I’m sure early retirement is a topic on a lot of our minds. The thought of it might not appeal to everyone but the concept of one day retiring is inevitable.
There is this conventional idea that we have to work until we’re in our 60s and then we can retire. The blessing of retirement is the time you gain to do what you want. But what if I told you there was a way to retire earlier, maybe in your 50s, 40s.. 30s even?!
Dare we dream this dream? Gaining years to travel, explore, see friends/family sounds great! Keep reading if you want to learn about how to retire early using the 4% rule.
Topics
- What is the FIRE movement?
- How to get started
- Calculate how much you need for financial independence?
- The 4% Rule
- How to save money towards your FIRE pot
- Top tips
Financial Independence Retire Early (FIRE)
In 2023 82% of adults in the UK feared how the cost of living will affect their retirement and 51% worried that they won’t be able to retire before 66.
I don’t like the thought that after working hard for so many years there is still a worry about money. Its never been more important to put your money to work. It’s easy to forget in the midst of living in the moment that one day you won’t be able to work, or not want to anymore. Not only do you have to use your income for current day to day life, but to also prepare and protect your future self.
Let me introduce to the idea of the FIRE movement.
Essentially it describes extreme saving and investing which allows you to retire earlier than the predicted retirement age.
Although it sounds pretty radical it’s actually a fairly straight forward concept. Before hearing of the FIRE movement, I had savings and investments, but never knew how much I needed and what the end goal was. This will give your savings a purpose.
How to get started
Before we get started I advise you research your current pension pot. This is applicable to those of working age and who are employed. There are three pension pots to research, including state contribution, employers pension scheme and private pensions.
It’s important to calculate how much you’re currently expected to earn when you retire by totalling the sum of these three pension pots.
State contribution
In the UK in order to qualify for a full state pension you need to make 30 years of national insurance (NI) contributions. You pay NI as soon as you start working, over the age of 16. The full state pension equates to £185.15/week per person (around £700-£800 per month).
If you don’t meet the criteria for a full state pension a basic state pension is £141.85/week. You can make voluntary NI contributors if you don’t meet the criteria for a full state pension.
However, if you consider the cost of living against either basic or full rates it isn’t a huge amount of money.
It is worth checking out on the government website how much you are entitled to. For UK residents check your state pension forecast here.
Employers pension scheme
If you are employed it’s likely your employer has a pension scheme. This is usually detailed to you at the start of your employment. Many companies will auto-enrol you to the scheme and therefore it is left to you to opt out.
It is beneficial to companies to offer a pension scheme as they receive tax relief by also contributing to your pension pot. It’s a win win as you’re saving for your retirement funds whilst receiving free contributions by your employer.
I bet there are many of us who have had multiple jobs over the years. Often when you start a new job a new pension is opened with the new employer. When you leave you can forget about the pension and who it is with. When you come to retire you want all the money from all your different pensions.
You can use private pension providers, such as pensionbee or virgin money, to find all your long lost pensions set up by different employers and combine them in to one pot.
Private pensions
Alongside your state pension and employer pensions, you can choose to start a private pension. This is a pension pot only you will contribute to.
Depending on how good your employers pension is you might feel an additional pension is needed to top up your future income.
Calculate how much you need financial independence
Firstly, you must consider how many financial commitments you might have in later years. (Remember the aim is to have paid off your mortgage, which will lighten the burden.) You’re going to need enough money to cover all these expenses without being employed. Calculate your financial commitments by totalling the expenses you pay currently per year. You can ignore things that you know will be paid off before you retire.
The big question is can your state pension and employer pensions cover it? Remember that these will only kick in late 50s at the earliest. So if you want to retire earlier then this, or need additional money to cover your expenses, a FIRE pot is needed.
When I talk about FIRE, I don’t mean literally, it’s stands for financial independence retire early and relates to extreme savings/ investments.
To understand how much you need in your FIRE pot, then use this calculation:
FIRE amount = total yearly expenditure X 25
Obviously, it’s a big pot of money. Now this is where is gets a little complicated, so stick with me.
The idea with saving up this money isn’t that you reach your goal, then just withdraw everything. The idea is that you make that pot of money last indefinitely.
And here’s how we’re going to do it, using the 4% rule.
The 4% rule
Once you’ve reached the figure needed for your financial independence, the trick is to make it last.
The way you do that is by withdrawing 4% per year to cover your expenses. If you’ve calculated your FIRE pot value correctly then this will work. The remainder of your money remains in the investments/savings account earning interest.
Based off the previous 100 years of stock market history, investments tend to grow by 5-6% each year. This means your FIRE pot of money should continue to grow each year by 5-6%. Obviously this is only approximately as no one can predict the future.
I know this all sounds pretty confusing, but here’s a summary of the 4% rule in 3 easy steps:
- Withdraw 4% for living expenses per year
- Remaining FIRE pot will grow by an estimated 5-6%
- 1-2% buffer for inflation
In other words, by withdrawing less than the estimated growth, your FIRE pot of money is constantly regenerating, whilst accounting for an increase in cost of living.
To allow your pot of money to regenerate like this you cannot withdraw more than 4% per year. So you can’t decide to withdraw a lump sum to pay off a mortgage, if you want this model to work.
How to save money towards your FIRE pot
If you’ve read some of my other blog posts you might have read about the need to portion off some of your monthly income to investing. This is an example of those savings, a FIRE pot.
To reach that pot of money needed for financial freedom and ultimately early retirement, I would recommend at least 10% savings per month.
If that sounds totally unrealistic for you then maybe you could think about ways to reduce your expenditure or increase income. In other words look at your budget or find a second source of income. The more you can save, the quicker you can reach your financial freedom:
- 10% monthly savings takes 51 years to reach financial freedom
- 50% monthly savings takes 13-15 years to reach financial freedom
- 75% monthly savings takes 7 years to reach financial freedom
My top tips
- Start budgeting: try saving 10% of your income towards your savings (financial freedom)
- Earn more than you spend
- Pay off debts first: the less you owe means the more that can go towards your savings
- Figure out your retirement goal: consider the lifestyle you want in later years and how much money that will require. Factor this in to your expected annual expenditure when calculating your FIRE pot value.
- Don’t compromise on your quality of life now: don’t save for a future that’s not guaranteed by compromising on the life you’re living now. Allow yourself to enjoy going out, travelling, making memories. Being really restrictive on your budget only hurts yourself. There are other ways to save, try adding another source of income to loosen the purse strings.
Final thoughts..
The 4% rule is a powerful strategy for those aiming to retire early and maintain financial independence. By saving and investing enough to build a portfolio where you can safely withdraw 4% of your savings annually, you create a sustainable income stream that can last throughout your retirement. The key is disciplined saving, consistent investing, and maintaining a diversified portfolio. By following this rule, paired with smart financial habits, early retirement can move from being a distant dream to a realistic goal.
