# Early Retirement Lesson #1: Savings Rate

I’ve now spent nearly 10 years and 10,000 hours actively reading, thinking, and writing about money and the pursuit of financial freedom. I’ve still got a few years until early retirement but I can finally see the finish line. I’ve been meaning to summarize some of the lessons I’ve learned over time, as I’d like to make something more permanent that I can share with my everyone including my own kids.

In retirement planning, your “number” is usually defined as the amount of money you’ll need to retire. Something like a million dollars, like I used as a goal when starting this blog. Well, I was wrong. Your savings rate is the most important number!

If you take your annual income, your annual spending, and your annual investment returns, most people will admit that they have the most control over the first two. Your income minus your spending equals your savings. Your personal savings rate is thus the percentage of your after-tax income that you can save (and invest) each year:

I’ll leave the details out, but with some accounting equations and rough assumptions you can determine the number of years until your savings can create enough income to support your expenses.

Rule of thumb: If you start at zero, you will need a 50% savings rate to retire in 15-20 years. You will need a 30% savings rate to retire within 25-30 years.

I’ve found that the math really does work out this way. You will need to save nearly half your income on a regular basis in order to retire early. Most people will never do this. But it is possible. My net worth was negative \$30,000 in 2000. My wife’s was zero. Over the last 10 years, we have saved over 50% of our income every single year except for one year where I quit my job and went back to school. More tips on how it can be done in future posts.

If you want financial freedom, you must calculate and focus on your savings rate.

1. Nick R. says:

I agree with your logic. I save about 50%. Some will say it is not possible. But if you are thrifty and buy things you really need and not the latest model of the iPhone, then it is actually not that hard to do.

2. Mike says:

Here’s a serious question, what do you plan to do with your early retirement? I mean realistically, especially with young kids and all. What do you see your time being spent on? Are you concerned about not having enough things to do? Will you miss work? Would you consider starting up some kind of small business?
My biggest concern with retirement is that I simply won’t have enough to do, especially if I’m leaving a job and workplace which I enjoy.

• That is a good question. For one, I will definitely play more sports (fun exercise) like hiking, tennis, skiing. I will actually probably try to start several small businesses, and involve the kids in some of them. I have some plans to start a Farmer’s Market stand, for example. If it goes bust, who cares? 🙂 But if you really enjoy your work, the best thing to do is see if you can do it on a flexible, part-time schedule. Then you don’t have to save as hard or as long. I’ve met semi-retired doctors, lawyers, judges, self-employed engineers. My sister was just married by a part-time/semi-retired judge who officiates wedding for fun and a little extra cash.

3. Nick R. says:

Mike, there are plenty of things to do. Especially if you have kids. I like to work out for example. I can spend 3 hours a day just doing that. Being a weightlifting freak I eat 6 to 8 times a day. That takes a lot of time. I can see myself traveling all over the world and keeping a small house here in the US. I can live in Australia for 2 months, then come back to US, sort my mail, rest for a couple of weeks, then go live in Europe and so on. My goal is to visit every county in the world. I am 30 years old and I have been to 27 countries already. So, that’s a good start. I plan to retire in my mid 40s. That’s if everything goes as planned. Or I just keep working. I like my job and people I work with.

• Ah yes, travel. With kids, my rough plan is to spend roughly 4-8 weeks every summer in one international location (say, Switzerland or a small town in Japan), rent a small private house, and really get to know the area beyond just the tourist landmarks. We may travel around the world for one year and homeschool the kids, although I don’t think I’d want to do that for more than a year. I was talking to a semi-retired Australian dentist who did that with her kids.

4. Jeff says:

So how do pre-tax 401(k) contributions get factored into this equation? For the sake of argument, if I contribute \$10,000 to a pre-tax employer-sponsored account, but only net \$40k after taxes (pay approximately 50% in federal, state, and local taxes) would the savings rate be based on my take-home pay (\$10k/~\$40k = ~25%) or gross pay (~12.5%)?

* Disclaimer: These numbers are for illustration, and not indicative of my true contributions or income.

