No matter what age you want to retire at, you need a plan to get there. Unless you take the steps now, you won’t have enough money to live comfortably in retirement.
But how much is “enough”? Each person’s answer will be different, but everyone can use the same simple math to figure out how much money they’ll need to save before they can stop working.
The One Factor that Determines When You Can Retire
Calculate your savings rate to see how much you can put away for retirement
Everyone has their own "savings rate," which is calculated as the percentage of your disposable income you set aside as a nest egg for your retirement.
Your disposable income is the amount of money you earn from all income streams after taxes are deducted (it's also known as your "take-home pay.")
Your expenses, including what you spend on accommodations, utilities, phones, and food, are subtracted from your disposable income to calculate your savings.
Divide your savings by your disposable income, multiply by 100, and then you've calculated your savings rate.
The math is easy, just plug your numbers in. Here's an example of a savings rate calculation.
Let's say a person has an after-tax disposable income of $60,000.
When they add up all the year's expenses, their total spending is $45,000.
$60,000 in disposable income, minus $45,000 in spending, means their total savings is $15,000.
If you divide $15,000 by $60,000 and multiply by 100, you get the person's savings rate which in this case is 25%.
You can substitute these numbers with your own to calculate your savings rate!
Zero in on some of the numbers impacting your savings rate. Your savings rate is important because it calculates the relationship between what you earn and what you spend.
How much you make on an annual basis, and how much you can live on, are two crucial elements you need to focus on if you want to achieve early retirement.
By making changes to those numbers, you'll be able to adjust your savings rate in your favor.
Your goal is to set your savings rate at the appropriate level so that you save enough money to support yourself in retirement as early as possible.
Your savings rate is so important because it determines how much money is left for investment toward the goal of a comfortable early retirement.
Are you happy with your savings rate?
Once you've calculated your savings rate, there's a good chance you won't be happy about the number you see.
Hopefully, it's not a negative number, or you're going in the wrong direction (into debt).
What you need to remember is the higher your savings rate, the quicker you'll have what you need to retire.
Follow the 4% rule. The general rule of thumb for determining how much you'll need to have saved in order to retire comfortably is known as the "4% rule."
By only withdrawing 4% out of your total retirement savings each year, you can keep a steady income stream without depleting your retirement accounts.
Experts say you should expect to spend about 70–80% of your normal pre-retirement expenses when you retire (adjusting for inflation at a rate of 2% per year).
It's the same math whether you retire early or later. Let's say you have current expenses of $45,000 a year.
If your expenses will cut back to 80% of that number in retirement, it means you'll expect to spend $36,000 a year.
$36,000 each year is 4% of a $900,000 total retirement savings nest egg.
Which means you need to build a $900,000 retirement fund.
By putting your savings into a low-risk investment portfolio you should be able to outpace the 2% rate of inflation and the 4% you withdraw each year.
Basically, you'll be enjoying life as a retiree by living off the investment dividends and interest from your $900,000 nest egg.
When you pass away, the money you worked so hard to save will be passed down to your family.
How to Buy Yourself the Freedom to Retire Early
Earn more income, spend less, and save more
If you're like a lot of people, what you'll realize is you can't retire early unless you can change the factors influencing your savings rate.
You need to earn more money, spend less of it, and save more of it to make the dream of early retirement a reality.
Increasing your income gives you more money to work with
If you're between 25 and 50, you're in your peak earning years.
You need to make the most of your earning potential and set yourself up with some passive income streams that you can continue to profit from post-retirement.
Diversify your income streams. Set yourself a goal to develop more earning streams in a specific amount of time.
Potential side hustles include rental income, making money by selling things on Craigslist, mowing lawns, tutoring students, or participating in paid market research.
Aim for getting a promotion at work. Most jobs will give you an increase of 1–3% each year to keep pace with the increases in the cost of living.
But what you need if you're going to increase your income enough to retire early is a promotion and a raise. Only ask for either if you can demonstrate you've added value to the organization.
Put together a list of all the problems you've recently solved and a list of the problems you could solve if you were promoted.
Present this list to your manager, and discuss what you could achieve in the future, and opportunities for growth.
Start a business. Changing from working for others to working for yourself usually also means an increase in income.
Take what you've learned from your career so far and bump it up another level.
Scale your existing business.If you already have a business, think about how you could expand it or make the most use of your current assets to generate more income.
