What is Early Retirement? Define Early!
In answering this ‘retire early’ question we should give consideration to what retirement means and further what constitutes as ‘early’? The definition of retirement refers to the time a person leaves the workforce. As pursuers of early retirement, we’re unlikely to quit work and spend the rest of our days playing golf or skiing in Morzine. You may consider earning an income in retirement, just not in the way you’ve done in the past. Those 80 hour work weeks are long gone!
For clarity across all articles in this site, we assume that retirement and financial Independence are one and the same. Financial independence is having a level of income equal to or greater than living expenses for the rest of your life. This passive income is without employment or dependence on others. You never need to earn money again, but you can if you want to.
To address the ‘early’ part of the question. In the UK, the traditional retirement age is increasing to 67 in 2028 (currently 65). This is kept under review in the future. With an aging population it is unlikely to be decreased in our lifetime. The focus of this article is to provide the knowledge and skills to help you retire early in your 40s. If you plan to retire early in your 30s or 50s, this knowledge will be equally beneficial. You can check your State Pension Age by visiting gov.uk/state-pension-age.
How Can I Retire Early?
Now that we’ve defined retirement as having achieved financial independence, we need to understand how to become financially independent. We also need to do this in a quicker timeframe than the majority of those around us.
What is Financial Independence?
When your income is greater than or equals your spending, without needing to work, this is financial Independence. To become financially independent we should to focus on 2 main areas:
- Reducing Costs
- Invest the savings in income-generating assets
Our goal is to generate enough income from our investments to cover costs. The lower the costs, the less investment income is required.
Calculating your Savings Rate
If you currently spend all of your income each month, your savings rate is 0%. For many people, 0% or negative savings through consumer debt is the norm. With this level of spending, you may never be in the position to retire early. Increasing the percentage of your income saved decreases the time it will take to achieve early retirement.
How to Retire Early – Our Step-By-Step Guide
Reducing Costs
Within our budgeting post, we cover the topic of reducing costs. You can find out more on managing your budget by clicking https://foundered.co.uk/how-to-budget-money/. As part of reducing costs in your household, give consideration to the reduction in costs and in which order to do so. Look at the line items costing you the most interest and work through those as priority.
- Pay off your debts (credit cards, store cards, car loans)
- Paying off your mortgage
Pay off your debts
Debts incur interest and this interest costs your more than any savings interest you might earn. Pay down the debts with the highest interest rates first. Ensure you meet the minimum payments on all debts. Failure to do so may incur further costs and charges creating a debt snowball that becomes much harder to manage.
Paying off your mortgage
There is an argument that paying off your mortgage is not the optimal way to plan for retirement. Many consider the ability to earn more through investments a better return. With that said, being mortgage free and owning your own home outright can have a greater mental impact.
Either way, it is a good idea to pay down your mortgage. You can do this through overpayments, early repayments or saving up funds to put towards your remortgage. Within our budgeting article, there’s also consideration given to business owners using offset mortgages to their advantage.
Once you begin to live within your budget, your focus should shift to investing the savings. Generating a suitable level of income to cover all costs is the goal. Give consideration to the additional funds you’ll need to enjoy your early retirement, or to meet emergency needs. Many early retirees fall foul of focusing on meeting a bare bones’ income level. Work on the assumption that early retirement should be wholly enjoyable time, not just an existence.
How Much do I Need to Retire Early?
With only a moderate level of searching, you will undoubtedly come across the often touted 4% Rule. The 4% rule is more a rule of thumb and generally not recommended for the UK Early Retiree. The premise of this rule is that, in any given year, you only withdraw a maximum of 4% from all of your investments. As your investments work for you, this will provide a steady level of income (inflation-adjusted), for the rest of your life.
The consensus in the UK early retirement sphere is that this 4% withdrawal rate is on the high side. Many opt for a more prudent 2.5%-3%. As extremely early retirees, we need to ensure our investments meet our needs for the rest of our lives. With this said, the lower the withdrawal rate, the greater the probability of long-term success.
If you fully undertook the budgeting tasks above, you will now know your annual cost requirements. In this case, it’s relatively easy to work out how much you need in retirement.
Withdrawal Rates
4% – Multiply your annual expenses x 25
3% – Multiply your annual expenses x 33
2.5% – Multiply your annual expenses x 40
Example – If you have an annual budget of £25,000, you will need the following income generating investments
4% – £25,000 × 25 = £625,000
3% – £25,000 × 33 = £825,000
2.5% – £25,000 × 40 = £1,000,000
With your debts reduced and your mortgage paid off, it’s sensible to consider that your costs won’t fluctuate drastically without your prior approval.
