Six Steps to Achieve Financial Independence and Retire Early (FIRE)

In recent years, the financial independence and retire early (FIRE) movement has gained a notable level of traction, especially among millennials and younger members of Generation X. Generally, the goal for FIRE enthusiasts is to curb expenses, save aggressively, and ultimately amass enough investable assets and budget flexibility to gain financial independence.

The meaning of financial independence varies. To some, it means fully retiring at an early age and never working again. To others, it means never fully retiring but foregoing the stress and time commitment of a typical nine-to-five job in exchange for work that ignites their passion or affords them greater control of their schedule and paycheck (commonly referred to as “Barista” FIRE). Some want to save aggressively now so they can spend more later (aka “Fat” FIRE), while others want to save aggressively now and always live frugally, spending at the same lower levels to which they’ve now grown accustomed (aka “Lean” FIRE).

Despite their differences, successful early financial independence seekers share several common characteristics. They’re personally committed to saving a significant portion of their income and have therefore trained themselves to live on less. Regardless of enjoyment, they tend to view their careers as fluid resources for generating income, wealth, and financial autonomy. Because they see work as a means to a happier and less stressful lifestyle, they’re generally open to the idea of “unretiring” (i.e., picking up work in retirement)—whether to reduce financial strain, increase personal fulfillment, or both.

That said, for a variety of reasons, many investors who want to retire earlier than age 65 may feel it’s unrealistic to achieve that goal in their 40s or early 50s. And in many cases, they are correct. Therefore, in this article, we will focus on the less extreme (and more attainable) objective of reaching financial independence by age 55—the age at which most workers can gain penalty‑free access to employer plan retirement savings. Though these steps can be applied to any early retirement plan, the age 55 milestone can serve as a reasonable target for a wide range of individuals.

Standard rules of thumb should be reconsidered and reframed

Regardless of how you define financial independence, retiring at age 55 or earlier will involve some planning complexity, and standard rules of thumb, often, will either not apply or should be viewed in a different light.

• The standard 15% annual savings rate is based on a typical retirement age of 65. Thus, it is likely not applicable for those targeting earlier retirement. Generally, the earlier the retirement age (or shorter the accumulation period), the higher your annual savings rate will need to be.
• A 4% withdrawal rate in retirement is generally appropriate for someone planning on a standard 30‑year retirement period. Those aiming for early retirement, however, will likely need their portfolio to sustain them for longer than 30 years, so typical retirement risks such as longevity (outliving your money) and sequence of returns tend to be more acute. Sequence of returns risk is the potential that several years of negative returns during critical periods in retirement (such as early on) can lead to an accelerated depletion of assets. Over a longer time frame, there is simply more opportunity for streaks of bad luck. To mitigate the risk of spending down your assets too quickly over a longer‑than‑average retirement, it may be prudent to plan on a lower‑than‑average withdrawal rate (and therefore a higher savings target). (See “What about the rule of 25?”)
• Conventional wisdom assumes that spending in retirement will remain constant, adjusted upward for inflation each year. Key to any successful early retirement, however, is the acknowledgment and acceptance that spending should be a moving target and one that can be adjusted downward as easily as it is maintained or adjusted upward. In other words, regardless of your initial withdrawal rate, you should build in enough budget and lifestyle flexibility to adapt your spending or earning power based on market performance and changing asset values.

Financial planning basics pre‑check

Before determining whether to further explore early retirement, make sure your essentials are covered. You should:

• Have three to six months of expenses in an emergency fund.
• Have no high or adjustable‑rate consumer debt balances (i.e., credit card, personal loan, etc.) aside from your mortgage.
• Have current savings that would put you on track to retire at 65.
• Be saving at least 15% of your income toward retirement already.
• Have additional cash flow available OR expenses you’d be willing to cut so you can dedicate more to savings on a regular basis.

If you placed a check mark next to each of the above, you’re likely in a position to explore the further actions needed to attain financial independence by age 55.

Planning steps for early retirement

The following steps can help you assess your current plan and understand what changes may be needed to improve your likelihood of early retirement.

Step 1: Evaluate your current savings rate and spending level (after saving), and run the numbers using an online tool such as the T. Rowe Price Retirement Income Calculator to gauge your current progress.

By entering basic information such as your current age, savings rate, account balances, target retirement age, and your annual living expenses (in today’s dollars), you can get a sense of your likelihood to successfully retire early based on your current planning.

