How To Retire Early And Never Have To Work Again
There’s nothing better than being free to do whatever you want. However, unless you’re born with a multi-million dollar trust fund, you’ll unfortunately have to work for your freedom.
You can follow my savings guide to increase your chances of a wonderful retirement by 50-65. But, what if you want to retire earlier? Say at the age of 40 or 45? You’re in luck, because I have a very simple, yet effective plan for you. This is something I’ve been following for the past 13 years to allow myself the option to retire as early as 35-45. I think you’ll like the option as well!
What’s important is recognizing your inner frugality, your Herculean discipline, the government’s generosity, and your mortality.
EXAMPLES OF PEOPLE WHO’VE RETIRED EARLY
Realize that it’s an absolute fallacy you must work until 60-65 to be able to retire. It’s up to you whether you want to have the freedom to do whatever you want. You just have to make some sacrifices.
I will assume that you enter the work force at age 22 after college. All you have to do is work for 18 consecutive years and save 55% of your after tax profits without fail. At age 40, mathematically you have now saved enough to last you 20 more years until age 60. At age 59.5, you are then allowed to withdraw any money from your tax-deferred retirement savings penalty free.
The money you saved in this time period can be spent in full, if so desired, every year until you hit age 60. By the time you are 62-65, you are then eligible for Social Security benefits to compliment your other tax deferred retirement savings.
EXAMPLE 1: AVERAGE JANE
|Age||Yrs Worked||Gross Income||Net Income||Effective Tax Rate||Disposable Income After Savings||Savings at 55%|
|Total||$ 1.34 mil||$1.06 mil||$583,275|
Jane is a University of Colorado grad who majors in English. She gets a job in Denver as a telecom services provider sales rep. It’s not the best job in the world given her interests, but it pays the bills while she stays with her parents for the first 3 years to save money. At the age of 25, she moves out and co-habits with her boyfriend, saving money in the process.
From ages 41-60, Jane can spend roughly $29,163 a year until age 60 and never have to do anything at all! That’s right. With her $530,250 saved up, she doesn’t need interest or investment returns to spend $29,163 a year. So long as she doesn’t increase her lifestyle she’s grown accustomed to for the past 18 years, she’s fine. Jane can also earn a risk-free 2% return on her $583,275, which yields roughly $11,500 to go on top of her $29,163 to equal roughly $39,000 in after tax income a year.
If we exclude the interest income, $29,163 a year is not exactly a lot to spend, but during her working years from age 22 to 40, she was only spending about $32,000 a year after taxes anyway. In order to make her money go farther, Jane could move to a cheaper country, live with a working spouse, work part-time, or attempt to invest their money. If she’s been used to living off $32,000 working, suddenly, there are 8-10 hours more a day to make $2,837 a YEAR to close the difference and then some!
EXAMPLE 2: FLOYD, THE GO-GETTER
|Age||Yrs Worked||Gross Income||Net Income||Effect Tax Rate||Disposable Income After Savings||Savings After 55%|
|Total||$ 2.13 mil||$1.64 mil||$902,605|
Floyd graduates from Virginia Tech and becomes a software Engineer at a small software company in San Francisco. Floyd isn’t the most brilliant of software engineers, which is why he couldn’t get into Google, and therefore doesn’t make as much as his fellow Googlers. That said, he’s making a healthy six figure income by age 30.
With a $902,605 nut Floyd has accumulated over the past 18 years, Floyd can spend a healthy $45,200 a year for 20 years without having to do a thing. At a risk free 2% return, Floyd can earn $18,000 a year to boost his annual spending to $63,200 if we want to get a little more realistic.
Couldn’t you live off $63,200 in AFTER-TAX income in practically every city in the world? Imagine if you found a spouse who worked, or actually made and saved the same amount of money you did? You could both live of $126,400 a year quite comfortably. But, the theme of this post is to retire early and only depend on yourself, so this is what Floyd will do.
EXAMPLE 3: FELICITY, THE TALENTED
|Age||Yrs Worked||Gross Income||Net Income||Effect Tax Rate||Disposable Income After Savings||Savings After 55%|
|Total||$ 3.23 mil||$2.5 mil||$1.36 mil|
Felicity graduates in the Top 3% of her class at UC Berkeley and gets a job at the Boston Consulting Group, one of the world’s leading strategy consultant firms. She has a fantastic career and gets promoted every 3-5 years on average until she becomes a senior executive at age 38. She has a couple little ones, and decides to retire at 40.
