**When are you financially independent?**

Financial independence comes from **two factors**— having **(1) enough assets to support (2) your expenses.** Most of us would prefer to focus on the first factor. We’d like to get our assets by earning a high salary (ideally for very little work), being a brilliant investor, or inheriting a windfall. (Or “Plan D”: winning the lottery.) Unfortunately it can be extraordinarily difficult to rapidly raise your income to build up enough assets to achieve financial independence in a short time. The harsh reality is that materialistic consumers will have to work for decades to gather enough assets to support their expenses.

**It’s easier to focus on the second factor by reducing expenses.** Notice that it’s “easier” to reduce expenses, not necessarily “painless”. Every hopeful retiree is eventually forced to choose the values that are most important to them: either working for decades to afford an affluent lifestyle with high expenses, or reducing their lifestyle to minimize their working years. You have to find the right work/life balance that’s acceptable to you and your family. You’re frugal if your values match your spending and you’re feeling good about your retirement goals. You’ve crossed the line to deprivation if you’re miserable and stressed out every day, struggling against all sorts of material temptations while trying to pile up enough assets to stop working. Refer to the related posts at the end for more details on drawing the line between frugality and deprivation.

**How much will you need?**

While some of us will struggle for years with the frugality/deprivation line, others will want to revisit that issue after finding the answer to the next question: how much will you need? **For this analysis we’re going to assume that the Trinity Study’s 4% is a safe withdrawal rate.** That study assumes you spend 4% of your retirement portfolio during the first year and raise the amount for inflation every succeeding year. Dozens of studies have clustered around SWRs of 2-6% using various assumptions and other complicated withdrawal schemes, but most of the studies agree that 4% is probably safe enough. Most new retirees will boost the “safe enough” assessment to “100% success” by keeping an eye on spending through the retirement years and not blindly raising it every year for inflation. Some will spend 4% of their portfolio every year and never raise it for inflation, while hoping that their portfolio will grow faster than inflation. Others will work for “just one more year” to pad their portfolios with a safety factor. Others might even decide to go back to work for a few months during recessions to help their retirement portfolio recover. (See Bob Clyatt’s “Work Less, Live More” book for another easy-to-use 4%/95% variable spending plan.) The odds of a 4% SWR failure are very low, and for the rest of this post we’re going to assume that you’ll be able to see problems coming soon enough (and slowly enough) to avoid them.

Having trotted out those disclaimers, the math result is that financial independence happens when your assets are equal to your expenses divided by 4%. In other words,

FI: Assets = Expenses / 0.04 = Expenses * 25.

**Once your assets are 25x your expenses then you’re financially independent** and able to retire at any time. It bears repeating that before you can solve this equation, you have to track your expenses and develop a realistic retirement spending budget.

**How long will it take?**

Once everyone has determined how much they’ll need, the next question is how quickly they can get there. Again we’re going to focus on reducing expenses (and on saving more money) rather than raising income. Military members will see their pay rise with longevity and promotions, but the forecasts on when that will occur (and for how much money) can rapidly deteriorate into wishful thinking instead of a realistic career timeline. We’ll get back to these pay raise/promotion issues after we look at the math.

**Let’s add another simplifying assumption: constant savings.** We’ll assume that your income and expenses will remain at about the same ratio for the time it takes you to achieve financial independence. Realistically the time to accumulate enough savings will be a matter of 5-10 years, although a few will take longer. There will probably be at least one pay raise and a promotion during those years, so the assumption makes the savings math a lot easier while keeping a practical forecast.

Let’s start with an extreme case. ** Jacob Lund Fisker, owner of the EarlyRetirementExtreme.org website, has managed to achieve financial independence through saving as much as 80% of his income.** Yes, that’s extreme. But yes, it’s achievable and sustainable if your values include achieving financial independence in your 30s. You’ll have to read his blog (and his book!) to figure out how he did it (and to decide whether you’re willing to do it) but let’s start with that 80% number.

If you earn $1000/year and save 80% of it, or $800/year, that means your expenses are $200/year. Achieving assets of 25 x expenses requires 25 x $200 = $5000. Savings are $800/year, so the time to financial independence is $5000 / ($800/year) = 6.25 years. In the real world those savings would be invested in a balanced portfolio of equities, bonds, and cash that would (over the long term) compound by at least the rate of inflation. Six years of compounding may accelerate the retirement date by a few months but that depends on the portfolio’s specific asset allocation, its volatility, and the annual performance.

