I didn’t start saving for my retirement until I was 40 years old. I actually semi-retired at that time too, even though my net worth was minus $30,000 (due to student loans). Yet I will be okay in retirement, in fact, better than 90 percent of people my age. The thing that I did was save 40 to 50 percent of my income when I started making a good income. Some people say this is impossible. I have actually been called a liar when I have made this claim on blog comments and newspaper articles.
Nowadays when people call me a liar for saying that I saved 40 to 50 percent of my income, I just refer them to the Retire by 40 blog where several people have indicated they are saving not only 50 percent, but up to 70 percent of their income.
Ernie, thanks for sending readers to Retire By 40! Saving 50% of your income is intimidating. No wonder people don’t think it’s doable.
Is it really possible to save 50% of your income? Isn’t it enough to save 10-15% of your income as most financial planners suggest? Sure, if you want to retire at 65 or 70, then you’ll probably be fine with the recommended saving rate. However, life never goes the way we plan. I didn’t plan to quit my engineering career when I first started out. Your health might prevent you from continuing in your chosen field. Your career might not be the right fit anymore after 20 years. Stuff happens and we have to react to it to the best of our capacity. Saving more will give you the freedom to choose when the stuff hits the fan.
Increase your saving as you age
I didn’t keep careful track of our cash flow in our 20s so I’m not exactly sure how much we saved back then. We maxed out our 401k and Roth IRA, so I’m sure we saved more than 15% of our income. As I got older and became disenfranchised with the corporate life, we began to save more and more of our income. In the last 2 years of my career (2010 to 2012), we saved all of my post tax and deduction income. That was definitely more than 50% of our gross income back then and it really beefed up our after tax accounts. Currently, we are saving a pretty good amount, but not 50% of our gross income. We’re pretty close to 50% if we look at the after tax/deduction income, though. Last year we saved $56,800 in our tax advantaged accounts if you’re curious.
Clearly, saving 50% of your income is doable. It’s not easy, but if you want to reach financial independence, then this is the sure fire way to do it. Some might win the lottery or inherit a fortune, but for the rest of us, here are the 3 simple steps toward saving 50% of your income.
Note: Let’s just go with after tax/deduction income for this article. It’s much easier because tax can take a huge bite out of your income when you are in the higher brackets.
1. Make Good Income
As Ernie mentioned in his comment, he didn’t save 40-50% of his income until he started making good money. Most of us don’t want to live in an RV and eat beans everyday just to save money. That doesn’t sound like a fun retirement to me. To live a comfortable lifestyle and save 50% of your income, you need to make good money.
What’s good income? Let’s go through a quick example. Let’s say Mary and John are both working in a household with no kids. They make $60,000 each for a total of $120,000 household income.
I used the estimator at TurboTax and it said they will have to pay $16,644 in tax. Let’s throw in 10% for state and property tax for an additional $12,000. That’s about $28,500 going to uncle Sam and your local government. We also need to add other deductions like health and dental insurance.
- Household income = $120,000
- Tax = $28,500
- Other deduction = $3,500 (This is just a guess because I haven’t seen an actual paycheck in a few years.)
- They will take home about $88,000
If our couple wants to save 50% of their take home income, then they’d have about $44,000 to work with. I guess it really depends on where you live and your lifestyle, but it’d be tough for us to live on $3,667 per month at this point.
Of course, you can save 50% if you are dedicated and live frugally, but it’s much easier if you make a good income. I think you need to make at least $120,000 to be able to save 50% of your income if you live in a city on the West coast. It would take less in Texas or other more affordable locations.
2. Live Below Your Means
The problem with making more money is that people tend to spend more money, too. A typical couple who makes $120,000 per year won’t want to live on $3,667 per month. They’d rather spend $6,500 per month and save about 10% of their income. That’s the norm, right? If you really want to save 50%, then you need to live below your means. You can afford to spend, but you value financial independence more. Saving 50% of your income will enable you to get there much faster.
This doesn’t mean you need to live frugally. If you make a million bucks per year, then you’d have a lot more take home income to play with. See why ‘Make Good Income‘ is #1? It is possible to save 50% by living really cheaply, but it probably is not sustainable for the long haul.
Here is the real secret to saving 50% of your earned income* – making your money work for you. We have been focused on earned income up to this point, but as we can see from our theoretical couple above, it is really difficult to save 50% of your income even if your jobs pay 6 figures per year.
*At this point, I’m going to cheat and say Saving 50% of your income really means Saving 50% of your earned income.
What you need to do is to invest all that saving. The compound return will give your saving rate a big boost over the long haul.
Here is a scenario. If John and Mary couldn’t invest 50% of their earned income now, they can start off with a bit less. I think a $5,000 per month budget is pretty comfortable. They can save $28,000 per year. Assuming 5% rate of return, their $28,000 will make $1,400 in the first year. The second year, their investment will make $2,870 and this amount will increase every year due to compound interest.
After 9 years, their saving rate will reach 50% of their earned income. We’ll ignore inflation and raises in this article. It’s already getting too mathy. Anyway, after 9 years, the interest from their investment will be about $18,000 per year. That will be enough to push their saving rate pass the 50% mark.
Now you see why the rich are getting richer. It’s just economics.
Here are the 3 simple steps.
- Make Good Money – You need to make money to save money.
- Live Below Your Means – Don’t spend every penny you bring in.
- Invest – Compound interest is your best friend when it comes to money.
It’s not easy to save 50% of your income, but the pay off will be worth it. The day your investment income can pay your living expense will be one of the happiest days of your life. That’s financial independence, baby!
Are you saving more than 50% of your income? What’s your secret?