retirement planning  |  january 23, 2024

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

With proper preparation, early retirement could be an option for investors at a variety of income levels.

 

Key Insights

  • A great deal of planning, discipline, and flexibility are necessary for any successful retirement plan, especially an early one.

  • The willingness and capacity to sustain an elevated savings rate is essential, which means you’ll need to grow accustomed to spending less of your income.

  • Since many workers can gain penalty-free access to retirement savings starting at age 55, that could be an achievable target age for investors at a variety of income levels.

Lindsay Theodore, CFP®

Thought Leadership Senior Manager

Roger Young, CFP®

Thought Leadership Director

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.

What about the rule of 25?

Many FIRE advocates contend that a savings accumulation goal equivalent to 25x an individual’s current annual expenses could be adequate to achieve early financial independence. This concept and calculation, commonly referred to as the “rule of 25,” is purportedly consistent with a 4% initial portfolio withdrawal. We’ve identified a few issues with this concept as it pertains to early retirees.

  1. The famous 4% withdrawal rule (typically applicable to 65‑year‑old retirees) is based on a 30‑year retirement. If you’re retiring early, that time horizon could be much longer. And 4% may not be so safe.

  2. Some or all of the dollar amount you withdraw using the 4% rule may be subject to tax. If so, that withdrawal is not the same as the net cash flow available to pay expenses. So, while it makes for easy math, the rule of 25 generally ignores taxes on withdrawals. To net 4% to cover expenses, a higher pretax withdrawal will be needed (unless your withdrawals are all tax‑free), thereby placing the portfolio’s long‑term sustainability at risk.

  3. The rule of 25 ignores Social Security benefits. That’s a very conservative assumption. While investors in their 20s, 30s, or 40s may doubt the solvency of the Social Security system, it is unlikely that they would receive no benefits later in life.

So could a savings goal of 25x expenses work out well for early retirees? Maybe. Two of the three oversights of that rule make it riskier, and one makes it more conservative. Depending on your situation and adaptability, perhaps 25x your expenses could pan out for you. But, as a rule of thumb, the rule of 25 could put you at greater risk of running out of money. If you’re serious about retiring early, you may want to accumulate more than 25x your expenses and you should definitely have a more detailed plan in place.

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.

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.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision. T. Rowe Price Investment Services, Inc., its affiliates, and its associates do not provide legal or tax advice. Any tax‑related discussion contained in this website, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.

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.

View investment professional background on FINRA's BrokerCheck.

202401-3311714

 

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