At this point most of the readers are probably still stuck a couple paragraphs back at that 80% savings rate. Maybe 80% is too extreme to be realistic for most. Let’s try a number at the other end of the bell curve.

**Most financial advisers (and the popular financial media) encourage new investors to save at least 15% of their income.** The assumption is that a new worker, fresh out of school and starting an independent life, will struggle to save even 15% of their income as they accumulate a wardrobe of office attire, transportation, living quarters, and furnishings (let alone a family). Another assumption behind the 15% sound bite is that a worker’s savings rate will accelerate as their income rises with their careers, and they’ll save a much higher percentage of their income when they’re in their 50s and 60s. The 15% number is chosen by the media to encourage their young readers while admonishing them to save more as soon as they’re able.

Unfortunately a 15% savings rate means they’re going to be working a long time. Saving $150/year with expenses of $850/year means that assets = 25 x $850 = $21,250. Time to financial independence becomes $21,250 / ($150/year) = 142 years. That can’t be right, can it?

**Luckily the actual answer turns out to be “only” 43 years.** The reason for the difference is that each previous year’s savings is compounding as a new year’s savings is added to the portfolio. The 80% saver was only saving for six years, and compounding wasn’t a very significant factor during that short time period. For the 15% saver, over their decades of working years the compounding becomes significant enough that the portfolio begins to grow exponentially. Notice, however, that 43 years is also the amount of time that most people will be in the workforce to retire in their 60s.

Before we bring out the math and the results tables, **let’s review the simplifying assumptions behind the numbers:**

– A *constant savings rate*, even though most military will have longevity pay raises and promotions along with occasional periods of tax-free combat pay. Bonuses are, well, just bonus!

– A *single income earner*, although a working spouse can greatly improve the savings rate.

– *Constant expenses*, even though expenses can vary from one year to the next and will generally drop as frugality skills improve. Expenses in a combat zone are even lower because that’s deprivation.

– A *conservative rate of return* of 5-6% per year, even though investment allocations will be in a high-equity portfolio (stock index funds) with very low expenses (the TSP).

– A *safe withdrawal rate of 4%* rising every year for inflation, even though a recession would cause most retirees to cut spending or work part time.

– *No pension, no Social Security, no Medicare.* This calculation assumes that you’re doing it all on your own investments and your own health insurance. I’m not going to get into the politics but I’ll confidently forecast that some form of Social Security and Medicare will still be making a difference even for those readers who are currently teenagers.

The math behind the savings and compounding is a more complicated exponential formula for determining the future value of a series of payments:

Assets = Expenses * 25

= (Savings rate) * [(1 + compounding rate)^^Time – 1] / (compounding rate)

The compounding rate is the rate of return on the investment portfolio. A realistic value is about 5%-6%/year depending on the asset allocation and the length of time that the assets are invested. (One version of this assumption is called the “Gordon Equation“.) Assuming a 5%-6% compounding rate means that the equation can be solved for the length of time required for various savings rates. I’m going to put the math in a footnote and go straight to the tables:

Years to Financial Independence at a **5%** rate of return for various savings rates:

Savings rate (%): | Years to FI: |

15 | 43 |

30 | 28 |

40 | 22 |

50 | 17 |

60 | 12 |

70 | 9 |

80 | 6 |

Years to Financial Independence at a **6%** rate of return for various savings rates:

Savings rate (%): | Years to FI: |

15 | 39 |

30 | 26 |

40 | 20 |

50 | 16 |

60 | 12 |

70 | 9 |

80 | 5.5 |

Alert readers of this blog will notice I’ve been claiming that financial independence comes in 5-10 years to most military members, with some needing a little longer. Even a 40% savings rate is within the length of a military career, and that career will be followed by an inflation-adjusted military pension with cheap healthcare. In other words, the pension will cover a significant percentage of retiree expenses and will dramatically drop the necessary size of the portfolio to cover remaining expenses. **A 20-year military career is a slam-dunk for financial independence– when saving starts early in the career.**

**More aggressive 60-70% savings rates, especially with a working spouse, will cut the time to financial independence to a decade even without a pay raise. Servicemembers are earning annual pay raises, longevity pay raises, promotions, and several other boosts to their income. Even as few as two service obligations (a total of 8-12 years) will see significant pay increases as well as large savings rates during deployments.**

Three other factors are working in your favor: Social Security, investment returns, and your retirement budget. All of these factors used very conservative assumptions to generate the results tables. The reality is that you’ll have years with higher returns, and your retirement expenses will also vary from one year to the next. A conservative retirement budget (and the ability to play extraordinarily frugal defense if necessary) will give you plenty of safety to enjoy your retirement years.

