Can You Afford To Retire Early?
The idea of retiring early, which was formerly nothing more than a fantasy for most Americans, has been gaining real-world traction over the past 10 years. Encapsulated by the ‘Financial Independence, Retire Early’ movement — also dubbed “FIRE” — it’s a concept that younger Americans are embracing.
However, behind the dream of retiring early is the hard math that retiring at 40 or even 50 requires. For example, if you think you might be able to retire with a $1 million nest egg at 65, retiring at age 40 may require three times as much — and you’ll have a much shorter time to acquire that money. Here’s a look at what you might need to retire at age 40 or 50, along with a list of things you shouldn’t overlook when planning an early retirement.
What is Early Retirement?
While there’s no official definition of early retirement–many define “retiring early” as retiring before your 60s. Technically, full retirement age (as defined by the Social Security Administration) is currently age 67. This means retiring before age 67 is “early retirement.”
However you want to define it–early retirement requires having enough money set aside to live off your investments and other income sources for the rest of your life. This is also known as becoming “financially independent”–meaning you never have to work for money again if you don’t want to.
In the past decade the “Financially Independent, Retire Early” movement has become popular–encouraging others to save large sums of money early in their careers. It is usually reserved for those with a high income and high monthly savings potential, allowing them to invest 50%, or more, of their income.
And you will need to save a lot of money to retire early. Not only do you need to save more because your money needs to last longer than a traditional retirement–but you may not have access to your pension funds or Social Security for quite a while if you retire in your 40s or 50s.
How Much Money Do You Need To Retire Early?
So how much, exactly, do you need to retire early?
While this question is a bit more nuanced and complicated than it seems–there are some general guidelines that you can follow to help you determine your early retirement number.
First, it’s important to understand that retiring early has much more to do with your spending habits than your earnings. While some financial planners may suggest aiming to replace 80% or your pre-retirement income–that doesn’t really work if you have a high income–but low expenses.
The simple early retirement formula requires planning out how much you’ll spend in retirement, and then reverse engineering how large of an investment portfolio you’ll need to afford that lifestyle. Here’s how to calculate your early retirement number:
Your retirement annual spend x 25 = Your early retirement number.
For example; If you anticipate spending $50,000 in your first year of early retirement, you’ll need $1,250,000 to be able to retire early.
This formula is derived from the “SafeMAX Withdrawal Rate” first published by financial planner Bill Bengen. The idea is that you can safely withdraw 4% or your total investment portfolio in retirement and never run out of money for at least 30 years.
Now, you may want to be more conservative for a longer retirement, and wait until you have 30x your annual spending (or more).
What About Social Security?
Social Security is a retirement pension plan operated by the U.S. government that provides lifetime income for retirees. A portion of your federal income taxes go to fund Social Security, and you can earn “work credits” that qualify you for Social Security income.
The earliest you can start receiving Social Security income is age 62. So if you plan on retiring in your 40s, you can’t count on that income for quite a long time. And if you retire early enough, you may not have earned enough work credits to receive Social Security at all.
So while you may be able to count on some Social Security income in the future–you’ll need to save enough to live on your own investment income until much later into your retirement.
How to Retire by 40
Retiring by 40 under any circumstances is ambitious. The major problem with retiring so early from a financial perspective is that you’re giving up time to save and extending the time you’ll need your money to last.
For example, if you retire at 65, you might only need your money to last 20 to 30 years (or less). But if you retire at 40, you haven’t even lived half your life yet. According to IRS tables, you should expect to live nearly 46 additional years from age 40. If you plan on spending $50,000 per year in retirement, that comes to over $3 million in lifetime retirement spending after adjusting for inflation.
Here’s a few steps to take to successfully retire by age 40:
Save 50% of your income. If you want to retire in your 40s, you’re going to need to save a BIG chunk of your income. In most cases–you’ll need to save at least half of your income to retire in 20 years or less. This helps in two ways–you’ll learn to live on less (which lowers how much you need to retire)–and you’ll invest a lot more money.
Max out retirement accounts. To get the most from your investments–it’s a good idea to take advantage of the tax savings on your retirement accounts. This includes maxing out workplace retirement plans (such as a 401k account) and IRAs. The tax savings allows you to save more and avoid taxes on the growth as well.
Invest in a brokerage account. If you plan on retiring in your 40s, you can’t lock all of your money into retirement accounts. It’s a good idea to build a “bridge account” that allows you to access funds without incurring any early withdrawal penalties. A taxable brokerage account allows you to invest as much as you want–and withdraw funds whenever you want. This is a MUST when you have 20+ years until you can access other sources of income like Social Security.
How to Retire by 50
Retiring by age 50 is much easier mathematically than trying at age 40, but it will still take a lot of planning — along with a lot of saving and investing.
