Freedom Life Planning

The Ultimate Guide to Financial Planning

How Much You Need to Save for Early Retirement

In this article, we will make you a savings plan for early retirement. Why wait until 65 to give up the 9 to 5? Retiring much earlier is possible, however you will need to plan for it. The government will provide less help for early retirees, so it is up to you!

So how do you retire early? By growing your investments to a point where they produce sufficient returns to meet your spending needs. If you are retiring young, you can’t rely on government pensions or social programs as they usually don’t apply in most countries until 60 to 65.

Now determining how early to retire is tricky. I know most people may read this and think, “well I don’t find it tricky, I want to retire right away”. But how much of your spending lifestyle will you need to sacrifice to retire very early? To help make this easier, I’ve put together a table below that shows you how much you will need to save to retire by a certain age. This table has nothing to do with how much you make, everything is expressed as ratio or percentage of income. There are two major factors that will determine how much you need to save.

  1. In how many years from now do you wish to retire?
  2. What is your current savings as a ratio of your income?

With these two values known, you can use the table below to get an idea of how much you will need to save for early retirement.

How to use the table:

  1. Years to Retirement: Take your target retirement age and subtract your current age. ex Retire at 50, currently 25 years old à Use the row for 25 on table above.
  2. Current Savings Ratio to Income: Current Savings divided by Current Salary à Savings value is $20,000, income is $50,000 à Use column for 2.5.

Assumptions:

  • Salary increases match inflation
  • Return on Investment before Retirement is 6% after inflation
  • Return on Investment after Retirement is 4% after inflation
  • You keep spending the same amount during retirement as you did during your years of saving for it, adjusted for inflation.

Before we continue, I want to mention a little about taxes. This table does not consider taxes. The assumption is that you are mostly using tax free (TFSA) or deferred retirement accounts (RRSP) to save. If you are planning to retire early, there are ways to minimize your tax bill significantly that I will cover in other articles. Therefore, I recommend using after tax income for calculations using this table. If you are using tax deferred retirement accounts (RRSP), you must also invest your tax refund and not count it towards your percentage above.

The second thing to pay attention to is salary increases. I’ve assumed your salary rises steadily with inflation. You do need to be careful if you have any large increases in salary, especially close to retirement. If you increase your spending accordingly, your savings won’t have time to catch up. In this case, I suggest you keep your spending increases still in line with inflation and save the extra salary for extra spending in retirement.

Making the Plan

Now it’s time to determine what works for you. The younger you are, the more options you have as years of compounded investment returns are ahead of you. You may also have other life goals to set money aside towards, such as buying a house or new car. You need to evaluate everything and then decide on how much you want to sacrifice to reach your goal of early retirement. The goal of this savings plan is to grow your investments to 25X your annual spending money in order to retire and take 4% out per year.

Retire in 40 years: I don’t consider retiring in 40 years as early retirement. This is an easy goal to achieve if you put an easy 15% aside from a young age. This should be the minimum savings target that you should establish towards retirement.

Retire in 30 years: This is a reasonable goal to have, especially if you already have some savings. If you have no savings, putting 24% aside per paycheck is very realistic if you spend your money effectively and stay on budget. As most people start their careers around 25 years old, this is the path to take to retire by 55.

Retire in 20 years: This is a more aggressive objective, especially if you have no savings yet. However, many people still achieve it when they put effort towards it. You may need to do more than just effective spending and make some sacrifices to save 41%. If you are a bit further into your career and already have some retirement savings, you can double check with the table above to ensure you are on the right course. If you start on this plan at 25 years old, it will allow you to retire by 45! This is the path I recommend for most people in their 20’s who want freedom early in life.

Retire in 10 years: This is a very aggressive objective if you have no savings. It can be done but it will take significant sacrifice to save 66%. There are still people who do this as they truly value time and freedom over luxury. This may allow retirement in your 30s! But it requires frugal living and a lot of discipline in your budget. For people who are further in their careers, this will allow a quick check to make sure they are on track and can retire as planned.

Now that you know what you’ll need to save, it’s time to make a budget around this savings goals. Check out my article on How to make a budget for more details.

A few Other Considerations

I mentioned taxes earlier in this article. You need to take advantage of all the tax shelters possible in your country. As I am Canadian, I am familiar with the rules here and will provide some details on this. There are two accounts that can save taxes in Canada, the TFSA and RRSP. Exhaust your contributions to these accounts first before starting any unregistered investment accounts. For the unregistered account, avoid holding bonds and savings accounts as these are taxed more heavily. Put the bonds and high interest savings accounts in the TFSA or RRSP.

Other factor’s that I did not consider in this article are government pension plans, social assistance and side income. As government plans only kick in at 60 or later, I’m being conservative by not counting them in my plan. I see these as extra padding in case I pay a bit more taxes in retirement than planned.

Not everyone will want to retire fully, especially if you retire very early. You may work part time or have a small side business or hobby that generates some income. Unless this income is very significant, I would not consider it in the calculations. Keep it as an extra and re-evaluate it closer to retirement. There is no guaranty this side income will last through your retirement. If your side income is significant, it can offset how much investment income you will need in retirement. As I mentioned early, your investments need to be at least 25X your annual expenses in order to retire. To consider side income in this, multiply your annual side income by 15 and subtract that number from your investment target.

For example:

Spending = $3,000 a month = $36K a year.

Investments needed $36K * 25 = $900K

Side income = $500 a month = $6K a year. $6K * 15 = $90K

Investment value needed to retire = $900K – $90K = $810K

I will be posting a new article on investing for retirement in the near future. Be sure to check back soon.

2 Comments

  • Jimmy says:

    If you are married, do you double the $810k in your example?

    Jimmy

  • Matt says:

    Hi Jimmy!

    If you are married, it would be best to consider your full household monthly spending when doing the calculation. So if you spend 36k each, that’s 72k and requires double the 810k to obtain financial freedom.