Next post: are you really willing to be frugal enough to achieve these savings rates?!?

Footnote:

Expenses * 25 =

= (Savings rate) * [(1 + compounding rate)^^Time – 1] / (compounding rate)

Rearrange the terms to get:

(1 + compounding rate)^^Time = (Expenses * 25 * compounding rate / savings rate) + 1

Taking the natural logarithm of both sides gives

Time =

= ln[(Expenses * 25 * compounding rate / savings rate) + 1] / ln(1 + compounding rate)

Solving for time (years) assumes that the compounding rate is an annual percentage yield expressed as 5% (use the calculator’s % key) or 0.05. Expenses and savings can be in percentages of total income or in dollars per year.

* 4 July 2011 update:* Thanks to Arebelspy on Early-Retirement.org, I’ve uploaded v1.0 of the quick & dirty spreadsheet to calculate your own assumed savings rates and returns. Save this Google file to your own computer and tweak away, or download from the following link: Time to Financial Independence and Retirement And please share your improvements with us!

**Related articles:**

Military retirement spending: how much will I need?

Start saving early

Simple ways to start saving

**Does this post help? Sign up for more free military retirement tips via e-mail, Facebook, or Twitter!**

By the way, I’ve joined the WordPress 2011 commitment to “PostAWeek”… to blogging at least once a week for the rest of the year. Every day is too frequently, Mon/Wed/Thu is about right, and once a week will be no problem!

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Hi ..not sure if I got the math right, based on the XL sheet time to retirement, if we decrease the safe withdrawl rate from 0.04 ( say) to 0.02 , the number of years for retirement, as calculated increases.

I think, that if we are able to decrease the SWR, the time to retirement should decrease ( and not increase) as calculated by sheet…

I may be wrong, but pls comment, if the above is correct (or) not..

Great point, Grunhead, and I’m sorry for the confusion. The spreadsheet formula is correct. You’re asking the right questions, but the data for that question goes in a different cell.

The “quick&dirty” assumption is that your retirement spending is going to resemble your spending during your working years. (This is surprisingly accurate for most retirees.) When you entered 0.02 in the SWR cell 4, the spreadsheet assumed that you were still keeping your spending constant because you left the same number in Expenses cell 3. However because your percentage withdrawals dropped by a factor of two while holding the spending constant, that meant that you had to double the size of the portfolio. By setting your SWR at 2% instead of 4% you wanted to be twice as safe with the same expenses, so your total investment portfolio had to be twice as big.

The “Years to Retirement” cell only went from 12.4 years to 20.1 years (instead of doubling to 24.8 years) because the extra 7.7 years added a lot of compounding to the original amount saved during the first 12 years.

Try entering 0.02 for SWR (as you’ve already done) but then enter half as much for the expenses in cell 3. (If you left it at 0.4 then reduce it to 0.2.) That tells the spreadsheet you’re significantly reducing your retirement spending (to half as much as your working years) and you want your SWR to be twice as conservative (2% instead of 4%). You’ll get the same 12.4 years to retirement.

Conclusion: if you want to be extremely conservative in retirement with a 2% SWR instead of a 4% SWR, you’re going to need twice the savings– and you have to work longer for it. If you follow the 4% SWR but reduce your expenses (to say 0.3 or even 0.2 instead of 0.4) then you’ll get to retirement faster.

The 4% rule works for 95% of retirements. If you’re trying to avoid the 5% failures then a military pension (with its annual cost of living increase) will probably protect you. (That’s been shown for fixed annuities.) If you don’t have a military pension then you can augment your Social Security with a single-premium immediate annuity, or a 4%/95% spending plan like Bob Clyatt’s “Work Less, Live More”, or by varying your retirement spending. Reducing the SWR is certainly more conservative, but as you’ve shown it greatly prolongs your working years.

I have been reading about Early Retirment a lot lately with 7 years out from military retirement, and wanting to know where to stash our extra income for those seven years, where we can have access to it before 59 1/2. After maxing out both Roth IRAs, you state above using the TSP. If we throw all the rest into Roth TSP for the next seven years, are you assuming rolling it over into the Roth IRA so that we can then pull out from contributions tax-free? Or would it be better to start putting it all into a taxable low-cost portfolio so that we can get our hands on it to supplement military retirement income? We would also like to pay off the mortgage right at retirement. Any advise or point us to an article that lists the order of allocating our extra income right now with the goal of early retirement in 7-10 years would be greatly appreciated! Looking to read the book soon!

