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There are a lot of reasons why I plan to retire early, but a huge factor is that retiring early decreases the risk of retiring without enough money.
Most of us are predisposed to assume we will have a long career and retire somewhere between ages 55 and 70. Our older family members, friends, and everyone around us models this behavior, so we assume this is the safest path to avoid our fear of waking up without money in the bank in our eighties.
Despite the conventional wisdom, retiring early is actually safer. The most financially conservative and risk-averse path to make sure you do not run out of money in retirement is an early retirement plan.
Retirement Math: The 4% Rule
One of the most common questions we receive is, “How much do I need to retire?” Unfortunately, that answer depends entirely on your lifestyle, and the only way to calculate it is to determine how much money you spent over the past year.
Here is the two-step explanation of how to figure out how much money you need to retire:
Calculate how much money you spent last year, excluding any retirement contributions.
Multiply the amount of money you spent last year by 25. The product is what you need to retire.
This is why retirement numbers vary. If you spent $20,000 last year, you can retire with $500,000 because $20,000 x 25 = $500,000. Oh yes, it is absolutely possible to retire on less than $1 million. A retirement nest egg of $1 million funds a $40,000/year existence in retirement (assuming no taxes, since long-term capital gains will incur a 0% federal tax rate in 2023 for total income under $44,625 to $89,250 based on your filing status). Since many retirees have paid-off homes and no work commutes, their lifestyles do not cost much. That said, if you want a luxurious retirement, that works too. If you want to spend $150,000/year in retirement, you will need $3,750,000 to retire.
The 4% rule assumes that 4% is a safe withdrawal rate, so if you save up a principal amount 25x your annual expenses, you will be able to withdraw 4% to live off of in perpetuity. Your investments will grow to cover your withdrawals and inflation, rising slightly over time. In other words, you retire with $1,000,000, withdraw $40,000 each year because it is 4%; the market grows 7% that year to cover your withdrawal and any inflation. You never have to withdraw the principal because you are just living off the interest gained each year. (The rates of 7% for market growth and 3% for inflation are long-term annual averages. In reality, some years they will be more, and some years they will be less.)
In reality, you can make the same calculations based on a 3% or 5% withdrawal rate if you have a lower or higher risk tolerance, but 4% is the commonly accepted safe withdrawal rate based on the Trinity Study, which examined what withdrawal rate would guarantee not running out of money in retirement by examining returns for portfolios invested in entirely stocks, entirely bonds, or mixed at different allocations over the period of 1925 through 1995. The abbreviated conclusion was that in stock-heavy portfolios (where stocks composed 50%, 75%, or 100%), retirees did not run out of money 95%-98% of the time over a 30-year retirement with a 4% withdrawal rate and never ran out of money with a 3% withdrawal rate.
So why not just wait and assume a 3% withdrawal rate to be safer?
In the example of living off of $40,000/year, living off a 3% withdrawal rate would require $1,320,000 instead of $1,000,000. That is an extra $320,000, a lot of extra years of your life, and just a lot of work. Do it if you need to in order to sleep at night, but I honestly do not recommend it.
Instead, I recommend aiming to invest enough that you would feel comfortable living off of 4% of it before retirement age since it saves you money, saves you time, and is a better safeguard against risk.
It should be said that historical precedent does not guarantee your results will follow suit, but my argument here is not that the rate of return will remain constant. Instead, at Phippen Tax & Financial Services, we believe retiring early, or at least having the money to potentially retire early, eliminates as much risk as possible in running out of money in retirement. In addition to alleviating risks, it has the added bonuses of saving you time and money. In fact, retiring early means saving millions of dollars over the course of your lifetime.
Retire Early to Save Money & Decades
I cannot explain this any better than Grant Sabatier did in Financial Freedom: A Proven Path to All the Money You Will Ever Need, so I will just use his words and encourage you to buy his book*:
“The younger you are, the less money you need saved before you can ‘retire’ as long as you follow a few simple rules.”
