Isn’t retirement a really complicated subject? There are so many different retirement calculators out there, heck financial planners are employed just to help others reach retirement, so it must be a confusing and complex subject, surely?!
The truth is, it’s not so difficult and it can all boil to down to a simple calculation. One calculation can tell you pretty accurately how long it will take before you can retire. Sure, there may be some variances and assumptions used when making the calculation but for the most part you could reliably estimate when you are going to retire.
You’ll also be very surprised to know it doesn’t even matter how much you are earning! You could retire in the same amount of time earning average wage as somebody earning twice as much as you.
I’m intrigued…please continue
All you need to know is your annual savings rate. This can be calculated as follows:
Savings Per Year / Annual After Tax Pay
So for example, let’s assume a family makes $100,000 after tax (pretty nice right?) and they manage to sock away $30,000 per year for retirement, they have a savings rate of 30%.
Let’s now assume your family makes $50,000 after tax and manage to put away $15,000 per year, you too have a savings rate of 30%.
Let’s plug both of these numbers into a savings rate calculator, which tells us how many years it will be until we can retire.
First, the household making $100,000 and saving $30,000:
So we can see that they will be able to retire in just under 26 years.
Now your family making $50,000 and saving $15,000 a year:
As you can see, this family is also able to retire after just under 26 years.
What is this wizardry?!
The reason the outcome is the same for both families is because all that truly matters when reaching retirement is your savings rate and annual expenses. A person earning $200,000 a year with a savings rate of 30% will only be able to retire at the same time as someone earning $50,000 if they too have a savings rate of 30%.
Now the following assumptions have been used by the calculator making these calculations:
- Your current annual expenses will remain unchanged in retirement
- You will never draw down on the principal and your net worth will never shrink
- Your income you used is after taxes
- Your annual return on investment is after taxes and inflation
You cannot change these assumptions, however, there are two optional assumptions that you can change, and they are:
- Return on investment
- Withdrawal rate during retirement
For the purposes of my calculations I used an ROI of 6%, which is a fairly conservative estimate for a diversified portfolio (which generally return 6-7%) and if you’re a more aggressive investor like I am, you could be touching on 9% or so, which will reduce the years to retirement drastically. For example, when I changed the ROI to 9%, the years to retirement at 30% savings went to 21.3 years, a whole 4.5 years earlier than 6% ROI.
The generally accepted withdrawal rate at retirement is 4%. This means you can withdraw 4% of your portfolio each year and the principal should last forever. So if you have a $1,000,000 portfolio, you can safely withdraw $40,000 a year and never have to worry about it running out.
Okay so how do I retire before someone earning more than me?
Well, that’s simple. All you have to do is increase your savings rate to a level above theirs. Let’s run the number of your $50,000 income assuming you can increase your savings rate to $20,000 per year (a 40% savings rate):
Well look at that, you’ve shaved almost 6 years off your retirement just by increasing your savings rate by 10%! Assuming the family earning $100,000 stays at a 30% savings rate, you’ll have retired well before they have.
As you can see from the graphs, the savings rate goes along the X axis and the number of years to retirement goes up the Y axis. The higher your savings rate, the lower the number of years to retirement. You will also note the average household savings rate of some major countries are included. The average US savings rate is just 6%, and the UK a measly 2%!
Pinch of Salt
As explained earlier, this calculator is pretty good for giving you a ballpark estimate of your retirement, assuming you stick to the savings rate. However, one of the major assumptions is that you will spend the same in retirement as you do now. This is a very vague assumption and varies greatly from person to person. Many investment firms/banks say you will spend significantly less during retirement, in which case you could retire even earlier, but there are plenty of arguments for people spending more in retirement, namely people wanting to enjoy life to the fullest, traveling the world and ordering pizza thrice a week.
If you’re anything like me, you’ll just focus on hitting a certain savings rate every year and hope all the pieces fall into place when it comes down to actually retiring. I can’t plan that far ahead, but I can take steps now to ensure I’m in the best possible position for retirement to enjoy it to the fullest. Currently we’re sitting at around a 29% savings rate, which would mean retirement in around 20-24 years depending on ROI, but I also envisage a pretty hefty drop in annual expenses when we do retire as we currently live in downtown Vancouver, which is a very expensive place to live. We could likely reduce our annual expenses drastically just in rent alone, which would allow us to retire much earlier. Hopefully we will also be able to step up our savings rate in the future when our career experience kicks in and pay rises take effect.
Some of the major FIRE bloggers have managed to retire in their 30’s, but they have typically been paid a salary that allows them to hit a savings rate well above 50%, sometimes even 60-80%, with retirement coming in 5 – 10 years. That’s the benefit of a high salary, if you are FIRE focused and you don’t live a luxury lifestyle, you have the ability to hit a massive savings rate and retire really, really early. I can’t envisage our salary ever hitting their heights, but we could certainly strive for something like 40-50% one day.
If you would like to play around with the calculator yourself, it can be found here.