What does solar energy have to do with early retirement? A lot if you are in a state that gets lots of sunshine or has high rebates (Oregon almost pays you to install it!).
Most people focus on what income you need to retire. Those looking for financial independence (FI) focus much more intently on the expenses they have now and what they will have in retirement. Let me first explain that rationale. If you reduce expenses now by changing your spending patterns/habits then it has the positive benefit of lowering expenses in perpetuity. An increase in income goes away when you leave the job. Effectively lowering expenses can be more powerful than increasing your income! A wise person would still try to do both, of course.
Now back to the solar panels. How do they factor in to my early retirement plan? Well, you can treat a purchase of a solar panel system (I will mention PPA and leases later on) like an investment. You have an initial cash outlay and in return you get periodic cash flow back from it (in this case savings from not having cash outflows for the power bill). In my case, the panels have a 25 year performance guarantee. This means that is three panels fall below the guaranteed production levels in year 18, they will be replaced (or any other time during that 25 year). Based on that, I consider the investment to be 25 years. There are of course other reasons it might not last that long, but that is why you should use multiple measures to evaluate the investment. Instead of receiving a check each month, I will receive free electric energy during that time, which reduces my expenses. Another way to look at it is I have setup an income stream that completely covers my energy costs for the next 25 years. With net metering, I will actually receive a small check each year for the near future. I made the system about 15% larger than the current consumption as I figure we will use more energy as the kids get bigger (until everyone is at school or work during the day). That should ensure I have no power bill for many, many years.
On a side note, net metering is being phased out in California, but I think I will get it for 20 years based on recent legislation in early 2014. Those that install after July 1, 2017 may have to figure out how that impacts the financial analysis for their particular situation.
The Financial Bottom Line
So let’s move on to the financial analysis. I evaluated the solar project using the Payback period, Net Present Value (NPV), and rate of return (IRR). The Payback period is crucial because it tells me how long it will take me to get my $15,000 investment back ($21,000 cost less $6,000 federal tax credit). Since I built a slightly larger system than needed, the math came out to 6.1 years. That means I will save enough each month to have paid for the entire system in about 73 months. What happens if I sell the house before then? Good question. The answer is houses with solar panels sell at a premium. Therefore I can expect to get most of the $15,000 back. If displaying before and after power bills doesn’t work to get buyers to pay that premium, you could always pay to have the system removed and take it with you.
|Utility Cost annual increase||4.5%|
|Total Discounted Savings||36,341|
Next are the NPV and IRR calculations (as seen above). These really work in tandem to display if this is a good investment relative to other options out there. If the NPV (in dollars) is less than zero, the project should not be undertaken. If the IRR is less than what I could earn in the stock market with that cash, you may want to do something else with the money. In this case the NPV was about $21,000 and the IRR was 17%. This means I am earning more than double what the long term return of the US equity markets would give me (7-8%). It is important to note that I used a 7% discount rate and 4.5% energy cost increases in my model. Some solar salespeople will really jack up the increases to make the savings look much higher. If you build the model correctly (I used excel) you can play with the assumptions to get a few different scenarios. In my case, they all came out to be an excellent investment for me.
Did I really include ALL of the costs of going solar? The short answer is I think so. I included $50 every four months to have the panels cleaned. The going rate around here is $2 per panel. I have 26 panels, but used $50 for round numbers in the model. I also included a $1,600 outlay in year 15 to pay for a new inverter. The warranty on it is 12 years, so at some point it will need to be replaced. Many sales people will not tell you about either of these costs, so be sure to ask. I did not factor in any other repairs, but given the model it would take significant issues to dent the high NPV and IRR. I also have a 10 year warranty from the installer, so those costs would be pretty far in the future (make sure the business will still be around to fix things for you when choosing a company!). I grew up in Kansas with hail storms, so if I lived there I might have factored in some higher insurance costs from wind or hail damage. Since Central California doesn’t have those issues, I decided that my current homeowner’s coverage will be sufficient. The panels are covered under your personal property clause, so if you have a lot of stuff already, you may want to increase that slightly. I can’t imagine it would cost more than a few bucks a year to increase that a couple of percent.
Solar Power and Retirement
Now that I have covered all of the costs, let me address how it impacts my retirement projections. I will assume people have read about the 4% SWR assumption for this part (if not do a google search and read more). Let’s say you have determined your expenses in retirement to be about $57,600 per year 10 years from now. Not a really frugal number, but still much less than the financial advice industry would say based on 80% of your final working year income or something like that. These are loosely base off my budget, but I have added back in a mortgage payment along with the electric bills. If that same budget included purchasing solar now it would be reduced to about $54,750 (almost 6% less). Using the SWR calculation, you would need to save $81,000 less before retiring! Of course there would be some additional costs for the solar panels at some point, but at least for the first 15 years in retirement (25 years total from now) there would be very little.
Finally, I want to address other solar options like leases and Power Purchase Agreements (PPA). If you are interested in solar for either cost savings or just because you want to reduce your carbon footprint, but don’t have the cash to purchase the system there are two other prevalent options available. Both of the options are viable to save some money each month, but it really depends on your particular situation. I would not really consider them as a strong part of an early retirement plan, however.
A PPA is basically a hedge against unknown price increases. You purchase power from the solar company at a set rate (and a set increase each year that you know now, something like 3% a year) that is lower than buying it from the electric company. They then install and maintain the system at no cost to you. You generally also have the option of buying the system later at market value. The benefit versus buying is no initial costs to you; the main drawback would be you don’t capture all the savings. You do get a somewhat lower bill that will rise at the predetermined rate, but have the risk of transferring the panels if you sell the house.
A lease works a little bit differently than a PPA. The main difference is you will be making a monthly payment for the equipment. With the PPA, you were paying for the energy not the equipment. If you are on vacation most of the month the PPA will be much lower, but the lease would be the same amount. A real life scenario was presented to me recently when I was evaluating my options. At current rates, my previous 12 months of usage would average out to $180 a month to Southern California Edison (SCE).
Below are two of the PPA bids and one lease bid I received. All three would save me some money, but not as much as purchasing it outright.
- $4,000 upfront payment
- $101 monthly solar payment to solar company
- $22 monthly average payment to utility company
- total savings = $40 per month
- 2.90% annual increase to solar bill
- Savings over 20 years estimated to be $30,579.
- This system would only be big enough to offset about 66% of my energy usage
Another PPA Option:
- $20,948 out of pocket (includes taxes)
- Pre-paid electricity for 20 years
- Works out to be about $.11 kWh
- No maintenance or other costs
- Estimated savings not provided
- $1,000 deposit
- $184 monthly payment for 10 years
- 120 payments totaling $20,400
- End of lease options: Renew 5 more years at rate TBD, Buy system at Fair Market Value, or return the system
- Includes all installation, monitoring, and annual inspections
Are there any other home improvements that can add value and/or decrease costs to help reach financial independence sooner that you know about? Let me know!