The FIRE movement, short for “financial independence, retire early,” has many people dreaming of an early retirement. But while some people think “early retirement” means calling it a career at 55, some have far more ambitious retirement goals, aiming to retire as young as 40. But could you really have enough retirement savings to retire at 40? And what would it take to make that happen? If you’re salivating at the thought of exiting the workforce at 40, here’s what you need to know.
Start With Your Goals
Before you start digging through the numbers, it helps to start with a vision. Specifically, think about what retiring at 40 would mean to you and what your life would look like post-retirement.
For example, assume you expect to live until age 85. How will you spend your time for the 45 years in between retiring and hitting that age? Would you start a business or side hustle? Explore hobbies? Travel? Something else?
If you’re married or expect to be married by the time you retire at 40, will your spouse also be an early retiree? Or will they continue to work? If you have kids, what will your day-to-day life look like?
These are all important questions to ask and the answers can help you find your personal starting point for how to retire at 40. That includes determining the target retirement savings number that would make it possible.
Calculate Your Retirement Savings Needs
When determining how much you need to save for early retirement at age 40, it helps to start with your retirement budget and work backward. Your estimated retirement budget should include everything you expect to spend money on, including:
- Life insurance
- Hobbies and recreation
- College expenses if you have kids or plan to have kids
Healthcare is an important factor to keep in mind since healthcare costs can increase with age. You might have fairly low health insurance premiums if you’re in your 20s or 30s but by the time you hit your 50s, you could be looking at higher costs if you need regular medical care. If you don’t have access to an employer’s health insurance plan and your spouse is also an early retiree, you’ll have to consider how much of your budget may end up going to healthcare costs over time.
A common withdrawal rule used for retirement planning is the 4% rule. According to this rule, you should be able to withdraw 4% of your retirement assets annually without running out of money. However, this rule typically assumes that you’re following a traditional retirement path and retiring at 62 or 65. In that scenario, saving $1 million or even $500,000 for retirement might be plenty, but it’s almost certainly not enough if you’re retiring at 40 instead.
That’s where it goes back to having a clear idea of your estimated budget in mind for retirement. This can keep you from under-saving to reach your goals or overspending once you’re actually retired.
What Retiring at 40 Might Look Like
- Your current age
- How much you already have saved for retirement
- Your income and how much you’re saving annually
- Where you’re saving that money (i.e. a 401(k) with an employer match, traditional or Roth IRA, taxable brokerage account)
- Your estimated annual spending in retirement and drawdown rate
- Whether you’re saving solo or you’re working together with a spouse
Let’s run a few scenarios to see if it would allow you to retire at 40.
Running the Numbers
Let’s assume that you’re 25 years old and you’ve just started your first job in your career. You’re making $50,000 and putting 15% of that into your employer’s 401(k), which offers a generous 100% match of the first 6% of contributions. You get a 2% pay raise each year from age 26 to age 40 and your plan earns a 7% average annual return.
Using those numbers, you’d have approximately $307,500 saved for retirement by the time you turn 40. Now, assume you plan to spend $2,000 a month in retirement and live to age 85. Some simple math tells us that you’d need a little more than $1 million to make that possible.
In other words, you’ve come up well short. Even living modestly, your money won’t last 40 to 45 years – even with a 15% contribution rate to your 401(k) and an employer match.
But how would things turn out if you’re in a more lucrative field with a much higher starting salary? Let’s assume your first job pays your $100,000; if you’re still saving 15% of your annual salary and it grew at 7% you’d have $420,000 when you turn 40. That’s still less than half what is needed to make it to 85.
Now let’s assume you’re an amazingly disciplined investor. You max out your 401(k), and also contribute the maximum to an IRA ($6,000 in 2020). For good measure, you save in a taxable brokerage account as well. All told, you manage to save half your salary, and that amount grows at 7% per year. Within 15 years you’d have about $1.41 million saved. That amount would cover monthly expenditures of $2,400 until you reach age 85.
What Are Your Options?
One way to retire at 40 is to get a side hustle, in other words, just retire from traditional employment but take a part-time job or become an entrepreneur. The income from such initiatives can go a long way toward making ends meet after age 40.
In addition to a side hustle, retiring at 40 could entail aggressively cutting your cost of living. Moving into more modest accommodations and relocating to a more tax-friendly state are two ways to do that.
Finally, you will likely need to look beyond just your employer’s plan for savings. For example, you could also open a traditional or Roth IRA. A traditional IRA could give you the benefit of a tax deduction for contributions while a Roth IRA allows for tax-free withdrawals. Minimizing taxes is another important step in planning for how to retire at 40. The less you pay in taxes, the more of your hard-earned money you have to live on so a Roth might be the preferable option.
What you have to remember, however, is that while you can withdraw original contributions from a Roth IRA at any time, withdrawals of earnings before age 59 1/2 can trigger a tax penalty. For that reason, it’s also a good idea to consider adding to your portfolio with a taxable brokerage account that you could withdraw from at any time.
Consider Your Investment Strategy
If you’re banking on retiring at 40, you’d want your asset allocation to reflect that. For example, that might mean being more aggressive and choosing to allocate 90% or even 100% of your portfolio to stocks to drive higher returns.
That, of course, can increase your risk profile, and if you’re still invested 90% in stocks a few years before your planned early retirement, you’re running a serious risk of a badly timed bear market wiping out much of your savings.
Diversification can help to balance out the risk in your portfolio, though with the obvious downside of potentially reducing market returns. When diversifying across stocks, mutual funds or exchange-traded funds, pay attention to fees. Similar to taxes, the goal is to keep fees as low as possible, so you get to hold on to more of your returns over time.
The Bottom Line
Even with an aggressive savings plan, the average person will have trouble socking away enough money over the course of their short career to finance such a long retirement. That doesn’t mean it’s impossible, though. If you’re committed to getting an early start and saving as much as possible, then an early retirement could be more in reach than you think. While it’s important to think about how much you can save, don’t forget to think long-term when it’s time to spend. Fine-tuning your budget and reducing expenses as much as possible can help your money last when you have several decades to enjoy retirement.
Tips for Investing
- Consider talking to a financial advisor about retiring early. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Seek opportunities to save money outside of an employer’s plan, IRA or brokerage account. For example, a health savings account (HSA) could be handy for covering medical expenses, and you may have access to an HSA if you’re enrolled in a high-deductible plan. These accounts offer triple tax benefits: tax-deductible contributions; tax-deferred growth; and tax-free withdrawals for qualified medical expenses.
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