We’ve all heard the intriguing stories of people who have retired early. They live on half their income, invest responsibly, and manage to leave their careers at 35 to start a family, travel, or found a non-profit…
It feels like these (very young) people essentially find their true calling and fulfill their destiny decades before most of us even begin considering when we’ll retire…let alone what we’ll do when the time comes.
In this post, I’ll give you some actionable steps to get you on the path to financial independence. I hope to show you that there is no magic to retiring early. It’s just math and careful planning.
How Much Money Do I Need to Retire Early?
In order to create a plan, we need a goal. First off, you need to know how much money you’ll need in order to retire.
It is conventional to use the 4% Rule to calculate how much money you’ll need in your early retirement. The 4% Rule simply says:
“I can withdraw 4% of my investments indefinitely and avoid reducing the overall balance.”
In other words, if I can live off of $X/year, then $X = 4% of my total investment account value. Here’s a simple example:
$40,000/year = 4% of $1,000,000
Therefore, if I can live off of $40,000/year, I only need $1,000,000 in total investments to support my lifestyle forever.
4% is considered the Safe Withdrawal Rate by many financial planners, and this is supported by research done in the 90s known as “The Trinity Study.”
For those that speak math, you’ve already realized that you can calculate how much you’ll need by multiplying your annual expenses by 25:
$40,000/year x 25 = $1,000,000
Likewise…
$80,000/year x 25 = $2,000,000
The more you spend, the more you’ll need to save in order to safely retire. Makes sense.
But wait! This isn’t your run-of-the-mill retirement. This is Early Retirement! Let’s compare…
Here are some assumptions we often make about traditional retirement:
- We assume that the retiree is likely going to die in the next 20 years or so.
- We assume that the retiree is spending less than they were in their “younger years.” (No mortgage, no kids in college, less active lifestyle, etc.)
- We assume that social security will kick in soon enough and at a high enough value to really make a difference in the retiree’s life.
- We assume that the retiree will not return to work.
And now we consider early retirement:
1. You could live another 50 years!
We have to be a little more cautious with withdrawals especially in the first decade of early retirement. As you know, time is the most powerful variable when looking to build or maintain wealth. If you withdraw too much in year 1, it could negatively impact your future plans.
2. You want to live it up!
(or at least maintain your standard of living.)
After all, you finally have time to see the world or dive into those expensive hobbies you been neglecting. And you may still have a mortgage.
Be sure to use a realistic estimate of your future annual spending in your calculations. Only you (and possibly your partner) can decide how much you’ll want to spend in retirement.
3. Social Security is a long. way. away. It doesn’t even make it into the calculations.
This one is self-explanatory. Sorry folks.
4. You’re more likely than a traditional retiree to create new income streams.
You might find that you miss the sense of achievement that comes with making money. This could drive you to start your own business, develop a side hustle, or pick up a part-time job.
And as a fallback, you could go back to work if you absolutely had to. This makes you more flexible than traditional retirees meaning you can take on a little more risk.
After taking all of this into account, I still use the 4% Rule for my personal retirement planning, but you have to decide if one of these factors carries more weight than the others.
How Will I Ever Save That Much?
There are two main factors that will determine how long it takes to get to “your number.”
- How much you are putting away, and
- Where you are putting it.
The first one is easy to understand and more powerful in getting you to FIRE sooner: save/invest every dollar you possibly can in order to get to FIRE earlier. Have a plan to put money away before you ever see it. Every dollar you save/invest rather than spend is one dollar more invested in future you and one dollar less in annual spending.
[Pro tip: this does not mean save whatever is left at the end of the month after paying your bills and spending whatever you feel inclined to spend. This means direct depositing/transferring money into separate accounts that are designated for investing.]
The second factor is a bit trickier, and I encourage you to conduct more research outside of reading this post. However, I will offer these recommendations to get started. Execute them in this order.
- Save as much as you can pre-tax in a 401(k), 403(b), or similar plan. Putting money into one of these accounts will likely earn you an employee match, and it will definitely reduce your taxable income. It’s a win-win. If you’re putting aside a large chunk of your income (40 – 50%), you’ll likely be in a lower income tax bracket in retirement compared to where you are today. And since you’ll pay taxes when you withdraw (not when you get your paycheck), you’ll end up paying less in taxes on the same money. Yes, there is a penalty for withdrawing before age 59 1/2, but you can use a Roth Conversion Ladder to get around this (be sure to study this carefully.)
- Traditional IRA if your investments are tax deductible. (See above for reasons why tax deductions are great.) Check the IRS limits based on whether you (and your spouse) have retirement plans through your employers and total household income. This one is often unavailable.
- Save as much as you can in a tax-advantaged Roth IRA. This money grows tax-free. Therefore, you pay no taxes on earnings. (There are valid arguments out there against the Roth, but for me, it is an easy way to automate my investing. Anything I can do to “set it and forget it” has the added benefit of sustainability. I’ll take it! I suggest doing some additional research.) Again, check IRS limits on Roth contributions.
- Invest any additional money in a brokerage account. I like Vanguard because the fees are very low.
Here’s a good calculator to try once you know how much you can afford to invest. Of course, there are factors outside of your control, such as inflation and annual return on investment. This particular tool assumes 5% ROI.
This post is getting long, so I won’t go into any tips on how to spend less and save more. We’ll have to save that topic for a later date!
Are you pursuing Financial Independence/Retiring Early (FIRE)? Let me know in the comments how you’re working toward your goals!