For example, if you want to live off $50,000 per year, by retiring at age 50, you might only need a little over $2 million in lifetime retirement spending, as your life expectancy according to the IRS at age 50 is about 36 years. Plus, you’ll have an additional 10 years to save and invest your money, which will make reaching your retirement goal that much easier. Still, you’ll need to begin an aggressive investment program at a young age to make this goal feasible.
Here’s a few steps to take to successfully retire by age 50:
Stash cash. Retiring in your 50s means you’ll soon have access to your retirement accounts (age 59.5 for most). But to afford your lifestyle in the meantime, you’ll want access to funds prior to age 60. This means stashing cash or opening a taxable brokerage account that you can access any time. These funds will “bridge the gap” until you can start withdrawing from your retirement accounts.
Lower your taxes. Retiring in your 50s means you’ll have a decent-length career–and lowering your taxes can help you invest more and pay less at the same time. Getting a good financial planner or tax strategist can help you invest in tax-advantaged accounts and lower your income taxes each year. This lets you save more money toward retirement.
Lower your fixed expenses. Retiring early is all about investing a large chunk of your income–and lowering your fixed expenses so you don’t need as much money to retire early. If you plan on retiring in your 50s, paying off large debts–like your mortgage–means you can retire on much less.
Things To Factor Into Your Calculations
Retirement projections are just an average best guess. As every person’s financial situation and lifestyle is different, there’s no best answer as to how much you’ll need to retire early.
To tweak your estimate to make it as accurate as possible for you, you’ll need to factor in some of the financial characteristics that are specific to your own life. Here are some of the most important to consider.
Your Retirement Budget
The most important factor to retiring early is understanding what you’ll spend in retirement–the more details, the better. This means reviewing your current spending, understanding your future needs, and talking through your retirement budget with your spouse or a financial planner.
In practical terms–for every dollar you need in your monthly retirement budget–you should have $300 invested. But the reverse is also true. If you cut $1 out of your retirement budgets–that’s $300 less you need to save.
So if you are planning on retiring early, reviewing your budget and lowering some of your expenses can save you serious money. For example; If you pay off your $1,500 monthly mortgage–that is $450,000 less you need to save in your retirement accounts.
Where You’ll Live
Since income in retirement is often fixed, the best way to stretch your dollars is to reduce your expenses. The single best way you can usually do this is by relocating to a more affordable place.
The cost of living varies so dramatically across America — and across the world — that a simple change in location can effectively translate into thousands of dollars per month in extra funds. If you plan on living in a high-cost area like New York or Los Angeles, you’ll likely have to raise your retirement “number” by quite a bit.
Rising Healthcare Costs
As you age, it’s a near-certainty that your healthcare costs will rise. This is something that younger savers often overlook, as it’s hard to imagine at a young age that your healthy body will eventually wear down and require extra care.
In addition to expenses themselves increasing as we age, the cost of healthcare services in general seems to go up every year, so you’ll have to factor that into your retirement equation, as well. Don’t overlook long-term care costs either, as they are not generally covered by Medicare, and you may require those services before age 65 anyway.
When to Claim Social Security Plan
Planning your Social Security strategy is an important step for those who plan to retire early. For one thing, you want to make sure that you work enough to at least qualify for Social Security, which generally requires 10 working years. But you’ll also want to maximize your benefits.
There are two ways that you can do this — through earning more and by claiming Social Security later in life. Even if you have a high income at an early age, the Social Security Administration bases your payout on your 35 highest years of earnings. This means that if you retire at 40 or even 50, there will likely be some years of zero income in that calculation, dragging down your ultimate benefit.
Waiting to file until age 70 is a way to boost those benefits, but 70 can seem like a long way away for someone retiring at 40. Since these types of calculations can get complicated, it’s best to work on them with the help of a financial advisor and/or retirement specialist.
Your Chosen Lifestyle
Your lifestyle goes a long way to determining how long your retirement savings will last. If you’re the type of person who needs to take six vacations a year, fly first class and cruise around the world, you’ll need a huge sum of money to retire early. But if you enjoy a simple life that mostly involves staying at home or in your local area, you can likely get by on much less.
To have a successful early retirement, you’ll have to find the spot where your income and your lifestyle needs overlap.
Investment Approach
Your investment approach in early retirement may differ from traditional retirement planning. Your money needs to last longer–which means you may need to save more or take on a more aggressive investment approach.
It’s important to review your personal risk profile and risk tolerance–understanding how you approach the volatility of your investment portfolio. This may mean creating an asset allocation that aligns with your stated early retirement goals and then adjusting along the way.
Working with a licensed fee-only advisor can help you create a spending plan in retirement and a balanced portfolio that helps you reach your early retirement goals.
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John Csiszar contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: Can You Afford To Retire Early?