The tool runs a Monte Carlo analysis that tests your inputs against 1,000 randomized market outcomes to estimate your “confidence score.” The longer the time frame under consideration (and the younger the investor), the lower the confidence score will generally skew, because there’s simply more time for things to go awry. Therefore, for clients who are age 44 or younger to be in the “confidence zone,” 70% to 99% of the simulations must result in dollars remaining at the end of retirement. For investors age 45 and older, with a shorter time horizon, the confidence zone is 80% to 95%.¹

Once you’ve obtained your preliminary confidence score, you can manipulate the various inputs to better understand which levers you may need to pull (such as savings rate, spending goal, investment mix, retirement age, etc.) to improve your likelihood of success. This could help motivate you to make the necessary upward adjustments to your savings rate and/or downward adjustments to your spending to meet your early retirement goal with some level of confidence.

Depending on your situation and goals, you may need to save anywhere from 30% to 60% of your annual earnings (including all employer contributions) to retire early. Let’s consider an example. (see “Confidence score based on age and savings rate”). Each of these investors earns $100,000 per year, has an annual retirement spending goal of $50,000 in today’s dollars, and would like to retire at age 55. Note that all four investors have current balances that would result in a confidence score over 90% based on a 15% savings rate and a retirement age of 65. But to retire earlier, additional savings are required.

Since one of the prerequisites for targeting early retirement is the willingness and capacity to sustain an increased savings rate, it means you’ll also need to grow accustomed to spending less of your income. If you’re currently saving 30% to 60% of what you earn, you’re probably already minimizing spending and training yourself to live on less, which is a healthy habit if you plan to retire early.

If you’re saving 15% but spending the remainder of your income, you may need to examine your spending outlay to look for ways to cut expenses so you can direct more of your paycheck to savings.

If you find that you regularly have money left over at the end of the month, you should increase the amount you’re automatically investing toward retirement. (For further details on available account types, see Step 4.)

Step 2: Consider partnering with a financial professional to assess your situation and goals, develop a personalized plan, and execute next steps.

While many financial independence seekers are capable of analyzing and executing an early retirement plan independently, others may benefit from talking through their plan with a professional. A financial professional can help you further fine‑tune your strategy by educating you on reasonable parameters for everything from your desired retirement age and annual spending goal to your savings rate requirement and return expectations.

From there, your advisor can help you understand options and trade‑offs, weigh the pros and cons of any planning choices, and determine which actions would have the greatest positive impact on your plan. Perhaps most importantly, a trusted advisor can assist you with implementing the strategy and hold you accountable for making (and then sustaining) the changes you enact.

Step 3: Explore options to cut or eliminate expenses to allow for maximum savings capacity now and optimal spending flexibility later.

Whether spending cuts are needed to boost your savings rate, or you just want to minimize your expenses and spend more mindfully, here are some of the many ways you might rethink and restructure your spending:

Redirect any planned or unplanned cash flow increases automatically to investments. If you pay off a car or student loan or cut an expense or if your child transfers from a private to a public school, direct any cash flow savings immediately via automatic investment to an account earmarked for retirement. The key is to redirect those funds right away, so you never grow accustomed to spending them.

Reduce housing‑related expenses. Housing makes up the largest share of most family budgets (~30%). Although none of the options for lowering housing costs are easy or sacrifice‑free, any cut in that area could free up a great deal of additional savings capacity and may be worth considering.

• You might start by exploring more common options (that typically impact only your immediate household), such as finding a housemate or relocating to a more affordable house and/or lower cost area. If you’re raising children and relocation could lower your total housing and education costs, this could lead to substantial combined savings. If you love where you live, your housing expenses are reasonably low, and you’re already saving at a healthy rate, you might explore options for paying down your mortgage before retirement.
• If you’re interested in taking more drastic cost‑cutting actions, you could explore options that would require mutual willingness to live with relatives for a temporary or extended period. For example, aggressive FIRE seekers might opt to sell their home, invest the proceeds, then move in with family members for a specified, agreed‑upon time and dedicate all previous housing expenses exclusively and automatically to investments. Others might opt to combine financial forces with parents, in‑laws, or siblings to purchase a larger home with separate living areas and reside together. Of course, these actions are less common and may not be realistic for many.

Avoid lifestyle creep. Just because you make more doesn’t mean you need to spend more. Take that commission, that bonus, that pay increase due to a promotion, or that annual raise and automatically direct it to your investments.

When it comes to vehicle purchases, choose safety and affordability over luxury and novelty. The simple act of buying an affordable, good-quality new or used car and redirecting the higher car payment you would have assumed to investments could be more impactful than you think. If your current car payment is particularly high, don’t be afraid to explore selling the car and purchasing a more affordable one.

Competitively price essential expenses regularly. The cost of ongoing expenses such as insurance premiums, bundled cable/internet packages, utility or cell phone bills, and gym memberships can often be lowered with a bit of online research and a few phone calls. This may require time and patience but could yield meaningful monetary results.

For more cost‑cutting ideas, see “Need to Boost Your Retirement Savings? Spend Less to Save More.”

Step 4: Increase and/or optimize your retirement investments through diversification of savings vehicles.