He means literally. You literally need fewer dollars to retire, the earlier you retire:
“You can retire with less money at thirty than you’ll need at sixty and not have to work for that extra thirty years. It sounds crazy, but because of how the market works and the magic of compounding, it’s true.”
Yes, that principal you need to save is lower if you retire at age 30 than if you retire at age 40, which is lower than if you retire at age 50, which is lower than if you retire at age 60.
For a lot of folks we work with, this is counterintuitive: You may be predisposed to think that the more years you will be retired, the more money you will need because you will need 40 years of retirement funds instead of 30. We also get questions about how to figure out how to save for retirement when you do not know your life expectancy.
The answer is simple. You do not need to know how long you will live or how many years you will be retired because that has no effect on the amount of money you need to retire.
So, how can you retire with less money at a younger age without figuring out how many years you will be retired?
You will never draw down on your principal investment.
Market growth will provide you the 4% interest you need to survive.
Market growth will account for inflation, making the principal grow.
To use Grant Sabatier’s numbers, if you retire at age 30 with $1,000,000 as the principal so you can live off of $40,000, your investment will account for inflation. The principal will grow each year. By age 60, you will still survive by withdrawing 4%, more than covered by the interest. However, the principal will be much higher. Much higher.
This is where the math becomes crazy and the argument for early retirement compelling. Say you need $1,000,000 to live off of $40,000/year at age 30, and assume inflation is 3% each year. Your invested principal will account for inflation and pay for your lifestyle, which will cost $97,090.50/year when you hit age 60.
If you retired at age 60 instead of age 30, you would have to account for inflation. That means you would have to save and invest 25x your annual expenses of $97,090.50, or $2,427,262.47
To summarize, to fund the exact same lifestyle, you would need to save the following amounts, the older you retire:
Personally, I would rather retire early and not need to work to earn an extra $1,427,262.47 to retire at age 60 or an extra $2,262,037.79 to retire at age 70. While I did not hit the amount I need to survive forever by age 30, I will by age 40. Even if you need a bit longer, it is still worth shortening your path to hitting that hypothetical retirement number: You can see that the number increases by a lot more between 60 years old and 70 years old than between 30 years old and 40 years old. That is compound interest working against you.
Retire early, and you let compound interest work for you instead.
Retirement Failure
If you are still afraid of retiring early, your fear is misplaced. You should be afraid of retiring at the socially acceptable retirement age.
If you remember that Trinity Study investigating safe withdrawal rates, there was a 2%-5% chance of running out of money with a 4% withdrawal rate. In other words, this is not a risk-proof retirement method.
But it is close. The 2%-5% of portfolios that did not survive shared a key characteristic. These portfolios were held by folks who retired immediately before a huge market drop, causing their portfolios to plummet within the first five years of retirement. Since they had to withdraw part of the principal, their portfolios could never recover from the initial economic downturn.
A severe economic depression is unpredictable, so there are two scenarios when it comes to your decision of how you handle an economic depression affecting your retirement:
You retire at age 35, the economy crashes within the first five years of your retirement, and you go back to work for a bit between ages 36-41 to bolster your portfolio until the economy improves.
You retire at age 65, the economy crashes within the first five years of your retirement, and you go back to work for a bit between ages 66-71 to bolster your retirement until the economy improves.
Most of the time, compound interest will work in your favor to carry you through retirement. If your portfolio grows through the first five years of your retirement, barring a crazy and historically unprecedented economic depression, you would weather any later economic downturn.
But let’s say you are in the unlucky 2%-5%. I would much rather get financially unlucky between ages 36-41 than ages 66-71. It is much better to fail at retirement in your 30s than your 40s, in your 40s than your 50s, in your 50s than your 60s, and in your 60s than your 70s.
If you are going to fail at retirement, fail early.