With a retirement savings of $1.36 million, Felicity can spend $68,000 after-tax a year as she stays at home and spends time with her 6 and 7 year old sons. Felicity didn’t have the best of luck with love, and divorced her $300,000 a year husband soon after the kids were born. They share custody of their sons, and also share the cost of raising them.
At a 2% risk free return, Felicity can generate $27,000 a year in interest income, boosting her annual spending to roughly $88,000 after tax. Felicity was living off of around $88,000 a year in disposable income at the age of 35, so it’s not that big of a stretch for her.
STUDY THIS SIMPLE RETIREMENT CHART CAREFULLY
|If You Save This Much Of Your After Tax Income||Every Year You Save At This Rate, You Save This Many Years For Retirement||After 10 Years Of Saving, You Save This Many Years For Retirement||After 15 Years Of Saving||After 20 Years Of Saving|
If you save 50% of your after tax income a year, you only have to work 1 year to accumulate 1 year of retirement savings. If you keep saving at this rate for 15 years, you will logically accumulate 15 years of retirement savings. If you save only 10% of your after tax income a year, you have to work roughly 10 years to accumulate 1 year of retirement savings!
The key here is after tax income and what you live on. The default, base case scenario is that one can live off 50% of their after tax income. Living off less for an extended period of time without making more than $100,000 a year is not very realistic or sustainable.
Use a simple $100,000 after tax disposable income figure, and a $50,000 yearly living expense target for retirement to work the math yourself. Save half of $100,000 = $50,000 = 1 year of retirement. Save only 10% of $100,000 = $10,000. You need to save $10,000 for 5 years to accumulate your $50,000 annual living expense!
WHAT ABOUT CHILDREN?
Children are obviously a big determinant in whether you’ll have the ability to retire early or not. But, are children really that expensive if you see plenty of couples who earn $50,000 or less have multiple children? The government provides a $1,000/year tax credit per child for middle class families as well.
The conventional wisdom is that if you decide to have children, you should immediately slap roughly 22 years of work to your life. You want to be able to provide for their living expenses and tuition through college, just in case your child isn’t that gifted to get a scholarship, or work to support themselves.
The good thing is that conventional wisdom is often times wrong. If two parents decide to save 55% of their after-tax income every year after college for 18 years, the “Average Janes” of the world will have $78,000 a year to retire on and provide for a family. The “Floyds” of the world will have roughly $120,000 a year to spend, and the “Felicities” of the world will have about $170,000 a year to spend. Can you make these numbers work to provide for your family? I think so, but it will obviously be much harder if you were a single parent.
What’s even “easier” than both parents saving 55% of their after-tax income is that one parent works, while only one parent saves as aggressively. This way, the early retiree parent can simply be added on the working parent’s healthcare and all other benefits. Hey wait a minute, I think this is what happens already for stay at home moms or dads! Again, the difference is the aggressive savings plan, so study the chart above once again!
WHAT ABOUT INFLATION?
Inflation is a beautiful thing that scares people who do not understand basic economics. To put it simply, inflation rises when the economy starts to heat up, and falls or stays flat when the economy cools. People often ask, “What happens when inflation hits 8%? We need to invest and save more! We’ll be screwed!” We won’t be screwed. If inflation ramps from 2% currently to 8% in the future, it means the economy is ROCKING AND ROLLING! There is too much money sloshing around the system, and demand is too great, causing prices to rise.
What happens when “prices” rise? Your income and real assets rise. Nominal interest rates also start to rise, meaning the real interest rate return on your investments, CD’s, and savings also begins to rise. Nominal interest rates are generally higher than inflation, otherwise you’d have negative real interest rates. In other words, in a 8% inflationary environment, you might receive a 9% nominal interest rate on your yearly savings account, leaving you with a 1% real rate of interest.
Everything is aligned folks! Don’t let the inflation pollyanas scare you. Look at the 35 year chart of the 10-year US yield. It’s done nothing but go straight down. If people want to go more into detail and understand economics, let me know. But before we have an economics debate, please make sure you’ve at least read the basics.
WHAT IF YOU HAVE A DESIRE TO DO SOMETHING AFTER YOU RETIRE?
Believe it or not, some people actually want to continue to be active during their early retirement. Maybe they become park rangers, tour guides, freelance writers, or consultants. If your monthly individual operating expense is $50,000 a year, and you find a job you enjoy that lets you work part-time and make $20,000 a year, then you’ve suddenly bought yourself many more years in living expense coverage. Or put it differently, all you need to do is be an “Average Jane” in the example above.
