If you want to retire early, you must maximize the value of your after-tax investments. Pre-tax retirement accounts such as your standard IRA or 401(k) are nice, but they won’t get the job done unless you think retiring after the age of 59.5 is considered early.
There is an exception to that rule, however, which allows an employee who retires, quits or is fired at age 55 to withdraw without a 10% penalty from their 401k called the “rule of 55.” You can also utilize Rule 72(t) for early withdrawal. The distributions must be “substantially equal” payments based upon your life expectancy. Once the distributions begin, they must continue for a period of five years or until you reach age 59 1/2 , whichever is longer.
But these rules are crutches for those who’ve bungled their early retirement plans. A successful early retiree waits until at least 60 to access their pre-tax retirement accounts because they have an abundant amount in their after-tax investment accounts.
Let’s first review how much you should have in your pre-tax retirement accounts by age as our foundation.
Pre-Tax Retirement Accounts By Age
The below chart is my estimate for pre-tax retirement account amounts by age. I’ve used the standard 401(k) plan, but the numbers encapsulate all pre-tax retirement accounts. These are the amounts you need to comfortably retire after the age of 60.
Assumptions from the chart:
* The Low End column accounts for lower maximum contribution amounts available to savers above 45 and/or lower returns.
* The Mid End column accounts for lower maximum contribution amounts available to savers below 45 and/or medium returns.
* The High End column accounts for higher maximum contribution amounts available to savers under the age of 25 and/or higher returns.
* After a couple years, one maximizes their contribution every year to their 401k plan without fail.
* Average starting working age is 22. But you can follow the number of years working as a different guideline if you graduate later or earlier.
* The rate of return assumptions are between 0% – 10%.
* Company match assumption is between 0% – 100% of contribution. As of 2018, the total maximum 401(k) contribution by the employer and employee is $55,000. The maximum employee contribution is usually $18,500, but there is a $6,000 employee catch-up contribution if age 50 or older by year end.
* The Low, Mid, and High columns should successfully encapsulate about 80% of all 401K contributors who max out their contributions each year. There will be those with less, and those with larger balances thanks to higher returns and more generous company profit sharing.
After-Tax Investment Amounts By Age (Base Case)
Now that everyone agrees with my pre-tax retirement amounts, it’s time to figure out what your after-tax investment amounts should be by age.
After-tax investments include all stocks, bonds, rental property equity, business equity, and private investments. You could include your primary residence equity if you plan to rent out rooms or sell the property, but a conservative person would not.
For those who aspire to retire early, pre-tax retirement accounts should mentally be considered “bonus money.” If the money is there when you turn 60, wonderful. If it’s not, no big deal because you didn’t count on it to retire on in the first place.
Maxing out your 401(k) is something you should just do as soon as possible for as long as possible. It reduces your taxable income and often has a company match or profit sharing component. Never pass up free money.
Given after-tax investment money is what is required to generate passive income and live a comfortable life in early retirement, it is therefore logical that after-tax investment money equals a multiple of pre-tax money. The greater the ratio of after-tax money to pre-tax money, the easier it will be to survive in retirement without a job.
Have a look at my base case after-tax investment amounts chart, which will allow you to comfortably retire between 40 – 50 if you so choose with a safe withdrawal rate of between 3% – 5%. This is the base case scenario. I’ve provided an aggressive scenario and a conservative scenario as well.
Your 20s: The hardest part about achieving financial independence is getting started. Your 20s is a time of uncertainty. You’re not exactly sure what you want to do, where you want to live, and how you plan to get your finances in order. Maybe you have student loan debt as well. The easiest way to get started is to read your employee handbook and contribute as much as possible to your company’s pre-tax retirement accounts ASAP.
Since you have the lowest earnings power, it may be difficult to comfortably max out your 401(k). However, it is important to also build up after-tax investments at the same time. The ideal situation is to max out your 401(k) and then save 20% or more of your after-tax, after-401(k) income.
By the age of 30 or after eight years in the workforce, your goal should be to have as much in your after-tax investment accounts as you do in your pre-tax retirement accounts. In this chart, that figure is $150,000 + $150,000 = $300,000.
Your 30s: You should hopefully know what you want to do with your life by the time you hit 30 or after eight years worth of work experience. If not, retiring early will be difficult.
For this decade, your goal is to get your after-tax investment accounts equal to at least 2X your pre-tax retirement amounts by 40. Once your after-tax investment amount surpasses your pre-tax amounts, you will finally start feeling like early retirement is a possibility.
Your 40s: If all goes according to plan, you’ll have accumulated between 2X – 3X in your after-tax investments. In such a scenario, you are free to leave work behind.
It’s important not to hit the eject button before you hit at least a 3X ratio (~$1.5M). Otherwise, you’ll likely experience a tremendous amount of anxiety in early retirement, which would defeat the purpose of retiring early. There are plenty of folks who decided to retire in their 30s because it was the fashionable thing to do and ended up decimating their wealth and their relationships.
