Believe it or not, our ability to reach financial independence is something that is completely dependent upon our own decisions.
It doesn’t matter if you’re in your 30’s, 40’s, or any age. If you want to make working optional and retire by age 55, then you just have to be willing to stick to a strategy that will get you there.
Forget about the things you think are holding you back. In no place do we see this more than in one of the most popular money-excuses “I don’t make enough money to ever retire”.
You might think that the dream of financial freedom is something that is only reserved for the rich or those who make over $100,000 per year. But I can tell you that a lot of the same tricks work even if you make much less than that.
In fact, for this post, I’m going to base all my calculations on a income that’s half of that rate using a figure of $50,000.
And honestly, that’s not a bad starting point considering that the current average income in the U.S. is only $59,039. (Don’t worry. The same lessons will work even if you’re making more or less than these numbers.)
So before we address the question of “how can I retire at age 55 or sooner?”, let’s get a better understanding of how your retirement savings rate and net income will play a major role in your strategy.
Building Our Retire By 55 Plan
There are literally thousands of ways you can save for retirement successfully.
Since this is just one little blog post, we’ll need to lay down a few rules and assumptions that will help us to better build-up our strategy.
Assumption 1: We’re going to use pre-tax retirement savings to fund your retirement dreams.
I’m a BIG advocate of pre-tax retirement savings. Because the money you save comes out of your paycheck before you pay taxes on it, this allows you to save potentially thousands of dollars each year. For me, I’d rather (legally) take advantage of the opportunity to keep more money for myself than have to hand it over to the IRS.
For our example, we’ll mainly be using the U.S.-based retirement plan, a 401(k), as our primary savings tool.
Of course, there are other retirement savings tools we could use as well or even in addition:
Assumption 2: You’ll want to continue to enjoy whatever quality of life you’re currently enjoying right now.
That means that by age 55 (or whenever we’re able to retire), you’ll be making approximately the same net take-home pay. No more and certainly no less.
What do I mean by take-home pay?
As you can probably guess, if you make$50,000 per year, are you really living off of $50,000?
Of course not!
It’s less because you have to subtract away taxes and 401(k) contributions.
No problem. But before we can calculate this, we’ll need to first establish how much we’re saving for retirement.
Assumption 3: Saving for Retirement – The False Start of 10%
The old, sage retirement savings advice I often read and see in just about every generic financial publication out there is that you should be savings at least 10% of your income for retirement.
Simply to make a point, I’m going to use this 10% figure as our starting point.
(And then I’ll show you why this is NOT the savings rate you’ll want to use if you want to retire as soon as possible.)
Putting it all together – Our actual take-home pay:
Now we can actuate what your true net take-home pay is:
- Start with your gross income. In our example, we’ll assume you make $50,000 per year before taxes.
- Subtract your 401(k) contribution. As we said, we’ll assume you’re contributing 10% of our income to your 401(k) every year. That’s $50,000 x 10% = $5,000.
- Subtract Federal taxes. In the U.S., your annual Federal taxes are calculated by taking your gross income, subtracting away your 401(k) contribution and your standard deduction (as of 2018, personal exemptions are no longer applied). If we assume you’re married and filing jointly, this drops your taxable income down to $21,000. Using our marginal tax bracket system, that calculates out to $2,484 in Federal taxes for the year.
- Subtract away FICA (Social Security and Medicare) taxes. At rates 6.2% and 1.45% against your gross income, that’s $3,825 per year.
- State taxes. For simplicity, we’re going to ignore State taxes because there is a wide range of rates to consider. To keep the example light, let’s just assume this is one of your expenses you’ll cover with your net pay.
Putting all of that together, this means that you truly live on a net take-home pay of about $38,991 per year (or $3,249 per month).
What is Our Target Retirement Income?
Good … but what does that mean for the future?
Again, we could go in many different directions for that question. But to keep this example simple and concise, one of the assumptions we’re going to make is that you’re going to want to continue to enjoy the same standard of living you’re already accustomed to.
In other words: Whatever your net take home is now will be what our target is in the future.
(Feel free to use whatever goal you want in your own calculation.)
There will be just two caveats:
The first thing you have to understand about the future is that inflation makes everything more expensive. Obviously you already know this because things you buy today probably cost you more than they did a few years ago.
Fortunately for you in this example, we’re going to be doing our calculations with inflation adjusted returns.