If you end up retiring at an unlucky time, the solution is simple: You just go back to work. Retirement failure sounds scary at first. However, if you remember that “failure” to retire early just means going back to work exactly like you would have been doing anyways if you had not retired early, it does not seem so bad.
Additionally, you probably made some great memories in the year or years you were retired. Going back to work early is also advantageous over going back to work in your 60s or 70s. You experience less age discrimination and likely can adapt more easily to changes that occurred over the years you were away from work.
A retirement “failure” is also along a spectrum. You will recognize that your retirement plan is not working long before you drain your investments down to zero. Once you have consecutive years of withdrawing part of the principal investment, the red flags should go up and indicate that you need to make some changes. If you really do not want to go back to work, those changes may be moving to a place with a lower cost of living or making changes that decrease the cost of your lifestyle. Going back to work may also mean going back for 10 hours/week or finding an extremely flexible remote position that you can do from anywhere in the world. You still have the kind of financial freedom that exists with being 90% of the way to a principal investment that could support you in perpetuity!
I cannot guarantee that you or I will not be one of the unlucky retirees who decide to retire right before the next economic depression. However, I can guarantee that it is a lot easier to make adjustments and potentially go back to work at a younger age. So give retirement a try, before the conventional timeline.
Retirement Fears
We typically see two prominent fears about retiring early:
Running out of money
You will not run out of money. The fear of “running out of money” stems from an assumption that you retire and never look at your finances again. In reality, if your retirement plan is not going according to plan, you will recognize it within the first five years and adjust to fix it, either by changing your lifestyle or going back to work. You do not completely lose the ability to think as an adaptable human being just because you retired.
“Failing” at retiring does not mean you suddenly have $0: It most likely means you withdraw $10K of the principal because the interest was not enough to cover your lifestyle, so you need to make a bit of money next year to replenish and cover that lifestyle difference.
Aging early and being bored
Retirement does not mean exclusively playing golf or tennis and sitting on a beach or a porch spying on the neighbors. It can, if you want that lifestyle, but that is not fulfilling for most, whether age 35 or 85.
A lot of folks discard the idea of retirement because they do not know what they would do with all their spare time without a job. Here is the solution: Pour yourself into your passions. In some cases these will be paid opportunities, and that is okay! If you are setting your schedule, controlling your time, prioritizing your values, and only doing the tasks that give you joy, you are “retired” even if you happen to be receiving a paycheck.
Alternatively, throw yourself into volunteer work. Improve your community. Use skills you acquired from your job to help low-income individuals access specialized skills they usually cannot afford. Spend more time with your family members. See the world, and become a more open-minded and knowledgeable individual along the way. Become a political activist and actually work to eliminate discrimination rather than just complaining about it. If you are not at work, you have time to change the world for the better in whatever way you see fit.
When Should I Retire?
You should retire at the time that is right for you!
Your retirement age will be different from mine, your best friend’s, and your coworker’s, and that is okay. Retire when it works for you, but here are a few pointers to help you determine when that is:
Aim to have a large enough principal invested that you could retire a few years before you want to retire, so you hit that number when you would not mind going back to work if you hit an economic depression.
If you can, it is nice to move your potential retirement date a bit earlier so you are less likely to encounter age discrimination and have more flexibility.
Use your early retirement to follow your passions. If you love your job, you do not have to stop working at the point that you have a large enough principal. You just have the freedom to decide.
While getting to retirement early decreases the amount of money you need to retire, frees up decades of time, and decreases the risk of retirement, you do not need to retire as quickly as humanly possible. The path to retirement is not a sprint, so make sure you spend to increase joy in your life while saving and investing prudently. Find a balance where you enjoy the ride of life but eliminate the fear that you will not be able to retire or will run out of money.
Because you will not run out of money, if you retire early.
*If you are interested in retiring early but unconvinced, or you have a partner who remains unconvinced, buy Grant Sabatier’s book, Financial Freedom: A Proven Path to All the Money You Will Ever Need! It presents the message and the math in a clear and digestible manner.
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