There’s often a lot of financial pressure in your 40s due to kids, aging parents, health problems, and so forth. This is the sandwich decade that must be taken very seriously.
Your 50s: If you’ve been wanting to retire, but still haven’t, hopefully it’s because you enjoy your job, enjoy the camaraderie, or are waiting for a meaningful pension that will set you up for life. Retiring in your 50s still feels great because it’s still 5 – 15 years earlier than when the average person retires. We’re also living longer as well.
I also stop the chart at age 60 because if you retire after age 60, then you’re retiring at a fairly normal age. If you’re retiring close to 60, there’s really no need to accumulate much more than 3X your pre-tax retirement accounts in after-tax investments because you’ll be able to tap into your pre-tax retirement accounts penalty free and receive Social Security as early as 62.
Aggressive After-Tax Investments By Age Guide
For those who are younger, who don’t feel like the amounts are enough in my first chart, or who have early retirement goals as soon as you graduate from school, below is a more aggressive after-tax investment guide to follow. Higher after-tax amounts are achieved through greater risk-taking, a side business, better returns, and greater luck.
This guide will allow you to comfortably retire between the ages of 35 – 45, depending on your level of frugality and responsibilities. Again, these numbers are based on firsthand experience and feedback from other early retirees.
Retiring at 30 (not recommended): Theoretically, a 30-year-old with no spouse and no kids to care for could retire with $150,000 in pre-tax retirement accounts and $450,000 in after-tax investment accounts, especially if they geo-arbitrage to a lower cost area of the country or world. But I wouldn’t recommend retiring so early after spending so much money and time on education. You need more time for your investments to compound. “Lean FIRE” is a difficult way to live if you have aspirations to live a more comfortable life or start a family.
Retiring at 35 (not ideal, but doable): By age 30, one should finally gain the confidence and expertise to really start earning an accelerated income. Your 30s is a time for rapid wealth accumulation. If you retire at age 35, you’ll have at least socked away an extra five good years of earnings. But unless you have something you really want to do after retirement, retiring at age 35 also is a little premature. Your $1,200,000 in after-tax investments based on a 4X multiple will only bring in about $36,000 – $60,000 depending on risk. Therefore, you will likely need to supplement that income with part-time work.
The good thing is that most people I know who’ve left Corporate America around 35 have easily been able to find things they enjoy doing which also pays them supplemental income. Online freelance work is a trend that is here to stay. If you’ve been able to retire at 35, you should have at least one valuable skill to sell.
Retiring at 40 (green light): The closer you get to 40, the more comfortable you will feel with retiring because you’ve not only spent more years working than you’ve spent in grade school and college, you’ve also built up a more robust net worth thanks to more years of compounded returns and savings. After at least 18 years of working, you won’t have as much wonder or regret leaving a job behind. You’ll probably welcome a break from the mundane in order to travel or spend more time with family.
With around $2,500,000 in after-tax investments and at least $500,000 in pre-tax bonus money, you have enough to live a relatively frugal life with a family. $2,500,000 will generate at least $75,000 a year risk-free and up to $125,000 a year in income based on a slightly more aggressive 5% annual rate of return. Once Social Security kicks in, you’ll earn an extra $1,000 – $3,000/month in spending money. Conceivably, you’ll never have to touch principal now that the risk-free rate is over 3%.
40 is still young enough to start a business or do some part-time consulting if so desired. Worst case, you can always go back to work as well. If you can hang on long enough, the ideal age to retire is between 41 – 45 to minimize regret and maximize happiness. Having a net worth between $3,000,000 – $5,250,000 should be enough.
Regarding the large net worth figures at the end: Getting to $10,000,000 – $20,000,000 by age 60 in my charts seems farfetched. Plenty needs to go smoothly with your job, your investments, or your business. For example, to grow your after-tax investment amount from $5,000,000 to $15,000,000 in 10 years requires annual contributions of $115,000 plus 10% compound annual returns.
These large figures should give folks some insight into the power of compound returns over time. As a result of compounding, it’s a mistake to retire before the age of 40 if you don’t have alternative means to earn and invest. Earning your 5th million is much easier than earning your first. At 41, I feel my life has just begun.
For those who are willing to retire at let’s say 40, their net worth will likely be capped at around $2,000,000 – $3,000,000 or at least grow much slower as they spend their passive income and potentially their principal. In other words, if you retire early, it’s likely you will give up millions of dollars of future wealth for the freedom you’ll enjoy today. You must be OK with this.
Conservative After-Tax Investments By Age Guide
Finally, for those who live in a lower cost area of the country, who plan to retire in a lower cost area of the country, and/or who simply have much lower overall living expenses, this guide may be more appropriate for you. In this scenario, I would not retire before the age of 45 and without at least a 3X multiple.