Depending on your income, a higher savings rate will likely require you to save beyond your 401(k), which has an annual contribution limit of $23,000 if under age 50 in 2024.² Additionally, you’ll probably need to use your investments to supplement or fully provide your income prior to age 59½. Withdrawals from pretax individual retirement account (IRA) or 401(k) savings are generally taxed as ordinary income and assessed a 10% penalty if accessed prior to age 59½, unless an exception applies.

So having other account types available with more favorable tax‑free or capital gains tax treatment and no penalty exposure is often critical to fully realizing early financial independence. Here are some common account types available for optimizing your retirement savings diversification strategy.

Take full advantage of your employer‑supported benefits

• 401(k). In addition to the potential benefit of an employer match, 401(k) plans offer higher contribution limits than IRAs, which means they can more easily accommodate the higher savings rate necessary for those targeting early retirement.
• Roth 401(k) option. Many employer plans now offer a Roth 401(k) deferral option. Unlike with a Roth IRA, Roth 401(k) contributions are not subject to income limits, so anyone is eligible. Although deferrals to a Roth 401(k) are nondeductible and therefore don’t provide an immediate tax benefit, the assets do offer potentially tax‑free income in retirement.
  • Of particular importance to early retirees, when you leave your company, you can roll over any Roth balances or after‑tax contributions to an existing Roth IRA. As long as that Roth IRA was established at least five years prior to withdrawal, any rollover dollars that were originally contributed to Roth or after‑tax sources in the 401(k) may be removed tax- and penalty‑free before age 59½.³ (See “Mega backdoor Roth option for higher‑income individuals.”)
• Rule of 55: The Rule of 55 is an IRS provision that allows workers who separate from service at age 55 or later penalty‑free access to funds held in their most recently active 401(k) or 403(b) plan.
  • This penalty‑free access makes it somewhat feasible for retirees whose savings are concentrated in 401(k) plan assets to have easier access to funds upon early retirement.
  • Distributions may still be subject to Federal and state taxes (depending on the source⁴), but the 10% early withdrawal penalty is waived. Keep in mind that plan-specific withdrawal guidelines may still apply. For instance, you might not be able to specifically take withdrawals from your Roth or pretax sources. Instead, the plan may require prorated withdrawals across all sources.
• Individual/Solo 401(k): If you’re self‑employed and have no employees (aside from a spouse), you can establish an Individual/Solo 401(k) and maximize contributions as both employee and employer. Contribution limits will depend on your earned income from the business but can reach as high as IRS maximums for larger 401(k) plans and will typically allow for higher deferrals than an IRA alone.
• Heath savings account (HSA). Most early retirees will experience an increase in health care expenses between retirement and Medicare age. So, while working, if your employer offers a high-deductible health plan (HDHP) and accompanying HSA, you may consider switching your health coverage to that type of plan and using the premium savings to maximize your HSA contributions every year.⁵
  • HSAs are unique in that they offer a federal “triple tax benefit.” Contributions are deductible, and assets grow tax‑deferred and can be distributed tax‑free at any age if used to pay for a wide variety of qualified out‑of‑pocket medical expenses.⁶
  • Tax‑free HSA withdrawals can then be used to cover qualified out‑of‑pocket expenses in early retirement, but another benefit is that personal reimbursements for qualified expenses from an HSA do not need to occur in any time frame.
  • So if you incur a medical expense after opening an HSA, you could pay it out of pocket while working, then wait until many years later to take a tax‑free reimbursement from your HSA at any point in retirement. Just be sure to maintain your records.

Take full advantage of savings vehicles unaffiliated with your employer

• Taxable investment accounts. Taxable investments are key to any early retirement savings plan because they can provide a much‑needed bridge for withdrawals needed to supplement income in early retirement. In addition to offering favorable capital gains tax treatment, there are no annual savings limits or penalties for accessing those funds prior to age 59½. That money is yours to grow and then spend at any age and for any reason. Dividends, interest, and capital gains on these investments are taxable each year, but what taxable investments lack in tax‑free or tax‑deferred growth, they might make up for in flexibility. Having a sizable proportion of your savings in taxable investments can help to minimize any penalties or ordinary income taxes you might incur on withdrawals prior to age 59½. Additionally, if you’re able to draw primarily from your taxable accounts early in retirement, it will allow your Traditional and Roth assets to continue growing on a tax‑advantaged basis—up to and beyond age 59½.
• Roth IRA. Compared with a Roth 401(k), Roth IRAs have lower contribution and income limits,⁷ but they typically offer a wider range of investment options. Roth IRA contributions are eligible for distribution tax- and penalty‑free at any time.
  • If a Roth 401(k) is part of your early retirement savings plan, you may want to prioritize getting a Roth IRA established in advance of retirement—either while your income is still within IRS limits to contribute or through execution of a Roth conversion. Having a Roth IRA established and ready to receive the rollover of Roth 401(k) funds upon retirement may facilitate a wider range of options in the future.
• Backdoor Roth IRA. A backdoor Roth IRA strategy is an option for higher‑income individuals who earn too much to contribute to a Roth IRA directly. Instead, an investor can make a nondeductible Traditional IRA contribution then promptly convert the funds to a Roth IRA. This strategy is ideal for those who don’t have existing pretax Traditional IRA balances at the time of execution and will therefore not incur taxes on the immediate conversion.
  • For those who have existing pretax Traditional IRA balances, some or all of the conversion will be taxable. The taxable amount of the conversion generally depends on the percentage of your overall Traditional IRA assets funded by deductible (pretax) versus nondeductible (after‑tax) contributions. Unlike with Roth contributions, converted Roth IRA balances must remain in the account for five years to receive penalty‑free access to contributions if you are under age 59½.

