Early retirement is a double whammy to your retirement savings. Making your money last through retirement is not easy and it becomes much more difficult if you retire early. Quitting your job and taking an early retirement means less time to save AND more time to spend.
Let’s look at some numbers here. We’ll keep it simple and use the life expectancy of 80. We’ll also assume $30,000 per year in expenses. We’ll ignore inflation and investment returns in this post.
|Roy – Regular retiree||Alex– Early retiree||Bob– Retire at 40|
|Age of retirement||65||55||40|
|Years in retirement||15||25||40|
|Savings prior to retirement needed due to expenses at $30,000 per year||$450,000||$750,000||$1,200,000|
It’s clear that the earlier you retire, the more retirement savings you’ll need. If we take social security payments into account, the regular retiree will need less savings. The average social security benefit for a retired worker is $15,000 per year. This will enable Roy, regular retiree, to save less for retirement. He only has two years to go before he reaches 67 and be eligible to receive full social security retirement benefits. He needs to spend $30,000 for two years. After that he can spend $15,000 of his own savings plus $15,000 from social security benefit for a total of $30,000 per year.
Taking the social security benefit into account.
|Years before social security benefit||2 years ($60,000)||12 ($360,000)||27 ($660,000)|
|13 years with social security benefit (15k/yrs)||$195,000||$195,000||$195,000|
So you can see that if you retire 10 years earlier you’ll need twice as much saved prior to retirement. If you retire at 40, you will need more than 3x the retirement savings of a regular retiree.
This is one reason why most people can’t conceive of retiring from their job in their 40s or 50s. Most people over 60 years old have less than $100,000 in retirement savings. Is it possible to save 2x or 3x so you can retire early?
Retire By 40 draw down strategy
All is not lost. There are other ways that we can stretch our retirement savings. Moving to an area with lower cost of living is one way to make our savings last longer. Another is working part time or making money from a hobby/micro business. Every situation is different and I am very lucky that Mrs. RB40 likes her job and is planning to continue to work.
Here is my personal draw down strategy. This is the targeted goal and it might fluctuate a bit. That’s why we have a large cash savings set aside at the moment.
40 to 55 years old
25% of expense – Rental and dividend from taxable account (including 11% from Peer to Peer lending) generate passive income.
25% of expense – My online and other freelance income.
50% of expense – Mrs. RB40 continues to work and contribute to her retirement fund.
55 to 65 years old
Mrs. RB40 can retire around this period and take a full or partial pension as needed.
25% – Passive income from rental and dividend from taxable investment.
25% – My online and other active income.
50% – Mrs. RB40’s work or pension.
65 to 70 years old
At this point, we might have a big college tuition bill and we can withdraw from the retirement account for this purpose. We probably need to spend more money on our health at this point as well. Let’s say I’m tired of freelancing and decide to just sit next to the pool at this point too.
25% – rental and dividend from taxable account
50% – Mrs. RB40’s pension
25% – Roth draw down
College tuition for baby RB40 or health spending – 401k withdrawal
Fun money – If we get any social security benefits, we’ll ear mark it for fun and travel. The more likely scenario is that we’ll use the extra social security benefit to cover inflation.
70 to 80 years old
Continue with what we were doing and take minimum distribution from 401k.
That’s my plan for the next 40 years. Of course real life rarely goes as planned so we might have to make some adjustments. If our investment crashes completely or if we run into other problems, I might have to go back to work for a corporation. However, if we keep our lifestyle inflation down and I can make some money freelancing, then I think everything will work out. The key to my early retirement is putting off the retirement account withdrawal until much later. The mix of passive income and online/freelance/part time job income are a big part of my plan. The truth is I can’t stop working completely yet, but I only need to make a bit of money every month to make ends meet. If I don’t make any money for a few months, we can use part of our cash saving to help pay the bills.
Early retirement is not easy, but if you invest a large percentage of your income and live a reasonable lifestyle, then it is possible.
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Update: I left my job in July 2012 and I’m being a full time stay at home dad for the time being.