Great questions, Michelle!

The biggest advantages of the TSP are its low expenses, its “G” fund, and the ability to automatically deduct contributions from your pay. The longer you can use those advantages, the faster you’ll get to financial independence. But you’re right– as you approach retirement, it’s more important to manage cashflow.

Once you forecast how much cash you’ll need between retirement and age 59½, the simplest option is to start saving it in a taxable account. Since you’re seven years from retirement, you could use CDs or I bonds to build up the cash with minimal risk. If you’re willing to take a little risk then you could use a short-term bond fund for the funds that won’t be needed right at retirement, but you don’t want to take on much principal risk. You’ll need the cash for expenses and you won’t be able to wait very long for the markets to recover.

A second option for retirement spending is withdrawing your Roth IRA contributions. A third option is continuing your contributions to the Roth TSP until retirement, and then rolling that over to a Roth IRA to withdraw those contributions. A fourth option, the most complex, is to roll your TSP over to a conventional IRA at retirement and then start a series of 72(t) distributions. You’ll want to consult a tax professional for help with that choice, but take a look at 72t.net.

More information is at this post:

http://the-military-guide.com/2013/02/14/when-do-you-stop-contributing-to-tax-deferred-accounts/

You should also forecast whether your military pension will cover your spending at retirement. You have seven years of pay raises, one or two longevity raises, and perhaps a promotion before the pension starts– that will help with your cashflow! Consider whether you’ll also be working a bridge career (full-time or part-time) in retirement. You may decide that you

don’t need to pile up a lot of cash in a taxable account, especially if you have employment income and you’re able to withdraw Roth IRA contributions when necessary.

If you pay off the mortgage at retirement, you may need to cash in assets from a taxable account– and that means you’ll be paying capital gains taxes. If being mortgage-free helps you sleep better at night then that’s what you should do. Another option (especially for a fixed-rate mortgage) would be to continue mortgage payments in retirement, and using the remaining “mortgage payoff” account for your budget expenses. Once you get to age 59½ you could withdraw Roth IRA funds to pay off the entire mortgage. Your pension will rise with inflation during retirement but a fixed mortgage payment will stay constant. You could always make a lump-sum mortgage payment if you feel you have extra cash, but keeping the mortgage allows you the maximum cashflow flexibility without consuming a large amount of your assets right at retirement.

Of course if you have an adjustable-rate mortgage then your choices are more complicated, and one factor would be when the interest rate resets.

Forecasting your retirement spending and handling your cash flow management can get complicated, so after you feel you have a solid spreadsheet then you may want to run the

numbers by a fee-only CFP to make sure you didn’t miss anything. Then you’d be able to dig into the choices with saving cash in taxable accounts and what you want to do with the mortgage.

Thanks for writing out all the options! That is where I am, I guess just have to decide where to put the money. I use Betterment already and LOVE it. They are really low fees as well, so it is a toss up between them and the Roth TSP, Betterment is easier to get at if needed. Thanks again!

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[…] 30 months ago(!), I wrote a post that helps estimate how much time it takes to reach financial independence. It made several “simplifying” assumptions* about income during your working years, […]

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Here’s another calculator to help estimate how long it takes to reach financial independence:

http://networthify.com/earlyretirement

Give it a chance to load. The website’s very busy.

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[…] I think the real value of a military retirement comes from its inflation-fighting COLA and cheap healthcare. (It’s not easily done with TIPS, I bonds, or annuities.) TERA’s 20% reduction in the amount of the military pension– just $7K/year– is easily made up by a civilian paycheck. The safety net of financial independence is to have some “guaranteed” income from reliable sources (military pension, Social Security, TSP annuity) and some control over expenses (Tricare and Tricare For Life). These are the biggest financial challenges faced by people retiring in their 40s and 50s, and the discussion board at Early-Retirement.org has tools and advice to help solve those challenges. You can save up the rest of your retirement funds from your civilian paycheck, and your financial independence might be closer than you think. […]

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[…] I have over 250 posts on the blog stretching back over the last 18 months, and you readers would only notice a comment on one of the old posts if you happened to subscribe to the “Comments” RSS feed. (It’s the orange icon over there on the right, under the “Please leave a comment!” text.) However WordPress notifies me whenever a comment’s added to an older post, and a reader’s asked good questions on the thread “How many years does it take to become financially independent?“ […]

Also, can you provide me with a link to the studies of withdrawal rates for 50 year spans that you reference in your comment?

