How much do you need to retire? It’s probably the most often asked question in the world of financial blogging and articles. So what really is the number? Is it as simple as the 4% rule and based on yearly expenses or something else entirely? Let’s dig in.
Does Financial Independence Equal Your Retirement Number
This site has a long history with posts about financial independence. I’ve made it a point of stating everyone should strive to be financially independent. But are financial independence and having enough to be retired the same thing?
The 4% Rule and Financial Independence
I asked the question are we financially independent way back in 2017. My conclusion of that post was a bit of a depends scenario. You see the traditional method of determining if someone is financially independent is the 4% rule. In general, if you can pay your annual expenses from 4% of your net worth in the year you retire, and only adjust your withdrawals for inflation, then your portfolio is pretty much guaranteed to at least last 30 years. By that rule, we are financially independent. Now that our house is paid off we have 25x our expenses in invested assets, meeting that definition.
But if you recall from that same post I noted that the 4% rule, otherwise known as the Trinity Study, only applies to 30 year periods. At the end of 30 years, you could have nothing left and still be a success. So if your time period is 60 years then the 4% rule wouldn’t cut it as your only source of income. After all, you’d still need the same amount in 30 years for the next 30, and there are no guarantees.
So we know that the 4% rule, at least for someone with a life expectancy beyond 30 additional years, is not sufficient. My statistically likely life expectancy exceeds 30 years, so it would be foolish of me to retire fully at this point.
I always Plan for a 60 Year Time Horizon With My Retirement Number
In fact, if the average person now lives into their 80s, a 45-year old or younger retire needs to handle way more than 30 years. Now you could like us target 55 as a retirement year. Then your most likely scenario is an additional 30 years. (Not the reason we are doing so) But then you are still playing an odds game many would not want to play. After all, how much would it suck to live to 90 and end up outliving your money by 5 years? No thank you. Instead, I feel more comfortable always planning for 60 more years, which would put me at 100 if I retired tomorrow.
Safe Withdrawal Rate for 60 years
Anyway, Early Retirement Now did a great study showing that 3.25% would be a sufficient number to make it through the next 60 years. That sounds like a great starting point for most people looking to decide if they have enough to retire. But is it enough to truly make the decision?
Here is the point where things get deeply personal. You see, the Trinity Study uses your expenses to determine how long your money will last. This is vastly superior to something that, say looks at income. That is because it looks at what you might actually need.
The Trouble with Deciding Based on Expenses: They Change Over Time
But… There is a big problem with expenses. That is they change over time. Some of that change is a result of things under your own control, say lifestyle inflation. Some are because of changes in life in general (say you now have kids, have health issues, get married, or get divorced.) The earlier you plan to retire, the bigger the risk is that you might change some significant part of your life that would drive your expenses up. So there is still risk even if you make the 3.25% number.
Scale and a Retirement Number
So that brings us to the one thing missing, scale. Retiring at 3.25% expenses is all well and good. In theory, you could allow yourself to live on poverty numbers, $17K for a couple. If your expenses stayed at that level as adjusted for inflation the money would last in perpetuity. But what are the odds your expenses could sit at the poverty level for a lifetime? Would you even want to have them do so long term?
Emergency Expenses and Your Retirement Number
We live in a world where an emergency car repair is $1K, a home repair is probably $2-3K (ignoring the big ones like roof), and a medical emergency could be $3-4K. These are normal repetitive surprises that would not be surprising to see regularly, we are not talking about go into a nursing home at 100K per year numbers here. I would theorize that $17K/year would be way too low to retire based on these numbers. Simply a few years of these normal life surprise would blow those savings projections apart. One minor unplanned vacation, medical issue, or home issue and your expenses would be 20-30% over budget, an amount your portfolio would likely never recover.
Simply put, it’s easy to measure your base expenses based on recent years. But there is no guarantee that recent expenses will be future expenses. So in a way, there needs to be some sort of raw retirement number floor on the rule or a built-in cushion, to ensure your expenses can absorb some level of expected shock. Basically, a margin of error would you. The higher your number the more error you can absorb caused by those surprises.
A Minimum Threshold For Retirement
I prefer bringing the base retirement number up to a minimum threshold rather than just planning an arbitrary margin of error. Afterall there is no easy way to guess what the true margin of error will be. Simply put we already have discretionary funds built into our retirement plans for things like travel. The size of that discretionary amount defines the minimum retirement number threshold for us. We can reallocate those discretionary funds to other things if such emergencies rear their heads. So it’s less about adding a cushion and more about giving yourself enough discretionary space (allocated or not) to move things around as needed.
Our Minimum Retirement Number Threshold
For us, as a couple, I’ve baselined our minimum tolerance at a raw number of $50K. Note this is not our expense number now or in retirement, which I will neither tell you if it is above or below this number due to stealth wealth. What I will tell you is that even if our expenses were below 50K, I would not retire on a number that could not support a $50K a year lifestyle.
Expense Contingencies and Your Retirement Number
Simply put at 50K your typical emergency expenses I listed earlier are below 10% of our total expenditures (most around 6% or less). These typical surprise expenses can still be significant, don’t get me wrong, but the more frequent ones are closer to the noise level of the stock market than a drastic dip. Also, the discretionary portion of our income at a level above 50K would exceed the cost of these normal potential risks. Just like an emergency fund, I view this as the contingency level built into our Financial Independence number for the purpose of retirement.
A Note About Retirement With Other Sources of Income
Now a note, your raw number is highly dependent on your tolerance of risk and any backup plans you have. If you have side hustles, ways to exclude certain expenses entirely, or some other form of additional income your need for such a floor diminishes. If you have guts of steal and are ok with the risk of living on rice and beans when you are 90, it also might be lower. But honestly, I think most of us feel we need some level of protection, within reason. The key is within reason, needless to say, this activity could turn into the never-ending one more year for the worriers amongst us.
Not the $5 Million Dollar Extreme
Now, I’m not recommending like Suze Orman that we all go out and save $5 Million to retire. In a world where few people even make $5 Million in their lifetimes, that’s hogwash. I am advising you that just because you can retire mathematically on say $400K, doesn’t mean you should. I’d also like to note, this article assumes by retirement you mean fully stop working. If you decide to go follow your passion after leaving your further career, then that number can be much less. As always, your situation may vary.
What is your retirement number? Did you consider emergency surprises in your expense numbers?