How to Retire Early
· 4 min readBrilliant, you'd like to quit your day job and do something more meaningful with your life. Now how do you do it?
Well, your investments need to make more money per year than your expenses. Great news:
Don't believe me? Let's do the math.
Your salary
This is the most important variable
Your federal tax status
Year | Income | Tax | HSA | 401k | IRA | After Tax | Nest Egg |
---|---|---|---|---|---|---|---|
2022 | 70k | 8.7k | 3.6k | 21.6k | 6k | 8.2k | 39.4k |
2023 | 71.4k | 9.1k | 7.3k | 44.8k | 12.4k | 18.1k | 82.6k |
2024 | 72.8k | 9.5k | 11.4k | 69.6k | 19.3k | 29.6k | 129.9k |
2025 | 74.3k | 9.9k | 15.8k | 96.2k | 26.6k | 43k | 181.6k |
2026 | 75.8k | 10.3k | 20.4k | 124.7k | 34.5k | 58.5k | 238.1k |
2027 | 77.3k | 10.8k | 25.4k | 155.2k | 42.9k | 76k | 299.6k |
2028 | 78.8k | 11.2k | 30.7k | 188k | 51.9k | 95.9k | 366.5k |
2029 | 80.4k | 11.7k | 36.4k | 223k | 61.6k | 118.3k | 439.3k |
2030 | 82k | 12.1k | 42.5k | 260.6k | 71.9k | 143.4k | 518.4k |
2031 | 83.7k | 12.6k | 49k | 300.8k | 82.9k | 171.4k | 604.2k |
2032 | 85.3k | 13.1k | 56k | 344k | 94.7k | 202.6k | 697.3k |
11 years to retirement / 24.4k withdrawable per year / 494.3k total contributions
The Catch
The biggest catch is that you're betting on the US economy. Specifically, we are assuming on average a 10% growth per year of the S&P 500, which is an index that adjusts to follow the 500 largest U.S. publicly traded companies by market value.
$24k/year
This isn't an unrealistic budget, even for a family of 4. Here's another testimony from a family of 5. The best part about low spending is that you get to save more while you are working, and the total nest egg you have to save until gets smaller. It is the single most important factor in the entire equation and the easiest one for you to minimize. If you were to live off $34k/year instead, it would take 15 years and a nest egg of over $1mil to retire!
You need a budget. Frugality will pay off. If you have one particulary bad area of spending, as chef Ramsay says, wake up!
Smaller Catches
These estimates are really quite conservative. Historically, the US economy is the safest bet to make.
Safe withdrawal rate
This is the rate you can withdraw from your investments per-year for the entire rest of your life while feeling "safe" in nearly every market condition. The number 3.5% is based off of a 45 year time horizon. To see actual chances of success, use a calculator like FireCalc or cFIREsim. If you're fashionably late to the party, simply adjust your time horizon to sooner and use a higher percentage such as 4% or 6%.
Inflation rate
To adjust for rising living expenses from inflation, we assume a high inflation rate of 3% by calculating our investments growing at 7% instead of 10%. Actual inflation rates fluctuate, which you can view per-month here.
Retirement accounts
This is the fun part where we get to dodge taxes and take advantage of every tax-deffered account available. Accounts are ranked in terms of advantages.
1. Health Savings Account (HSA)
HSAs are tax deductable, and earnings are tax-exempt. Withdrawals from a health savings account are tax-free as long you use the money to pay for qualified medical expenses. All you need are receipts of medical expenses from any time period, so you can pay out-of-pocket for expenses now, save the receipt of your payment, and later withdraw money from your HSA to "pay" for that expense long after it's been paid. This makes them the best tax-advantaged account. They are offered through your employer, usually along with a high-deductable medical plan. The contribution limit is $3450 for 2018, and was $3400 for 2017.
2. Individual Retirement Account (IRA)
IRAs come in two flavors, traditional and Roth. Traditional IRA contributions are tax-deductible, but withdrawals are taxed at ordinary income tax rates. Roth IRAs provide no tax break for contributions, but earnings and withdrawals are tax-free. For early retirees, Roth IRAs are the way to go because of the tax-free growth, which will be very high! The limit is $5500 towards all IRAs for 2018 and 2017. To withdraw money from your Roth without penalty, Roth Laddering is possible if you know how much you want to withdraw 5 years in advance.
3. 401k
401k plans vary per-employer, but the gist is that you can contribute up to $18,000 of tax-deductable income per-year. Gains from the account are tax-deffered. 40% of employers do a 6% match on your contribution, but usually only up to 3% of your salary. 38% of employers do a 3% match (but also only up to 3% of your salary), which is a nice little added bonus. However, don't count on the employer match, especially since technicalities vary. If you're self-employed, a solo 401k also permits your business entity to contribute up to 25% of your salary to your 401k up to a total of $54,000. To withdraw money early without eating a 10% penalty, rule 72t provides a loophole for withdrawing from the account, provided you do it for 5 years or until you turn 59 1/2 – whichever is later.
4. Taxable account
If you're a savaholic, after your 401k your second largest account will unfortunately be a taxable account. Money put into the account is not tax-deffered, and gains are taxed as income. However, withdrawals have no penalty or restrictions (except for what your brokerage states)!
Conclusion
If you want more control over the numbers, you can play around with an (incomplete) Python script I wrote or the source code for the calculator on the page. I hope you realize retirement is closer than you think!
Remember, your mileage may vary!