Before the coronavirus pandemic, there was maximum Fear Of Missing Out (FOMO) with the Financial Independence Retire Early (FIRE) movement. It seems like lots of people want to retire early because they are seeing other people do so and living a fabulous life.
When I helped started the modern day FIRE movement in 2009, the focus was on earning as much passive income as possible to pay for our lifestyles.
Unfortunately, a lot of people are retiring early and ruining their finances and their lives because they did not accumulate enough after-tax investments to generate enough passive income to cover their expenses. People are retiring without strong fundamentals because they see so many retire so soon.
Does it really make sense to retire early only to live near abject poverty? I don’t think so.
Suze Orman, a famous personal finance guru for the past several decades says she hates the FIRE movement. She says retiring early will be the biggest financial mistake of people’s lives and that we should work at a job we’re passionate about for as long as possible.
Further, she says that we need $5 million to retire early. Her views have ruffled a lot of feathers, but after crunching the numbers, I have to agree. $5 million sounds about right if you want to retire before the age of 60. Bad things happen in life all the time that costs money!
Here’s Why You Need $5 Million To Retire Early
After maxing out your 401(k) and other pre-tax retirement contributions, it’s important to generate as much after-tax investments as possible for passive income.
After-tax investments include all stocks, bonds, rental property equity, real estate crowdfunding, business equity, and private investments. You could include your primary residence equity if you plan to rent out rooms or sell the property, but a conservative person would not.
Given after-tax investment money is what is required to generate passive income and live a comfortable life in early retirement, it is therefore logical that after-tax investment money equals a multiple of pre-tax money. The greater the ratio of after-tax money to pre-tax money, the easier it will be to survive in retirement without a job.
Have a look at my base case after-tax investment amounts chart, which will allow you to comfortably retire between 40 – 50 if you so choose with a safe withdrawal rate of between 3% – 5%. This is the base case scenario.
Retiring at 40: 40 is the earliest I’d recommend anybody retire. You’ve worked at least 18 years and have given your investments a good enough amount of time to compound. Accumulating $1,000,000 in after-tax investments sounds great if you’ve been diligently saving and investing since you entered the workforce, but it’s only going to spit out about $40,000 a year in gross income. Unsubsidized healthcare premiums alone cost roughly $20,000 a year in after-tax dollars for a family today. Good luck enjoying a comfortable life with what you have left.
Retiring at 45: If you retire at age 45 with $1,875,000 in after-tax investments, you’re still only generating about $75,000 a year in gross income at a 4% rate of return. After tax, we’re only talking about $52,000. That’s definitely not enough to retire comfortably if you have family and elderly parents to support.
Retiring at 50: With $3,000,000 in after-tax investments at age 50, you’re earning $120,000 in gross income before taxes or $85,000 after-tax. Not bad! But you’ve got to live in a cheaper part of the country and stay frugal if you have kids and parents to care for. At this age, you might as well keep on working until you’re 60 to eliminate the risk of financial shortfalls. Only at 59.5 can you withdraw from your pre-tax retirement accounts without a 10% penalty. By then, you’re so close to receiving Social Security.
Retiring with $5,000,000: Having $5,000,000 in after-tax income generating $200,000 a year in passive income is about right if you have a family and plan to live in an urban city like SF, LA, NYC, Seattle, DC, and Boston. In fact, $200,000 a year in passive income was always my goal when I left the work place in 2012 at the age of 34.
When I left, I had about $80,000 a year in passive income. That was enough since I only had myself to take care of. But with a son and a non-working spouse, I definitely need around $200,000 in passive income today to live a comfortable lifestyle in expensive San Francisco. Here’s a realistic budget for a family of three living in San Francisco.
We’re ultimately trying to get to $250,000+ in passive income or more by the time our boy goys to kindergarten. If he doesn’t get into a good public school due to the SF lottery system, grade school tuition will be between $25,000 – $40,000 after-tax. That’s nuts!