Putting Early Retirement In Perspective
82% of Americans retire after the age of 61. Therefore, if you somehow feel irked by my money targets, it’s understandable because most Americans won’t retire early. Just remember that this is a financial independence site that focuses on living one’s best life as soon as possible. The Financial Samurai community does not strive to be average.
Since 2012, I have met only a handful of people who retired early and then ended up going back to work full-time because they couldn’t find something meaningful to do with their free time. The second most common reason for going back to work is usually a miscalculation of the amount they needed to feel financially independent, hence the purpose of this post. Those who miscalculated tend to skew under age 35.
Key Points To Remember
1) Passive income is everything if you truly want to live a carefree retirement lifestyle. Shoot to have as much in after-tax investments as you do in pre-tax investments by age 30. Don’t get to a 1X multiple because you have so little in pre-tax investments. Get to at least a 1X multiple because you have been aggressively contributing the maximum to your pre-tax accounts in your 20s.
2) 40 years old with a 4X multiple is ideal. Don’t retire before you hit at least a 3X multiple. Ideally, you’ll be able to get to a 4X multiple ($1M – $4M in after-tax) between ages 35 -50. If you do, there’s no reason to continue working at a job you don’t absolutely love. It is OK to take some risks with a new job that pays less, start an entrepreneurial endeavor, or even completely retire and do nothing. However, after about three years of doing nothing, you will get bored and want to do something productive again.
3) Earning supplemental income in early retirement is extremely common and beneficial. Almost everybody I know who has retired early found something they love doing part-time that generates a little to a lot of income. The younger you retire, the higher the likelihood you’ll end up generating supplemental income that drastically extends the life of your financial nest egg. You can retire with less than my guide suggests if you have other means of earning extra income. Every $10,000 in supplemental income you make equals $250,000 in capital at a 4% withdrawal rate.
4) Bad things that cost money tend to happen in higher frequency the older you get. Not only must you take care of yourself, you may have parents and children to take care of as well. Therefore, believe the figures in the chart are not only realistic, but necessary for those who wish to retire early comfortably. Do not extrapolate the returns of the past 10 years into the indefinite future. If you do, this will be one of your biggest financial mistakes.
5) Focus on the after-tax columns. If for whatever reason your pre-tax retirement accounts are short of my targets, then simply focus on the after-tax column in both of my charts as an amount to shoot for by age. As an early retiree, you won’t be pilfering your pre-tax retirement accounts anyway, so they don’t really matter unless you have some serious financial emergency.
6) Make a judgement call on the amounts in my guides based on your overall living costs. If you plan to retire in places like San Francisco, Manhattan, and Honolulu, you may want to focus on the more aggressive guide. If you plan to retire in places like Omaha, Des Moines, Dallas, and Ft. Lauderdale, the conservative guide is more appropriate. If you and your life partner are a team, then my guides can be the combined total amounts for both of you. If you plan to retire between 55 – 60 years old, you most likely do not need as much as my charts indicate. My charts are guides, not early retirement law.
7) The longer you work, the less you need. Although your net worth starts to skyrocket the older you get due to the power of compounding, you ironically need less money the later you retire. People suffer from the “one more year syndrome” all the time due to this fact. Therefore, the hardest part about retiring early is overcoming the mental fear. If you follow the numbers in my guide, you will more easily handle the psychological aspect of the transition.
8) A safe withdrawal rate is between 3% – 5%. The risk-free rate of return (10-year US treasury bond) is now roughly 3%. Therefore, you can withdraw 3% from your after-tax investment accounts every year and never touch principal. Keep the maximum withdrawal rate at 5% if you don’t plan on making any supplemental income in retirement. By the time you turn 60, your pre-tax retirement accounts will provide you an extra financial boost if necessary.
For those curious, at 34, I left with a multiple at around 4X. Yes, it was a little scary to leave so young. But with a severance package and only myself to provide for at the time, I wasn’t overly worried in 2012. The goal after leaving work was to build Financial Samurai and accumulate enough in my after-tax investments to generate a $200,000 passive income stream to provide for my potential family.
Now that I do have a family, I’ve discovered that due to inflation, a passive income amount closer to $300,000 is more appropriate if we are to remain in San Francisco. It has definitely been a challenge to try and generate more passive income, especially now as a stay at home dad.
If I hadn’t received a severance package, I most likely would have worked for three more years and saved at least 50% of my income to boost my after-tax investment accounts to 5X. Thankfully, it’s been a raging bull market since I left, so my multiple has continued to expand.
Leaving a steady paycheck is not easy, especially if you’ve had one for decades. But if you hit these target multiples, I promise you that everything will turn out all right in the end. If things are not all right, then it is not yet the end!
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