Saving to Retire Early
Let’s look at withdrawal rates once again, but from a different perspective. For every £1 we need in retirement, we need to save the following amounts:
4% – £1 × 25 = £25
3% – £1 × 33 = £33
2.5% – £1 × 40 = £40
If we begin to value our purchases not at today’s value, but at their future cost, then their true value is shown. For example: The PCP hire on a standard 3 Series BMW sits today at £449 per month or £5,388 per year. As a prudent early retiree, we work on the basis of a 2.5% withdrawal rate. To cover the cost of the finance of this car alone in retirement. Multiply the £5,388 × 40. The investments required to meet this expenditure total £215,520.
If you consider your after tax annual income and divide the cost of the car by that value. This gives you the number of years you need to work to afford this car in retirement.
Example: Imagine your salary is £45,000. After tax and national insurance your net take home pay is £34,240.
To calculate time taken to cover this cost, we divide required investments of £215,520 by the net pay of £34,240 = 6.26 years.
Tip: Consider each purchase not at today’s’ cost, but at the future value. This makes saving and investing a much more attractive option.
Earning Income in Early Retirement
To retire early in your 40s, we must be focused on creating income generating assets. Not just in the traditional sense of private or workplace pensions only accessible in our 50s and 60s. We also require assets we can withdraw from or that provide income in our 20s, 30s and 40s. Your assets may include:
- Private (SIPP) or workplace pensions
- Investments in stocks, shares or index funds (not Bitcoin)
- Savings
- Income generating assets such as rental properties
- Business ventures
As we determine retirement or financial independence to be ‘work-optional’, this opens up many opportunities for us. Our goal should be to meet our expenses without work and then use any earned income from work for our discretionary spending above that of our budget.
Some income from our combined assets will be presented as lump sums, while others may be more regular income. A sensible approach to income when you retire early, is to plan a withdrawal strategy. This strategy can of course change over time. However, the focus is to plan the use your assets from an income and tax planning perspective.
Pensions
It is advisable to make use of your workplace pension or private pension allowance from a tax perspective. For many retirees, a pension is their sole income and this can be achieved via drawdown or an annuity. An early retiree we must be mindful not to put too much reliance on our pension pots. From 2028, the earliest you will be able to drawdown your private pension is 57 and this age is only likely to increase.
Investments
Many early retirees use index funds to put their money to work for them. Investments should not just accumulate and grow, but they provide a hedge against inflation. Left untouched, inflation reduces the value of your money in the future. It is wise to put your money in assets that beat it.
Savings
Having savings on hand provides assurance and safety for the unexpected. Inflation will eat away at this value, but the ability to put your hands on a level of cash is also invaluable. For most people having no more than 6-12 months of cash on hand in savings accounts is recommended.
Income Generating Assets
Rental properties are a great way to earn an income in retirement. The maintenance schedule and upkeep of most houses are relatively straightforward. With a regular income such as rental, you can confidently put this toward your annual expenditure.
You may also be somewhat of a content creator. Assets such as books, videos and courses often provide a residual income long after creation. Without the restriction of 9-5 working hours, give consideration to the assets you can create. Assets that may provide an income.
Business Ventures
To achieve early retirement in your 40s, the chances are that you have some entrepreneurial flair. Before becoming an early retiree, you may want to put these businesses on auto-pilot or take a more passive role in the business.
Will My Money Last if I Retire Early?
The question of being able to retire early at any age almost always focuses on having enough. This question becomes even more prominent for those aiming to retire in their 40s and 50s. With an extended retirement, we not only require our money to last longer, but also we have less time to save and invest. It’s mindful to air on the side of caution.
As a nontraditional early retiree however, we’re not averse to earning money in retirement. If our needs are met by investments, then the ability to earn towards our discretionary spending should become a much easier task.
Summary
Once you understand how much you need to retire, the focus should be on accumulating this wealth as quickly as possible. We’ll investigate opportunities in much greater detail across other articles on the site in due course.
Your key take away today should be to: reduce costs, increase savings and invest this within income generating opportunities.
Frequently Asked Questions
How much money do I need to retire early in my 40s?
The ability to retire early in your 40s is achieved by being financially independent. To understand how much money you need to retire, we first need to understand how much we spend. When the value of your investments is equal to or greater than your spending, you will be a great position to retire in your 40s.
Is £1million enough to retire at age 40?
Using the 4% rule, investments totalling £1m will give you an annual withdrawal rate of £40,000. While there is dispute over the legitimacy of this rule, it gives a great baseline to work out your annual expenditure from £1m investments.
Is 40 too early to retire?
Arguably the only time too early to retire is when you cannot financially afford to live from your retirement portfolios. However, as retirement is defined as the point when we stop working for money, there are other sociological challenges we face. What is our purpose? What to do next?
If we assume that earning money is not off the table in the future, then we remove the need to retire but rather, not work for money at this time.
Is it too late to start saving for retirement at age 40?
No, you are never too late to start saving for retirement. However, because of The Benefits of Compound Interest, the earlier you start to save for retirement, the easier this will be.