There are thousands of things in this world that you can do to make money. And to let your mind languish after retiring from your day job is one of the dangers of early retirement. By making just $20,000 a year in a hobby she enjoys, “Average Jane” increases her disposable income in retirement by 50% to $59,000 from just $39,000 previously.
LESSONS LEARNED AND A 4th EXAMPLE
1) First and foremost, get a college degree because it will help set you free. Without a college degree, it’s unlikely any of these three would land their jobs.
2) The second lesson is that by living below your means, and sacrificing, you can essentially live for the rest of your life after 40 without having to work another day in your life.
3) Third, there will be people who say it can’t be done, but it can be done, because all three examples are real. Furthermore, I am a 4th example!
For 13 years I’ve saved 50-75% of my after tax income, leaving me with roughly 16 years worth of current living expenses (13 years x 1.2 in the chart above) based on my cash savings. If I decide to sell my house and live in a more cozy 2 bedroom condo/house, the living expense coverage rises to about 25 years. And If I sell my rental properties, the living expense coverage shoots to over 30 years.
What’s important is NOT the amount saved, but the annual living expenses coverage saved, since each person’s desirable living expenses are different. Maybe some people in the Mid West are happy with $3,000 after tax a month to live on, while others in NYC need $10,000 in after tax income to comfortably survive. Shoot, some of you might even want to move to Thailand, Malaysia, or The Philippines, where $2,000 a month in after tax income will let you live like Kings and Queens! Who knows the right dollar amount. It all depends on the individual.
WHY I SAVED SO AGGRESSIVELY FOR SO LONG
If I wasn’t whipped so hard my first two years out of college, I would never have saved so much. Thank you sir, may I have another! I worked for a firm that made me get in at 5:30am every morning and have me stay until 7:30pm on average every evening. Some evenings, we went to 10:30pm, which was brutal. Furthermore, I constantly had to work at least 5 hours a weekend, leading to a total time spent of roughly 75+ hours a week. I gained 20 lbs, was constantly under pressure, and was generally pretty stressed. Despite the pain, the one thing I knew was that if I could just get through these first two years, I would be set.
Given the difficult experience right out of school, I swore to myself that I would save like a maniac to have the optionality of retiring early if I wanted to. I NEVER wanted to go back to that situation again. To be able to have the freedom to answer to no one is priceless. Hence, saving 50-75% of my after tax income is such a bargain for priceless!
I should still probably work 4 or 5 years to save another 5-7 years worth of living expenses, just to be safe. However, ever since I published “The Curse Of Making Too Much Money And Not Following Your Dreams” over two years ago, I’ve been dreaming of doing something else. The dreams have led to my site, and I simply did not anticipate how much fun I’d have working online and writing! To top it all off, there’s actually an income component as well.
As a result of this unforeseen online opportunity, perhaps I will reach early retirement even earlier and stop being shackled by golden corporate handcuffs anymore. Retiring from a job I’ve done for well over a decade is scary since it’s been such a part of my life. However, I don’t know if there’s ever the right time to leave even if I do save another 5 years of living expenses. The signs sure are calling….
Recommendations For Helping You Reach Early Retirement
* Manage Your Finances In One Place: The best way to retire early is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing, how my net worth is progressing, and where my income and expenses are going to stay on budget. The best feature is their “401(k) Fee Analyzer” which is saving me over $1,500 a year in fees I had no idea I was paying! To build wealth, you need to be on top of your wealth. There is no better online tool I’ve found that has helped me build wealth than Personal Capital. The process takes less than a minute to sign up.
* Refinance Your Mortgage: If you are a homeowner and you have not refinanced in the past year, I strongly suggest you check online to see what the latest rates are and refinance your mortgage. I always check with Quicken Loans because they are fast, quick, and provide a no obligation real quote based on the input you provide. I recently refinanced to a 5/1 ARM for 2.625% in the Summer of 2012 after just refinancing in the fall of 2011 for 3.125% from 3.625%! Refinancing before retiring is crucial, because once you no longer have a W2 income, you become invisible to the banks!
* Check Your Credit Score: Everybody needs to check their credit score once every six months given the risk of identity theft and frequent credit score errors that need fixing. For over a year, I thought I had a 790ish credit score until my mortgage refinance bank on day 80 told me they could not continue due to a $8 late payment by my tenants from two years ago! Thanks to the late payment, my credit score was hit by 110 points to 680 and I could not get the lowest rate! I had to spend an extra 10 days fixing my score by contacting the utility company to write a “Clear Credit Letter” to get the bank to follow through. Check your TransUnion credit score for free here at GoFreeCredit.com and protect yourself.
Photo: Sunset at Islas Mueres, Cancun. SD.