Career Break: How I Got Here

For the past 5½ years, I’ve been saving towards retirement, but I recently decided to take a career break. This is the first post in a two-part series:

• Career Break: How I Got Here
• Career Break: What Will I Do

Let’s start with some terminology:

• A career break is a broad term for stepping away from a career for any reason at all. It doesn’t require permission.
• A mini-retirement is similar, but carries connotations of rest, leisure, and travel.
• A sabbatical is time off arranged with an employer, with the expectation of return, and an emphasis on professional development or research. In the case of university professors, a sabbatical leave is often paid.

For the purposes of this post, I’m using the broader term career break.

How I got here

In late 2019, I happened upon The Simple Path to Wealth by JL Collins (Talks at Google). I subsequently binge-read several personal finance books, starting with The Simple Path to Wealth 🇺🇸, followed by Wealthing Like Rabbits, Millionaire Teacher, and Quit Like A Millionaire.

I was working part-time and enjoying an extra free day every week. But I was starting to think about retirement, maybe early retirement, or even just “F-you money”. I decided to go full-time at the beginning of 2020, but rather than inflate my lifestyle, I would invest the difference in low-cost index funds (ETFs).

Fintech

In 2021 I began a new project working in financial technologies (fintech). So in 4½ years, have I learned any deep insights that impacted my own financial journey?

No, not really.

The high-net-worth individuals who need specialized software to manage their wealth are not on the same path as I am. Besides owning companies and real estate, they are invested in a huge array of complicated financial instruments.

On the other hand, I have one globally diversified index fund, one mortgage, and some cash.

The good news is, if this interests you, you can learn everything you need to know about personal finance by reading a few books. And I do suggest you read a few books, because disclaimer: this post is to share my experience, not to provide financial advice.

Mortgage

After renting for decades, I purchased my first house in 2017 with 10% down. Fortunately, I don’t live in the most expensive of Canadian 🇨🇦 cities, so it was relatively affordable at the time.

My mortgage came up for renewal in late 2022, with interest rates that were difficult to stomach. Such is life, I guess. 🤷🏼‍♂️ I decided to let my investment portfolio coast, while diverting much of my income towards the mortgage.

When I first got a mortgage, the plan was to pay it off by 2042. That is still the case today, even though I’ve paid off ¾ of my home. The difference is that today my payments are only ~$550 per month.¹

Compared to renting, my housing costs are quite competitive, even when accounting for property taxes, home insurance, and maintenance. The downside is that a large percentage of my net worth is locked up in home equity, rather than invested in assets with higher returns and better liquidity. I’ve come to terms with that.

House hacking

I have been renting out a room for much of the 8 years that I’ve owned this house. The Canadian 🇨🇦 government doesn’t tax rental income when renting below fair market value. My current housemate is a sibling, so this works out well for him. A little tax-free income to help with the bills works out nicely for me as well.

Cost of living

Before taking a career break, I need to know how much money I can live on. For this exercise, I’m focused on surviving comfortably – without much for discretionary spending.

Monthly

These are my numbers:

• ~$1,000/month¹ = mortgage + property tax + home insurance
• ~$500/month = utilities + mobile phone + internet
• ~$400/month = groceries + personal care
• ~$150/month = haircut + transit + discretionary

Note: Utilities are ±$100 depending on the season – this is a 12-month average.

I try to keep my monthly expenses low:

• For one, I don’t own a vehicle.
• No monthly subscriptions for entertainment.
• I keep tabs on the rates for power and natural gas.
• I revisit my mobile phone and internet plans occasionally.

At the same time, there is still room to reduce some of these numbers:

• I’m not frugal enough to cut my own hair – that may never change.
• I should be able to reduce my spending on groceries.

Annually

Those monthly numbers add up to $24,600/year. From there I have two different scenarios.

In the first scenario, I’m renting out a room for the entire year. That means I’ll receive some tax-free income, because the rent is below fair market value. For any income withdrawn from my retirement savings (RRSP 🇨🇦), I need to pay taxes.

Finally, I need some money for occasional expenses. Dentist appointments, software subscriptions, home maintenance, etc.