If I was completely comfortable with having ~$5,000,000 in after-tax investments, then I’d probably relax more and also not write as much on Financial Samurai. But, once our son was born in 2017, I became motivated like Popeye after eating some spinach to try and earn some supplemental income in retirement just in case. I didn’t want to leave our life up to a lottery.
Finally, one of our largest and most necessary costs is our monthly health insurance premiums at $1,700. Spending over $20,000 a year in health insurance premiums alone is something every early retiree with a family needs to strongly bake into their numbers.
Below is a snapshot of my passive income streams with real estate crowdfunding my favorite passive income stream at the moment. I’m focused on investing in the heartland of America where valuations are cheaper and net rental yields are higher.
This detailed passive income portfolio has taken about 19 years to build and is worth about $5,000,000. Yet, it’s still not considered enough due to healthcare costs, ever rising tuition, and elderly parents I need to take care of soon.
Very Few Retire Early
Only 18% of Americans retire before the age of 61. Therefore, it’s normal to feel bothered by Suze Orman’s statement and my realistic after-tax calculations.
Even if you don’t achieve my figures, at least with focus, and proper financial planning, you will come closer than those who don’t even bother. Retiring younger while living longer does not make good financial sense.
Key Points To Remember For Early Retirement
1) Passive income is everything if you truly want to live a carefree retirement lifestyle. Shoot to have as much in after-tax investments as you do in pre-tax investments by age 30.
2) Earning supplemental income in early retirement is beneficial. Every $10,000 in supplemental income you make equals $250,000 in capital at a 4% withdrawal rate.
3) Don’t underestimate the cost of healthcare and accidents. The average company pays $20,000 a year in healthcare costs for their employee. If you retire early, you will bear these costs as we do with our $1,700/month bill. Bad things do happen all the time folks! Think about sickness, aging parents, accidents, infertility treatments, and more.
4) The longer you work, the less you need. Although your net worth starts to skyrocket the older you get due to the power of compounding, you ironically need less money the later you retire. People suffer from the “one more year syndrome” all the time due to this fact. However, we’re living longer so either working longer or having more money is a must.
5) A safe withdrawal rate is between 3% – 5%. The risk-free rate of return (10-year US treasury bond) is now roughly 3%. Therefore, you can withdraw 3% from your after-tax investment accounts every year and never touch principal. Keep the maximum withdrawal rate at 5% if you don’t plan on making any supplemental income in retirement. By the time you turn 60, your pre-tax retirement accounts will provide you an extra financial boost if necessary.
6) Don’t confuse brains with a bull market. One of the most dangerous things you can do is extrapolate the gains you’ve made in the last 10 years with the next 10 years. Your risk-tolerance, income payouts, and investment returns will all change once the market turns down. A lot of FIRE people got slaughtered during the March 2020 downturn and panicked.
Retire Early Smartly
For those curious, at 34, I left with a 4X multiple, which equated to about $2,000,000 in after-tax investments producing about $80,000 in passive income. Yes, it was a little scary to leave so young.
But with a severance package and only myself to provide for at the time, I wasn’t overly worried in 2012. The goal after leaving work was to build Financial Samurai and accumulate enough in my after-tax investments to generate a $200,000 passive income stream to provide for my potential family.
If I hadn’t received a severance package, I most likely would have worked for three more years and saved at least 50% of my income to boost my after-tax investment accounts to 5X. Thankfully, it’s been a raging bull market since I left, so my multiple has continued to expand.
Leaving a steady paycheck is not easy, especially if you’ve had one for decades. But if you hit these target multiples, early retirement is much easier to experience.
The folks selling you the dream of early retirement are either trying to justify their early retirement move or trying to actively earn money online by selling you the dream. If you truly were comfortably in early retirement, you wouldn’t have to incessantly tell everybody how wonderful it is.
Finally, make sure you’re diligently tracking your finances on your road to early retirement. It’s vital to make sure your investments are properly allocated based on your risk tolerance. When you’ve no longer got a safety net, it’s up to you to create your own!
About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $200,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.
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