How Much Do You Need to Retire? / What is the Formula for Financial Independence?

How Much Do You Need to Retire?





3-Year-Old Son: Daddy, can you play trains with me?

Me: I’m sorry, I can’t play right now, I need to go to work.

3-Year-Old Son: [Sad Face]

Me: One day, I’ll have enough money that I won’t have to work.

3-Year-Old Son: And then you can stay home and play with me all day? [Happy Face]

Unfortunately, by the time I have the money to stay home, I’m not sure my son will want me to play trains with him all day. I expect that he may have other interests by then.  I was very impressed by how quick he grasped the concept of doing what you want with your time once you have enough to support yourself.

Once You are Financially Independent You Can:

  • Continue working to increase your lifestyle
  • Quit a job that makes you unhappy
  • Start a business without the pressure of needing to succeed right away
  • Spend more time with friends and family
  • Spend time on a hobby you are passionate about
  • Work to financially support or volunteer for your favorite cause
  • You may even be able to do a number of these things, – or thousands of others – the possibilities are endless!

How Much Do You Need to Retire?

In one of the first posts here, How do you define winning, I said I had a goal of being financially independent by 2028. Per Wikipedia, “Financial independence is the state of having sufficient personal wealth to live, without having to work actively for basic necessities.” I’m using a slightly different definition: I consider financial independence or “FI” to have enough personal wealth to cover “my planned lifestyle,” which is a higher bar than just “basic needs.” Basically knowing your FI number answers the question: how much do I need to retire? I tend to use “having enough to retire” and “financial independence” interchangeably. To be clear, I’m not saying I will retire once I reach FI, but if things go according to plan, I could. The true beauty of reaching FI is you are free to do what you want, when you want. After spending time reading as much as I could about FI and updating my spreadsheets, I felt 2028 was a conservative estimate.

Immediately after that article was posted, I received feedback asking how it would be possible for me to retire in my mid-40s. After all, everybody knows you need to work until you’re at least 65 no matter what. Well, guess what? That assumption is false! There is a very easy formula to figure out how much you need to retire and thankfully, waiting until “retirement age” is not a requirement.

Until relatively recently, I never thought retiring at 45 would be possible. I’ve always prioritized savings and understood the concept that my savings would buy me time and other options in the future. That said, my back of the envelope quick math was that I needed to save something like $5M to retire. I figured if my $5M earned 2% returns, I can live on $100K per year without digging into the principal. While the math behind my initial thinking would work, I’ve come to realize that it was way too conservative.

What is the Formula for Financial Independence

Don’t worry if you hate math, a third grader can solve this formula.

How Much do I need to Retire?FI Calculation Step One

Calculate your expected annual expenses in retirement. If you have not thought about your spending plan in retirement yet, use your current spending amounts as a proxy and you can always make adjustments later.  I’m sure you already know how much you’re spending annually after reading about the $121K mistake I made.

The hardest retirement expense to predict may be healthcare costs. I have no clue what options will be available for private health insurance two years from now, never mind more than a decade. Since I’m just trying to solve for a total number, I’m using my current costs now and will figure out the retirement expense amount when I get closer to retiring.

FI Calculation Step Two

Reduce amount in step one by any guaranteed fixed income you can expect in the future such as a pension or social security. If you don’t have a pension or don’t want to rely on social security, you can be conservative and skip this step. If you are trying to retire well before traditional retirement age, you should not reduce your calculated amount by a pension or social security right away as you’re not going to receive those amounts for years to come. When I’m doing my early retirement math, I don’t rely on social security at all. I figure it will offset my likely underestimate for healthcare.

FI Calculation Step Three

Multiply amount remaining after step 2 by 25. This is your required retirement savings for FI.

That’s it! The amount in step three is how much retirement savings you need to retire. Notice, that your income amount and your age are not needed for the calculation.

Examples of the Financial Independence Formula

To make sure the steps above are clear, let’s run through two examples.

John Smith FI Example:

  • Wants to live on $100K per year in retirement
  • Does not have a pension
  • Is conservative and does not want to rely on any social security income
  • He will need $2.5M [FI=$100K*25] to be financially independent.

Jane Jones FI Example:

  • Wants to live on $75K per year in retirement
  • Does not have a pension
  • Is planning to retire at 65 and the calculator at My Social Security says she is entitled to $10K annual social security income at that age.
  • She needs $1.625M [FI=($75K-$10K)*25] to be financially independent.

Who developed the FI formula?

