiny. (Though if you listened to episode 2 of The Fairer Cents, you know we thought of our money as joint well before we actually combined it.) That phase of our joint moneying was the third arrow from the left, in light green:

I say “without fear of scrutiny” as the reasoning for the allowances instead of “without scrutiny” because we we both trust each other a ton, so it truly was the fear of scrutiny that we each had within us that was the actual concern, and never any actual scrutiny.

And that’s why, not too long into marriage, we scrapped the allowances and just bought the things we each wanted or needed for ourselves without stressing about it, moving into the “married no allowances” phase before we moved into full-on pursuit of early retirement.

But going from working with ample income to retiring with a whole lot less income feels like a huge moment in life, about as huge as getting married and combining our money. And so just as allowances were a great tool to smooth the transition then, we think they’re an ideal tool to smooth the transition now.

The Allowance Reboot

I’ll happily admit that I am the driver of Allowances 2.0, because I am the most anxious about the adjustment to our new spending regime. And yes, I know we’ve been (mostly) spending on our retirement budget for a few years already, but I just prefer a safety net. (Seriously, if this is a surprise to anyone, you have not been reading this blog for long. I’m bucking for the title of “Most Cautious” when the FIRE yearbook comes out.) And just as I don’t want to have the ability to screw up our traditional retirement, and therefore plan to leave our traditional retirement funds alone while we live in early retirement, I don’t want to screw up our early retirement by getting over-eager at Whole Foods or falling head over heels for a new hobby that requires gear.

That’s why allowances are perfect. By giving ourselves an allowance that we sock away in our individual checking accounts at the start of the year and then don’t refill, we each have this little pot of funds to spend capriciously if we feel like it, without having to justify anything. And there’s another good reason to have them besides fear of screwing up our retirement:

Fear of screwing up our relationship.

Allowances As a Money Relationship Hedge

We haven’t had any money stress burdening our relationship for years now, and there are several good reasons for that: We trust each other, we’re both mostly responsible with money and we have a shared vision of what we want our money to do for us. But the biggest reason of all has been the one we have the least control over: We’ve had more money than we require coming in each month, and ample cushions saved.

That last factor goes :::POOF!::: at the end of the year, and while we’ll still have the trust, responsibility and vision, we’ve never tested our relationship before with the challenge of not having more money coming in each month than we need. The last thing we want is for money to become a new source of stress, though we’d be naive to think that couldn’t happen to us.

Perhaps the main reason we’ve trusted each other with spending in the past is that we’ve known we could afford whatever the other partner chose to buy, even if the other one of us didn’t love the idea of that purchase. And now, when “afford” will mean something different, the last thing we want is for either of us to resent the other for making a spending decision we don’t agree on when our margin of error is suddenly so much slimmer.

So that little chunk of cash we’ll each have to spend without scrutiny each year? It’s so much more than the money itself. It’s pretty darn cheap peace of mind, with the bonus effect of taking a big potential source of tension off the relationship. I will take that any day!

Let’s Talk Infrastructure, Allowances and Budgeting!

So much to discuss here! Are you better at operating without a safety net in your relationship than I am? Do you use allowances? Think you’ll use allowances in retirement? What other infrastructure do you use, in any stage of your financial journey, to keep you on track? Are you a skilled budgeter who’s utterly befuddled at how we can be smart people but still suck so much at budgeting? Let’s talk about all of it in the comments!