Get rid of debt as quickly as possible
One of the biggest barriers to saving enough for retirement is debt.
If you're carrying a lot of high-interest debt, the money you could be putting away for retirement is being drained on interest payments.
The types of debts you might be paying interest on include your mortgage, car loan, student loan, credit card balances, or personal loans you took out to cover other expenses.
If you're struggling with managing different types of high-interest debts, you could benefit from consolidating them all into one single loan.
A debt consolidation loan can help you regain control of interest rates by repaying your debt in a fixed time-frame while also having the ability to pay fixed rates.
Get smart about taxes
Another drain on the money you could be putting toward your retirement savings is income tax.
Talk to your accountant about ways to sync your retirement savings with reducing the tax you're paying now.
Save on taxes by saving for retirement.For example, by putting money into registered retirement savings accounts like 401(k)s or IRAs, you can defer paying tax on the income until you cash them in.
Since your income will be a lot less when you're retired, you will probably be in a lower bracket and you'll save money.
Reducing spending is as important as increasing your income
Tighten up your everyday spending. You'd be amazed at how much our little daily indulgences add up.
You don't have to cut out things you really enjoy, but you could be more mindful of where your dollars are going.
Waiting until something you want is on sale or finding wholesale sources for things you consume in bulk are two great ways to reduce your expenses without cutting stuff away from your life.
Avoid a lifestyle creep as your income increases. When people increase their income, it's natural to expect changes in their lifestyles.
If you want to retire early, keep your expenses exactly where they were before you were making more money.
Then take the difference and save or invest it.
Cut your housing costs.For most Americans, their single biggest expense is housing costs.
If you're willing to put in the effort required to lower your housing expenses, you could definitely save a ton of money. You could do this by refinancing your mortgage, downsizing, or adding rental income.
Plan ahead for medical costs.Keep in mind as you get older, some costs increase, especially the costs of medical care and health promotion.
Health care is a huge expense for most Americans, since, even with health insurance, out-of-pocket expenses like deductibles and copays can really add up.
Having good health insurance is essential to managing the costs of care, but another great strategy is to put money into a health savings account (HSA).
An HSA is a fantastic way to save up money for health costs you may face in retirement.
It's also another way to defer paying tax on your current income (you pay the income tax when you withdraw the HSA funds in retirement, hopefully at a lower tax bracket).
The Last and Most Critical Key to the Early Retirement Puzzle
One word: Invest!
Your pension will probably not be nearly enough to let you live the life you want to live in retirement.
When you're saving money for retirement, don't bother stowing your money in a bank savings account or a Certificate of Deposit (CD).
Since these rarely yield you interest of more than 2% per year, your money isn't growing fast enough to keep up with the rate of inflation.
Inflation is your #1 enemy since it eats away at the purchasing power of your entire savings.
If you don't plan appropriately, inflation can destroy the financial security you've worked so hard to achieve for your retirement.
The best advice is to create a cushion by investing your money wisely.
If your money multiplies at a rate higher than inflation, you won't have to worry about your savings funds losing value over time, and you can stay financially secure.
Max-out your retirement savings contributions. Retirement plans like the aforementioned 401(k) and IRAs are designed to help you save for retirement and put off paying income tax.
401(k)'s are set up by your employer to be taken off your monthly paycheck and often include a matching portion from the company.
IRA's are accounts you set up with a bank or brokerage firm to hold retirement investments like stocks, bonds, and mutual funds.
Each of these retirement plans has a cap on how much you can contribute each year, which you should always try to hit.
Consider other taxable investments. Investing your retirement savings in the stock market, mutual funds, and bonds have the potential to grow your money a lot faster than the rate of inflation.
Real estate is also a lucrative investment for retirement since you can collect income as a landlord and then sell it later and profit from the appreciation on the property.
Retiring early is simple if you know the math
There's a saying that goes, "The best time to plant a tree is 30 years ago… or today."
Even if you haven't thought of saving for your retirement until recently, there's no time like the present to actually start.
Retiring early isn't a dream reserved for people who inherit massive fortunes—it's something you can achieve if you set yourself on the right path and stick to it.
Are you thinking of retiring early? At what age?
What strategies do you plan to implement to increase your savings rate?
Have you saved enough money as a nest egg for an early retirement?
Any success stories or tips you'd like to pass along?
If so, please share them in the comments below!
