Have you ever plugged your information into a retirement calculator on a site like Fidelity.com? If you have, you’ll find their starting point for your retirement income is your current income, which I suppose makes sense if you’re one of the vast majority of people who spends every last dollar you earn.
In that case you would need to replace your entire post-tax current income with retirement income since you are living so close to the edge that you use every last dollar to prop up your lifestyle.
But being realistic, what is the chance that someone who spends every last dollar of their income has anything remotely close to the millions put away in their 401k in order to replace their entire current income? Zero chance!
For those who read this website and have started to implement some of the suggestions, you’re hopefully saving at least 20% of your income (and maybe much more).
Now let’s look at what you actually need in order to retire:
Your actual yearly spending is your starting point, not your income level, which is why it is crucial that you track it. I would then go under the assumption that your mortgage payment will be gone by the time you retire, so back that out of the yearly spending column to come up with a total amount of yearly expenses.
Now multiply that number by 25 and that’s the amount you need to retire.
Why do you multiply by 25? Most experts say you can safely withdraw 4% of your total investment balance each year and still have it exist for decades (or even in perpetuity if returns are as expected). The anticipation is that investment returns on the balance will more than offset the 4% you take out each year to cover your expenses so not only will the balance cover your expenses but it will likely continue to grow.
Our yearly expenses for 2013 were well under $40,000, but we’ll use that as a nice round number even though I think it is inflated. Multiply $40,000 by 25x and we will need exactly $1,000,000 to retire once our house is paid off.
$1,000,000 sure sounds like a lot of money, right? Not really when you dig into it:
Let’s say you and your spouse each started off making $45,000 per year and that stays constant throughout your working life (no raises). If you each saved 15% of your income and got a 5% employer match in your 401k you’d be saving 20% of your income. This would amount to $1,500 per month (though a quarter of it is completely free from your employer, so it feels like much less than that out of your pocket).
If you invested this $1,500 each and every month in a low-cost index fund (we recommend Vanguard) and it grew at 8% annually, it would take 22 years for this amount to grow to over $1,000,000.
Twenty-two years might sound like a long time, but if you started fresh out of college, you’d be 44 when you were set to retire! That’s a whole lot better than the bleak future most spend-happy baby boomers are looking at now in their 60s and 70s.
And this is all assuming you never got a raise and only saved 15% of your income on your own (plus the match). How much faster could this have been done in you saved:
25% plus the match? 18 years total.
35% plus the match? 15 years total.
Throw in some raises and/or higher salaries and you can reduce those amounts even further!
These are amazing numbers when all we hear in the media is how impossible it is to retire. All you have to do is keep your expenses low and save a reasonable amount of your income in order to retire 15 to 20 years after you start saving. It really is that easy.
And even if you are more conservative than this article suggests, and you want to have 30 or 40 times your annual expenses in your retirement account (not an unreasonable position at all!), the concepts are the exact same: Save as much money as you possibly can, and keep your expenses as low as possible, because they determine how much you need to retire, not your income level!
If you want to read about people who really retired early by keeping their expenses low and their savings rate high, check out the Mad Fientist, Root of Good, Mr. Money Mustache and Pretired. And 1500 Days and Bucking the Trend aren’t far behind…
Note: We try to keep things simple on Richmond Savers and not get bogged down in details that are too incredibly complex, but the first question I know I’d ask if I read this article is: “Okay, so you’ve convinced me how I can save enough to retire decades earlier than normal, but how do I actually access this money before I’m 59.5 when I’m allowed to pull it out of my 401k/IRA without a penalty?”
There are two methods that I know of, and I’ll let the people who introduced them to me explain: