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Retiring early is scary if you do not understand the numbers justifying the logic. Even once you learn that retiring early is less risky than planning for regular retirement, pinpointing how much you personally need to retire can be daunting. For those seeking financial independence to retire early, the amount of money required to never work another day in your life is called your FI Number. Since this is supposed to be your ticket to forever freedom, it makes sense to calculate your FI Number precisely for your specific needs.
My FI Number will be different from your FI Number. There are folks who can acquire $500,000 and happily maintain their lifestyle in perpetuity, and there are others who need $12,500,000 for happiness. You most likely fall somewhere in the middle, but here is how you determine your FI Number:
1. Calculate or Track Your Annual Spending
Your FI Number is one of the many personal finance numbers that relies on an accurate calculation of your annual spending. There are multiple ways to calculate your annual spending, whether tracking it over the next year or completing a treasure hunt to determine everything you spent over the last twelve months. Pick a method that works for you, and end up with a number that you are confident covers your annual spending. This is a judgment-free number. It may be $20,000 or $500,000, and either is okay.
2. Identify Current Expenses You Will Not Need in Retirement
Most individuals have expenses related towards being able to work, and those expenses will not exist in retirement. For anyone who attends a physical office, commuting expenses may include the cost of public transportation, the cost of gas to drive to work, any tolls or parking expenses, the cost of much of your car’s wear and tear, and even your car insurance if you anticipate driving much less or giving up a car entirely in retirement. In addition to a commute, attending a physical office or workplace means you likely spend a bit of money on either professional or functional shoes and attire, and potentially even hair gel or makeup to look the part.
Regardless of where you work, you may pay for subscriptions, software, or home office improvements. Even the electricity cost may go down after you stop spending so many hours a day at a computer! You also may pay for conveniences like grocery delivery, food preparation, home cleaning, child care, or elder care that you would be happy to do yourself if you were not working. Realizing savings in these areas can result in a significant reduction of annual spending, even if you decide to take on only some of these responsibilities while outsourcing others.
Be honest about all of the costs associated with working that you plan to reduce or completely eliminate. List the annual cost of all of them and the amount by which you would reduce them in retirement. Add all of these together to calculate the sum of all expenses you will not need in retirement. If most of these are monthly fees, you can take a month’s calculations and multiply by 12, but remember to include seasonal costs, like summer camp for kids that need an activity while parents work, in your calculations.
3. Identify Expenses in Retirement You Do Not Need Now
For the 65+ retiree, this one is far less complicated due to the ages when folks typically enjoy mobility and good health. However, if you are retiring at 30, 40, or 50 years old, you may have some adventurous retirement plans ahead of you. Climbing Mount Kilimanjaro will likely cost more than the typical week-long vacations you took while still working, and you should account for those costs.
To estimate these annual costs, list out all the activities you would love to enjoy or purchases you would like to make over an ideal year while you still have mobility and health but also have the freedom of retirement. Examples may include traveling to see friends and family, participating in at least three races a year (with two requiring travel), living abroad, attending concerts or sporting events, attending fundraisers across your region for a cause close to your heart, taking language classes, and more. List anything you are not doing now or that you would like to do more of in retirement.
Next to each of these future plans, estimate the annual cost of making them happen. If it is something like participating in three races across the country and you already participate in one, use the one you already attend as a reference point and list the cost of adding two more to your annual spending. If you are adding a completely new activity, conduct some basic research on the cost. Once you have numbers for all of the expenses you plan to add in retirement, add them up to get the sum of your anticipated new expenses in retirement.
4. Calculate Your Annual Spending in Retirement
Your annual spending in retirement can be calculated using the three numbers outlined above:
Current Annual Spending – Expenses You Will Not Need in Retirement + Expenses to Add in Retirement
For example, if your current annual spending is $60,000, the expenses you will not need in retirement total $9,000, and the expenses you want to add in retirement are $7,000, your calculation to find your annual spending in retirement would look like:
$60,000 – $9,000 + $7,000 = $58,000
Your annual spending in retirement may be higher or lower than your current spending, and neither is inherently good or bad. If you have a long commute to a physical office five days a week, you are likely to see a lot of savings. If you work from home running your own remote business, the additional travel may add more new expenses in retirement. All of this is okay and is just information needed to calculate your FI Number!
5. Choose Your Expected Annual Withdrawal Rate
While the generally accepted safe withdrawal rate is considered 4%, you should assess your own risk tolerance and investigate your options for higher or lower withdrawal rates. We are actually working on some research into higher withdrawal rates (that means scary withdrawal rates above 5%!), but you ultimately need to make the decision about how much risk you want to carry when choosing a withdrawal rate. If you want to dive a bit deeper on safe withdrawal rates, read Financial Freedom: A Proven Path to All the Money You Will Ever Need by Grant Sabatier. If you are interested in higher rates of withdrawal check out this article for the recent model forcing us to think deeper and watch for our take on this study in November!
One point to always remember on risk and safe withdrawal rates: Historically, if a portfolio grew in the first five years after retirement, the retirees never ran out of money. This means you will most likely know within the first five years after retirement if you retired at an unlucky point of financial decline and may need to supplement your income. It is possible to fail at early retirement, but it is just as possible to fail at conventional retirement. Going back to work at age 45 is easier than age 70, so we love the risk hedging that comes from an early retirement plan.
6. Multiply Your Annual Spending in Retirement According to Your Annual Withdrawal Rate
Depending on your chosen safe withdrawal rate, you will multiply your annual spending in retirement by a certain number to determine your FI Number. If you choose the standard 4%, this means you will multiply your annual spending in retirement by 25. Here is a chart to outline common withdrawal rates:
For example, if your annual spending in retirement was $58,000, like the previous example, and your safe withdrawal rate was 4%, your FI Number calculation would be:
$58,000 × 25 = $1,450,000
This results in a FI Number of $1,450,000. That means, if you invested $1,450,000 and retired, you could live off of the gains from that investment for the remainder of your life without ever working another day.
7. Bonus Step: Accounting for Inflation Depending on Your Timeline
The one caution to identifying your FI Number is that that is your FI Number right now, at this moment, with the current value of money. Annual inflation tends to make our dollars worth less over time, so that FI Number will grow a little while you are still working to reach it.
The good news is that once you do reach your FI Number, the annual growth rate considered in the 4% rule accounts for inflation. Your money will grow more than 4% annually on average, and the additional growth above 4% will account for inflation. Your money makes enough money to make inflation irrelevant! However, before reaching your FI Number, you have to account for inflation.
If you anticipate being able to reach your FI Number in less than five years, inflation will have a relatively minor impact. However, if you are decades away from your FI Number, inflation is huge. Take this example of a 30-year-old with anticipated retirement annual spending of $75,000 and a FI Number of $1,875,000 (based on a 4% withdrawal rate, i.e., $75,000 × 25, ), assuming a 3% inflation rate:
If that 30-year-old retires today, they will only need $1,875,000 to retire. That will be enough money to let their money account for inflation for the remainder of their life. However, if they wait to retire until age 60, they will need to accumulate the additional $2.7 million that their money would have earned for them in order to account for inflation.
Regardless of your retirement timeline, it is worth calculating your FI Number today as a starting point. However, if retirement is a long way off for you, revisit your FI Number calculation each year to account for inflation. If retirement is close (or here!), you now have a confident calculation on which to base your retirement plan. Go into retirement knowing that you have enough money to sustain your lifestyle forever.