Early retirement depends on the savings rate, the rate of return, the rate of withdrawal

Rob Berger is the author of the new book "Retire Before Mom and Dad".Courtesy of Rob Berger

Your ability to take early retirement is only taken into account by three figures, and none of them is your salary.

According to Rob Berger, deputy editor of Forbes and author of the new book "Retire Before Mom and Dad". He says that income has a minimal influence on how quickly we can save 25 times our annual spending, the target number of attacks on financial independence, which he calls "level 7" in his book.

Berger founded the DoughRoller.net personal finance site and retired at age 49 from his legal career.

If you earn a high salary and spend a lot, he said, not only will you save a smaller share of your income every year, but you'll need a bigger nest egg to retire, because this amount is simply a multiple of your income. annual expenditure.

"What you earn does not change the results – the time it takes to reach level 7 financial freedom depends on the percentage of income you save, the rate of return and the withdrawal rate," said Berger.

"If two people each save 10% of their income and get the same rate of return," he continued, "it will take the same amount of time to reach level 7, even if one earns $ 50,000 per year. year and the other $ 500,000. "

Berger assumes that the assumption here is that the person who earns six digits spends all the money she spares, so her annual spending multiple is much higher.

1. The percentage of income you save

Expenditures and savings are inversely related, Berger said.

"When our savings rate goes up, it has a big impact on our years of financial freedom," he said. "The first is that we save more and we increase our investments faster The second effect is just as important: we spend less, because we spend less, the amount we need to reach each level of financial freedom decreases. "

Your savings rate can be calculated as a percentage of your gross income or after-tax income, depending on where you save money, Berger said. For example, saving in a Roth account or in taxable investment accounts means that you will save money already taxed, whereas in a 401 (k) or traditional IRA, you will save in pre-tax dollars.

2. The rate of return on your investments

This is the only part of the equation that is largely beyond our control. The stock market has historically averaged 9.3% a year, Berger said. Once inflation is taken into account, the annual rate of return is reduced to 6.3%, which Berger uses in his calculations.

But nothing says what the markets will do in the future, he added.

"The results are very sensitive to the rate of return," he wrote. For example, a person saving 10% of their income will need 50 years to reach level 7 assuming a real return on investment of 5% Increase the real rate of return to 6.3% and the time needed to reach Level 7 Financial Freedom Increases 43 A one percent difference in investment returns can add five years or more to the time needed to reach level 7. "

3. Your expected withdrawal rate

To arrive at the figure 7 – 25 times your annual expenses – Berger assumed a 4% withdrawal rate, a general guideline used in retirement planning.

"The rule is designed to provide an easy way to determine how much of your nest egg you can spend each year without running out of money," he wrote. "As the name of the rule indicates, you can spend 4% of your investment the first year.You adjust the amount spent the previous year according to the inflation rate."

To obtain your level 7 number, you can either multiply your annual expenses by 25 (eg $ 50,000 x 25 = $ 1,250,000), or divide your annual expenses by 4% (eg $ 50,000 / 0.04 = $ 1,250,000).

Although the amount of your annual expenses remains fixed, it is possible to lower or increase your withdrawal rate, Berger added, thus changing the amount that you must have saved. If your savings rate remains constant, this adjustment will lengthen or reduce the time needed to reach your goal.

"Although I think 4% is a reasonable assumption for most people, especially to set our goal of the Freedom Fund, extreme cases exist," Berger said. "For example, if your goal is to retire at age 30 and never earn a penny more in the rest of your life, a better assumption is 3 or 3.5%." Why? Because your money must support you for more than 60 years or more "

Personal Finance Insider offers tools and calculators to help you make informed decisions with your money. We do not give investment advice or encourage you to buy or sell stocks or other financial products. What you decide to do with your money depends on you. If you act according to one of the recommendations listed in the calculator, we get a small share of the revenue from our trading partners.