Scenario 1. with rental income (below fair market value)

$27,000/year with a portion coming from rental income

• ~$900/year for federal income tax
• ~$1,500/year for occasional expenses

In the second scenario, I have no rental income for the entire year. This would require withdrawing more from my retirement savings, and paying a noticeable amount of additional tax. I also take a hit to my budget for occasional expenses.

Scenario 2. without rental income

$28,000/year ($28K) entirely from retirement savings

• ~$2,400/year for federal and provincial income tax
• ~$1,000/year for occasional expenses

Withdrawal rate

The early retirement crowd likes to promote the 4% safe withdrawal rate from the Trinity study. Based on the 4% rule, I have nowhere near enough to retire, but I’m not retiring yet. So is there another formula that will work?

In Die With Zero, Bill Perkins provides a formula that he calls the survival threshold. It goes like this:

Survival threshold = 0.7 x (cost to live one year) x (years left to live)

This formula assumes a rate of return of 3% above inflation using a portfolio of stocks and bonds. The book warns that returns will vary, with some years having negative returns, but the formula doesn’t attempt to be safe.

Mitigating a market downturn could be accomplished by using cash savings, tightening spending, or returning to work. For the purposes of a career break, this formula seems reasonable. Just substitute “(years left to live)” with the number of years for a break, and voila!

For example, a 3-year career break at $28K/year could be accomplished with $59K in investments. To mitigate volatility, I could plug two years into the formula and have a one-year cash cushion (more on that next). That would require $39K in investments and $28K in cash.

Cash

Holding too much cash is risky!

The purchasing power of $1,000 today is less than 10 years ago, and it will be less in another 10 years. A high-interest savings account may keep pace with inflation, but not always.

Still, there is a place for cash.

Emergency fund

It’s common advice to have 3-6 months of living expenses saved in case of an emergency. While working, this is mainly for unexpected job loss. During a career break, I’m thinking more about home maintenance.

Savings

For a career break of a year or less, it would make sense to fund it entirely from cash savings. If I were planning a longer career break from the get-go, I would’ve likely used a combination of cash savings and investments in a TFSA.

However, since I was saving towards retirement, much of my net worth is held in RRSPs. Therefore I have been saving enough cash to last until the end of the current calendar year.

Next year I can withdraw from my RRSP at a lower tax bracket when I’m not working – though I will lose that contribution room.

Cash cushion

In the context of retirement, a cash cushion is part of a bucket strategy to help mitigate the volatility of the stock market. In the long-term, the stock market will outperform cash and hedge against inflation, but in the short-term it is volatile.

Stock market corrections of 5%-20% are fairly common, and may take 3-8 months to recover. Instead of withdrawing from investments, I could live from a cash cushion, and then replenish it after the market recovers. At least that’s the idea.

A stock market crash could take several years to recover. I don’t have that much cash! In such an event, I may still need to withdraw when the stock market is down, just in order to live. A cash cushion may help, but it wouldn’t be enough to mitigate a market crash entirely.

Since I’m taking a career break and not retiring yet, in the event of a crash, I’d just go back to work. If I weren’t able to return to work immediately, having a cash cushion and/or an emergency fund could come in handy.

Withholding tax

Withholding tax is specifically for withdrawals from an RRSP. It’s a bit like income tax deducted from your paycheque, even if you get a tax return in the end.

For example, if I withdrew $28K from my RRSP, the government would withhold $6,400, so I would only receive $21,600. Yes, even though I would only owe $2,400 in income tax and should get $4,000 back the following year. It’s an interest-free loan to the government. 😅

Rather than withdrawing even more from my RRSP, I think it makes sense to set aside $4,000 to account for withholding tax. I plan to repurpose some of my emergency fund for this.

An Experiment

Taking a career break will help answer several questions, which will inform my plans for retirement in ways a spreadsheet simply can’t.

In relation to finances, it is a test to rein in discretionary spending and live within a smaller budget. How will that feel? It’s also an opportunity to experience and learn more about the wealth preservation phase (drawdown) as opposed to wealth accumulation.

All of this is a means to an end. Setting aside the money to enable a career break is important, but the real value is in how we use our time. That is a topic I intend to cover in my next post.

Until next time. 👋🏼