So no worries!
That means we’ll assume that $38,991 today has the same purchasing power it will whether we’re looking at 20, 30, or even 40 years from now.
If our net take-home pay is $38,991, is that all the money we’ll need in retirement?
Because we’re assuming this income will come from your pre-tax retirement savings, that means you’ll likely have to pay those taxes when you finally retire.
Therefore, you’re going to need a little extra dough to cover Federal taxes.
How much extra?
That’s a bit tough to answer since no one knows what the tax code will look like in 10, 20, or 30 years.
The best we can do is assume that whatever Federal taxes you’re paying now will be similar to what you will pay in the future.
If we go with that logic, then we can calculate our true retirement income needed as:
$38,991 + $2,184 = $41,175
What about FICA taxes?
Thankfully, you do NOT pay FICA (Social Security and Medicare) taxes on your retirement income. These were already paid on your gross income while you were working.
What is Our Target Nest Egg Size?
Okay. Now we have our target retirement income size.
From here, we can reasonably estimate the size of our target retirement nest egg by using our old-friend, the 4 Percent Rule.
Remember: The 4 Percent Rule says that says you should be able to safely and consistently withdraw a portion of your retirement savings equal to 4 percent of your starting nest egg balance year over year with inflation adjustments for the next 30 years; regardless of whatever happens in the markets.
Since our goal is to retire by age 55, that will take us to at least age 85 (and probably longer).
To calculate your target nest egg size, simply divide your target retirement income by 4 percent:
$41,175 / 0.04 = $1,029,375
How Many Years Will We Have to Save?
In order to figure this out, you’ll need to consider 2 more very important factors:
- How much return you’ll make on your investments each year.
- Your annual savings rate.
Investment Return Rate
Again, we could talk for days about all the different types of investments there are and whether or not you’d ever want to invest in them.
But if you want my advice, the easiest way to approach investing is to simply put your money into a stock market index fund.
There is a TON of evidence to support why this is a good decision. In fact, there’s a whole forum called the Bogleheads devoted to the idea.
For our example, let’s say you take this approach. On average, the stock market makes a 10% return each year (when you look at it over the course of 10 years or more).
Remember that we said we’re going to adjust our example for inflation. Inflation is roughly 3% per year.
So to figure out the true rate of return on our investments every year, we subtract:
10.0% – 3.0% = 7.00%
Your Personal Savings Rate
As we’ll soon show, how much YOU plan to save each year will have a BIG impact on how quickly you retire by age 55 or before.
As we’ve already said, we’re going to start off this model assuming you’re saving at least 10% of your 401(k) each year. (And then I’ll show you why that won’t work …)
Can we assume we’ll save more each year because we might get a raise?
You could. But unfortunately I’d guess that most raises (if you get them) are about 3%. That means you’d be getting just enough of a bump to keep up with inflation.
So since our example is inflation adjusted, 3% – 3% = 0% increase in purchasing power every year. In other words, we’ll keep that $50,000 income the same throughout this example.
Now the good news: In addition to your own personal savings rate, there’s one more thing we haven’t considered that will really help you out each year:
The 401(k) employer match!
401(k) employer matching plans are as far and wide as you can imagine. Some are very generous (matching dollar for dollar). Others give you nothing.
On average, we can find that most employers will match an amount that is equal to roughly 3% of your salary. So for simplicity, if we use this figure, this means you’ll be saving an additional:
$50,000 x 0.03 = $1,500
Combining your 401(k) employer match with your 10% savings, that’s:
$1,500 + $5,000 = $6,500
Putting It All Together
Combining a savings of $6,500 with a return rate of 7.0% per year, how long will it take us to accumulate our target nest egg of $1,029,375?
The answer: 37.3 years
… Hmmm …. Now you can see why a savings rate of 10% is NOT a good choice.
In order to make our age 55 target, you would have had to start saving your money around age 17.7. (… Weren’t you thinking about saving for retirement at age 17? …)
How Adjusting Your Savings Rate Will Lower Your Number of Years
As you can guess, to reduce the number of years, we’re going to have to bump up that savings rate.
And potentially by a lot!
Well, the answer will depend on you and what age you’re starting at.
If we were to run through this same model over and over again using multiple savings rates, we can get a very clear picture of just how much time we’ll need to achieve our goal.
Say we’ve only got 20 years until we turn age 55.