Also, thank you for your service to our country.

You’re welcome!

Let me combine your questions into one answer. I’m also going to turn it into a separate blog post with more links. I expect to have it up within a week.

For starters, the best data I’ve seen on a 50-year retirement is at Raddr’s pages:

http://raddr-pages.com/research/enhanced_monte_simulation.htm

Note that many of the issues he attempts to solve have still resisted rigorous research analysis, which is why it’s so encouraging to see Wade Pfau tackle the subject.

But I’ll go into more detail in a new post, along with links to other posts.

Doug,

This is a great article. After reading this and numerous other mentions of the “4% Rule” in the early retirement community I decided to do some research on it. There is an important caveat to their research that I think you should mention: their “experiments” were only conducted over a 30 year period. And many of their sample portfolios “failed” (that is, ran out of money). I wrote an article summarizing the applicability of the 4% Rule to early retirement that you might find interesting:

http://arilamstein.hubpages.com/hub/The-4-Rule-and-Early-Retirement

Thanks, Ari!

I think you’re just scratching the surface of the 4% discussions on this blog (and in the book “The Military Guide to Financial Independence and Retirement”.) The finer points of the 4% rule are discussed here in two other posts:

http://the-military-guide.com/2011/11/16/is-the-4-withdrawal-rate-really-safe/

http://the-military-guide.com/2011/07/25/details-of-the-4-safe-withdrawal-rate/

I have another post coming on Wed 25 April that highlights more of Wade Pfau’s research on the implications of blindly following the 4% rule.

While the Trinity Study looked at 30-year periods, Early-Retirement.org & Bogleheads.org threads have extended it out to 50 years. The issue with extending the retirement period is that there just aren’t enough rolling 50-year periods to give the historical method any validity. (The Trinity Study also ignored Social Security benefits.) For extended retirements, Monte Carlo simulations will run thousands of scenarios to cover any length. However those simulations have their own flaws:

http://the-military-guide.com/2011/10/27/problems-with-retirement-calculators/

http://the-military-guide.com/2011/11/24/retirement-planners-and-calculators-part-1-of-2/

While the Trinity Study’s portfolios saw failures, I’m not sure I’d use the word “many” to describe their mainstream 4% withdrawal rates of typical stock/bond portfolios. Any failure rate is unacceptable, but Wednesday’s post will present solutions to the failure issue.

Doug,

Thanks for the thoughtful reply. Your link to Pfau’s research on the international perspective on safe withdrawal rates was particularly illuminating. I’m curious, do you know of any other approaches to financing an early retirement? For example, I’ve heard some people mention trying to live off dividends, but I have not seen any academic research on this.

Ari

[…] 10. Focus on your progress, not your regrets! It sounds like you’ve done a great job of raising a family under tough conditions. It hurts to remember where all that lovely money went, but at the time you were doing the best you could with the skills and knowledge and opportunities that you had. Now you’re smarter, and the pain of the experience has given you the motivation to succeed. Consider the money to be tuition payments to the School of Life, and now you have a graduate degree in the subject. Now that you’ve paid off most of your debt, it may take you fewer years to achieve financial independence than you expect. […]

[…] Here’s another example illustrated by Nords showing the connection between income and expenses. In other words, at a 5% rate of return, if you save 15% of your income, you will be come financially independent in 43 years. If you started working at 22, that means you’ll be 65 when you reach early retirement. Will anyone think you are rich when you retire at 65? It certainly doesn’t impress us. But, at the same rate of return, if you up your savings rate to 40% of income, you’re financially independent in 22 years. So, if you retire at 44, is that an impressive feat? Of course, there are assumptions in these equations and neglects things like social security. And we can all tweak them to our content, so no sense arguing over rate of return. Nords has a spreadsheet on his blüg you can play with. […]

Thanks for the trackback, PFBlogWatchDog, and feel free to leave a comment with a different perspective anytime. There are many paths to early retirement…

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Note the update at the end of the thread with links to a spreadsheet where you can enter your own assumptions and calculate the results.

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Thanks! As you can imagine, there’d be some skepticism from certain segments of the military if I didn’t have equations & numbers to back up the claims…

Excellent post Doug. The popular press seems to tell people they are not saving “enough” for retirement but rarely give good solid information of what may be enough, and how long you will have to save to retire.