Step 5: Set your savings strategy on autopilot.

Once you’ve determined an appropriate strategy for diversifying the tax treatment of your savings, automate your plan as much as possible.

• First, it could be helpful to have the funds directed automatically through your employer’s payroll or via ACH from your bank to the destination account.
• Second, it may be beneficial if the funds deducted from your paycheck or checking account are automatically used to purchase into an appropriately diversified and growth‑oriented investment such as a mutual fund or an exchange-traded fund (ETF).

The more you can automate your savings and investment plan, the likelier you’ll be to stick to it.

Step 6: Bridge the income and expense gaps.

Of course, in addition to saving aggressively and getting accustomed to living on less, you’ll want to consider other ways of bridging the income and expense gaps when retiring earlier.

Complementary income streams

Planning to assume part‑time or full‑time work in retirement or setting up a “side hustle” can provide many benefits, both personal and financial. In some cases, it can come with health care benefits and access to a savings plan. It can also provide additional cash flow for discretionary spending and allow for the deferral of larger withdrawals from your investment portfolio. Alternative income streams, such as rental income from real estate, can also help to improve cash flow and reduce pressure on your investments. If anything, these complementary income sources can help you set extra cash aside for when you eventually transition from financial independence to full‑time retirement.

Health care coverage

As mentioned previously, having a carefully constructed budget with the capacity to absorb increased out‑of‑pocket health care costs will prove crucial in the early years of retirement.

• When you separate from an employer, you have the option to stay on your employer plan through COBRA for 18–36 months. You’ll be responsible for the full premium, but if you’ve saved in an HSA and have 13–24 months of expenses in cash and an ample amount in conservative taxable investments, that could help pay the higher premiums and/or deductibles.
• You may also want to explore your options on your state‑sponsored insurance exchange. If you’re in good health, you can opt for a plan with higher deductibles and lower premiums. The cost of insurance exchange plans is typically income‑driven, so if you’re able to keep your taxable income low through the use of cash, Roth assets, and taxable investments, you may qualify for lower premiums.

Social Security

Social Security benefits are based on your highest 35 years of earnings. Therefore, while retiring early may prevent you from meaningfully boosting your average 35, any additional years of part‑time work can help by reducing the number of zero‑income years factored into your benefit calculation. Regardless of your benefit base, waiting to collect will lead to higher benefits due to deferral credits. Generally, the longer you can hold off on collecting your benefits, the greater your Social Security income will be.

Pensions

Though much less commonly available now, for decades, defined benefit pension plan access and early availability was a primary driver of early retirement for public and private sector workers alike. If you have a pension, make sure to understand eligibility rules and how much you could receive based on your service and timing of claiming.

Cash cushion to hedge against sequence of returns risk

As you get closer to retirement, consider setting aside a couple years of expenses in cash so you can minimize the risk of being forced to sell your investments when they’re down.

Flexibility and discipline

Adaptability is crucial to any retirement plan, especially an early one. Being prepared to pare back on discretionary spending can help to ensure that you don’t spend down your assets too quickly. Diversifying the tax treatment of your savings, maintaining a proper asset allocation with a healthy mix of growth and income‑oriented investments, and building a substantial short‑term cash cushion are also key contributors to achieving financial independence.

In summary, key requirements for early retirement are the willingness and capacity to sustain an increased savings rate and the discipline to spend mindfully and live on less. An invisible benefit to reassessing your priorities and reconfiguring your budget to accommodate a higher savings rate is that you will train yourself to make do, and enjoy the lifestyle benefits that money can’t buy—distraction‑free time with friends and family, a peaceful morning with a good book, a mid‑afternoon stroll, or a free concert or yoga session at a local park. Regardless of how you define financial independence, discipline and thoughtful planning now can lead to invaluable benefits later.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of December 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

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Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

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