The FI formula is better knows as the “4% rule” of thumb.  To the best of my knowledge, it was pioneered by William Bengen in a paper he first published in 1994.  One goal of the paper was to calculate a Safe Withdrawal Rate (SWR), or the dollar amount one can safely withdraw from their nest egg so they don’t outlive their money. His key finding was that if you wanted your nest egg to last for 30 years, using an allocation of 50% stocks and 50% intermediate-term Treasuries, “a first-year withdrawal of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe.”

Many studies have followed this initial research including the famous Trinity Study and an updated version of it.  The study shows there is a 96% chance of your nest egg lasting 30 years using this methodology.  To the best of my knowledge, nothing written disputes that using the 4% withdrawal method described by Bengen is relatively safe.

If you are about to retire, the 50/50 allocation and 4% inflation adjusted withdrawal strategy discussed in the Trinity Study may be a bit too simplistic. You would want to consider your specific situation to establish an asset allocation and draw down rate you are comfortable with. For the purpose of trying to figure out a target “retirement number,” the 4% rule works perfectly. This is the reason you multiply your retirement needs by 25 (4% * 25 = 100%).  The rule of thumb allows us to comfortably assume that with proper asset allocation, you can withdraw 4% of your assets in year one of retirement and increase that amount annually based on actual inflation. This way, your nest egg is extremely likely to last through your retirement.

Two Strings of Financial Independence

There are two strings you can pull to get closer to financial independence.

two strings of financial independence


1 – Save More

  • Increase Earned Income – Earn a raise or start a side hustle and save the difference.
  • Passive Investment Income – Generate returns on the amounts you’ve already saved in your retirement and other savings accounts.
  • Reduce Expenses – Cut out the excess spending in your budget and save the difference.

2 -Reducing Retirement Needs

  • For every dollar that you reduce your annual retirement spending needs, it reduces your FI number by $25.

The Double Whammy of Expense Reduction

It’s possible to reduce current expenses and your retirement needs at the same time to supercharge your progress towards financial independence!

For example, say you live in a $5K per month luxury apartment in New York City. But you realize you’re spending all your income and have no savings to show for all your hard work. You decide to pursue FI and move to a $2K apartment in Brooklyn. You plan to stay there in retirement as well. This one decision, helps you twice! First you will be saving an additional $36K per year towards retirement. Additionally, you can reduce retirement targeted savings by $900k (25 times $36k) because your rental expense in retirement is now projected to be so much less. And it doesn’t have to be just housing. Cutting cable comes to mind as a smaller example where you can save now and need less later. When I came upon the realization, that with one action, I can save more and need less it was life changing. It’s had me really motivated to find as many of these opportunities as possible. I’ve made some life changes recently that have reduced my time to FI by YEARS!

Almost everything you read on this site is designed to get you closer to FI. We will do this by discussing what you can do to pull each of the two strings of FI with a special focus on cutting expenses that could be a double whammy.  Why? Because once you are financially independent, you are truly free from selling your time to support yourself. Even if you choose to continue to work, there will be nothing forcing you to.

Additional Reading

My goal with this site is to educate my readers as much as possible, even if that means sending you to other sites. I know that this post is a little high level without much of the mathematics behind the 4% rule. The good news is there are many other articles with a different twist on the same subject. If you want to read more on why 25X annual expenses = financial independence and related material, here are a few great places to continue your reading:

(If you run a website that has a post with a view of financial independence not covered by the above, send me a note with the link via the contact page and I’d be happy to add it here.)

6 thoughts on “How Much Do You Need to Retire? / What is the Formula for Financial Independence?”

    1. Thank you! Glad you liked it. I was trying to keep this post simple and provide the more in depth resources for those that want to explore more.

  1. This is a great look at a topic that I wish more people were exposed to. It’s crazy to me that everyone assumes “retirement age” is right around 65, without really being able to say why. We need more people to actually take a look at the numbers and make informed decisions.

    1. Matt, thanks for coming over to my corner of the internet. For those that don’t know, Matt’s blog is about optimization of not just finances but life in general and it’s a must read. I agree that the concept of a true retirement number based on projected expenses should be more widespread. I was truly life changing for me. Hopefully this post helps get the word out a little more. I know I’m not the first to write about this subject but I’m pretty sure this will be the first exposure to it for some of my readers.

  2. Hi Jason, thanks for the informative article. I’ve played around with some financial calculators out there and it really is crazy how much you can shave off your retirement age by just spending less now. And the power of compound interest really can help get you there, if you start young. Thanks again!

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