Using our chart above, we can see that we’ll need a savings rate of roughly 30-35% to accomplish this goal.
Can someone really retire with a nest egg of $500,000?
Absolutely! Check out my post How to Retire on $500,000 In Your 50’s or 60’s for all kinds of good tricks to make your dollars stretch.
Why Saving More Equals Needing Less
Take a good look at the chart above … notice anything interesting?
In every row, you earn the same amount of gross income. But as our savings rate changes, your net income is reduced.
Is this a problem?
In reality, no. Since your income is spread out of the over the course of a year, you adapt. If you can stay disciplined and stick to a budget, then your lifestyle will adjust to fit this new level of income.
And then something beautiful happens …
Because you need less money to cover your expenses and live happily, that means you need to save up less money in your nest egg in order to retire. And that means fewer years until reaching financial freedom!
Take a look at the lines for 10% and 25% savings rates.
When you compare the net income you live off of at each of those rates, it’s a difference of $6,666 per year in the present.
If you can learn to live off of $32,325 instead of $38,991 per year, this shaves $187,500 off of your nest egg savings goal dropping it down from $1,029,375 to $841,875.
At that pace, you’ll reach financial freedom in 24.4 years instead of 36.8 years, a difference of approximately 12 years!
Doesn’t that seem worth it to give it a shot?
This phenomenon is something I’ve called the double-ended approach to early retirement. Not only are you saving more money to reach your goal faster, but you’re moving the goal-line closer to you by needing less money to get there. Though its very subtle, it can be a very useful strategy to reaching financial freedom without a lot of extra fuss.
What About Social Security?
Why haven’t we talked about Social Security here? After-all, if we’re using age 55 as our bench-mark for retirement, shouldn’t Social Security work into the equations (since you can most likely start collecting it at age 62)?
The answer is, of course, yes!
But Social Security is not such an easy topic to reduce down to just model. As you might already know, there are lots of different factors that can play into when and how much money you’ll actually receive when you’re finally eligible to receive Social Security. Some people might start collecting it right away and only receive hundreds of dollars per month whereas others might delay it and receive thousands.
If nothing else, we can think of Social Security as a buffer or safety net for using the 4 Percent Rule. As I’ve shown in this post here, when you factor in Social Security to your retirement plan, you can almost raise your safe withdrawal rate by approximately 0.5-0.75%.
Therefore, if you thought 4.0% was a bit too high for a safe withdrawal rate, we could assume that our Social Security income with help to supplement our income. This should give us more confidence that we will not run out of money.
The Alternative to Saving More Money
So maybe hiking your savings rate up to 25% or higher is just something you don’t think you can do.
I get it … we’re all human.
The good news: There is an alternative strategy to saving your money.
What is it?
Earning a supplemental income through other means. This could be done either through an asset, side hustle, or part-time income.
How does supplemental income change my retirement goal?
Consider what would happen if you were to find a means where you could a reliable $500 per month from some other income source.
In the traditional system of retirement, you would have needed a nest egg of $500 x 12 x 25 = $150,000 to generate this income passively.
Increase that number up to $1,000 per month, and now you’ll need $300,000 of nest egg less.
Ways to generate supplemental income:
Like we already mentioned, there are a couple of ways to generate additional income outside of your retirement savings.
- Passive income streams. Know anyone who owns rental properties or receives checks from dividend stocks? There are tons of ways generate passive income streams that will help support you into retirement. Check out our extensive list here.
- Start a side-hustle. Side hustles are all the rage these days. And thanks to the Internet, they are easier than ever to get started. You could pick up freelance writing or become a virtual assistant. Even something as simple as collecting advertising revenue from running a blog can help generate a few hundred dollars per month.
- Get a part-time job. No one ever said that retirement has to mean “no more work ever”. Studies have shown that at least some level of work or activity in retirement can be just as good for your body and mind as it is for your wallet. Consider taking on a low stress job where you only need to work a few days per week with coworkers that you enjoy.
The takeaway in all of this:
The answer to “Can I Retire at 55” is possible. Financial freedom is possible. But getting there isn’t something that’s just going to happen. There are no shortcuts to early retirement planning. Though it can take a little thought, planning, and execution, it’s totally possible to devise a strategy that can and will work.
Readers – Do you believe it’s possible to retire early under an income of $50,000 or so? What do you think of this model? How would you help someone at this income level to retire by age 55 or sooner?