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 since I graduated from college in 1999. In 2012, I was able to finally leave my day job in finance and I haven’t returned since.
As I look back upon my time as an early retiree, there really isn’t much I would change. Having all the freedom in the world is priceless. You will not regret all the work it takes to achieve financial freedom. But you may regret looking back on your life and wishing you didn’t try harder or take more risks.
What’s important is recognizing your inner frugality, your Herculean discipline, the government’s generosity, and your enormous hustle. There’s nothing better than taking action with your finances and seeing results!
Example Of People Who Have 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 complement your other tax deferred retirement savings.
Example One: Average Jane
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 Two: Floyd, The Go-Getter
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 Three: Felicity, The Talented
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 Savings Chart
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!
Below is another savings good you can follow to help you retire early. I recommend saving at minimum 20% of your after-tax income. If you can save 50% of your after-tax income a year, you should be able to retire after 18 years.
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 Child Tax Credit is worth up to $2,000 per qualifying child. The age cut-off remains at 17 (the child must be under 17 at the end of the year for taxpayers to claim the credit).
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.
As a father now, one thing I strongly believe is this saying: “have children and the money will come.” I have never been more motivated to earn more and provide for my family than after my son was born.
But I will be honest with you guys, we pay a hefty $2,380/month in health insurance premiums in 2020 for a family of four. When the stock market began melting down in March 2020, I felt an uneasiness I had not felt in over 10 years. Retiring early with more than one child is hard!
Not only are we aggressively saving in each child’s 529 plan, we’ve got to pay for preschool tuition and potential grade school tuition of our children do not get into a good public school that’s close by.
What About Inflation Eating Away At Returns?
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 5%? We need to invest and save more! We’ll be screwed!” We won’t be screwed. If inflation ramps from 2% currently to 5% 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, money market savings rates, and real estate also rises.
Inflation is why I’m a big buyer of real estate. Not only does the price of real estate rise and often increase faster than the rate of inflation, rental income also rises with inflation. One of the easiest ways to gain exposure to real estate is through Fundrise, my favorite real estate crowdfunding platform.
With Fundrise, you don’t need to come up with a 10% – 20% downpayment and take on massive leverage to buy a single property. You can invest a small amount in one of their specialty eREITs to give you exposure to specific regions of the country. Fundrise is free to sign up and explore.
Everything is rational folks. Don’t let the inflation pollyannas scare you. Look at the 40-year chart of the 30 year mortgage rate. It’s done nothing but go straight down. But if inflation does tick up, interest rates will tick up, and risk-free coupon yields and dividend yields and rental yields will also tick up. In other words, you’ll be earning a higher rate of return on your income producing investments.
Everybody needs to take advantage of all-time low mortgage rates and refinance now. You can check the latest rates and receive real quotes from Credible, my favorite mortgage lender. Credible has qualified lenders competing for your business so you can get the lowest mortgage rate possible.
What If You Desire To Do Something After You Retire
Believe it or not, some people actually want to continue being 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.
A 4th Early Retiree Example
For 13 years after college, I saved 50-80% 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 downsize, my 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 so much the amount saved, but the annual living expenses coverage saved, since each person’s desirable living expenses are different.
Maybe some people in the Midwest 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! The right dollar amount. It all depends on the individual.
Since leaving work for good in 2012 at the age of 34, I’ve consulted part-time for financial technology startups, wrote a book on how to negotiate a severance that now brings in ~$50,000 a year in passive income, became a championship high school tennis teacher for four months out of the year, and built Financial Samurai into one of the largest independent personal finance sites on the web with over 1.5 million pageviews a month.
Further, in 2017, I decided to sell my SF house I bought in 2005 for 30X gross annual rent and reinvested the proceeds in real estate crowdfunding for less hassle, lower valuations, and higher passive returns. Building passive income is the name of the game in order to stay retired. Below is my latest snapshot.
As you can see from my latest retirement portfolio, my wife and I no longer have to work day jobs again. We can remain stay at home parents because we have saved and invested regularly for the past 20 years. We also find alternative ways to make money in retirement thanks to the internet.
The Sacrifice Is Worth It
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 5:30 am every morning and have me stay until 7:30pm on average every evening. Some evenings, we went to 10:30 pm, which was brutal.
Further, 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!
There is no rewind button in life. Save aggressively, invest consistently, and I’m sure that after 10 years, you will be able to see the finish line.
Recommendation To Build Wealth
Get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts on their Dashboard 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 track 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 spending is going.
One of their best tools is the 401K Fee Analyzer which has helped me save over $1,700 in annual portfolio fees I had no idea I was paying. You just click on the Investment Tab and run your portfolio through their fee analyzer with one click of the button.
Finally, they just launched the best Retirement Planning Calculator online. Unlike other retirement calculators, their calculator pulls in your real data and runs a Monte Carlo simulation to produce the most likely financial scenarios. You can input multiple different expense, income, and life events to see how your finances shape up.
Charts completely updated for 2020 and beyond.