Depending on the methodology, I’m either doing pretty well (~35% with a long time horizon), or have to consider stepping up contributions a bit; of course – more is always better, but I wish to enjoy a few small luxuries during my working years since there are few guarantees that people will enjoy a healthy, energetic retirement.

• In my opinion, it should be based on the tax rate upon which you plan to withdraw. If your expenses right now are very low and you think they’ll stay low in retirement, then your taxes upon withdrawal should be lower than now as well. Let’s say they’ll be 25% total instead of 50%. Then I’d reduce your pre-tax contributions by 25%. But really, they could be as low as zero:

/pay-zero-income-taxes-in-retirement.html

5. Dan says:

I’ve been looking for this target savings rate number for years. Thanks for making this so clear.

My biggest expense is (probably like most people) housing costs.

How do mortgage payments factor into this model? Would you consider the portion of payment that goes against principal to be savings, but the rest count towards spending?

• Jeff says:

your mortgage should be paid off before retiring.

6. Kevin says:

I can’t help but think there are a couple of things missing from your analysis. How much money you plan to spend when you retire (if you plan to move to the woods, become a hermit, and grow your own food you could probably retire on less than 100000\$). I believe you are assuming you would spend as much in retirement as you do now? its not explicitly stated though.

Also, I think it’s important to note how much income you make. Sure you, and other readers can save 50% a year, but I’ll bet a single mother of two working a minimum wage job can’t save 50% no matter how many “luxuries” she gives up. You’ll note that you were unable to save 50% when you went back to school and your wife and you were forced to live on a much smaller salary. The same applies to others who have to live on that smaller salary all the time. This observation doesn’t invalidate your analysis wrong, sure IF a minimum wage earners saved 50% they could retire on that salary in 15 years, but it seems pointless running the numbers to conclude that if we know it’s not feasible.

• Jeff says:

a single mother working a mw job isn’t going to retire early. her choices have limited her abilities. her choice to have kids and her choice to not have a better education limit her income

7. Steve says:

The discussion on early retirement is interesting. I had a *plan* to retire early but now 61 and will retire. While all the early retirement ideas are great, the problem is that you are thinking what you will do based on your experiences at your current age. I wish it was that easy. My wife and I laugh now on some of the ideas we had for our 50s. The ideas weren’t bad but not realistic as you get older. I’m fortunate to still have my health but as we all know, that can change in an instant. The advice I give to younger (45-55) people is to make sure you have choices at 60 (money). Until you retire, live below your means, save and be a disciplined investor. Retirement is all about choices.

8. Joe says:

This is very depressing. Forget about early retirement. I cannot save enough even living extremely frugal.

9. brkf says:

Hmmm. 50% of salary or 50% take home? I can’t see how that’s possible if you’re already in a 30+% tax bracket. Let’s say two salaries of 200k, both contributing full 401k. That leaves only 10k a month. From that, add in childcare, food, gas, utilities, housing, clothes, etc. You’d have to keep all of that below 4500 to reach 50%. Childcare, food and mortgages usually gobble up that amount. Not much left for utilities, gas, cars, etc.

• I’d count any 401k contributions as savings, wouldn’t you? Running quick after-tax salary number for a California married person earning 100k, net pay is roughly 70k. If you lived in say Texas (no income tax but higher property taxes), net pay is \$79k. So if two people both earned 100k gross, they would have to live on 70-79k of take-home pay to achieve a 50% savings rate. Living on \$6,000 a month take-home is done by the majority of people in this country.

If both people earned 200k (400k total), the numbers are 125k (CA) and 145k (TX) per person. So if you banked one person’s income you’d have to spend 125k-145k annually.

• brkf says:

\$6000 a month?

Maybe my numbers were fuzzy. These are all just kinda middle of the road – 2 adults, 2 kids.
200k – 35k 401k.
Take home 10k.

\$1500 a month for childcare
\$350 power/water
\$2000 mortgage (low for socal)
\$400 gasoline (Two cars @2500 miles/25 mpg * 4.00 gallon)
\$200 auto maintenance
\$150 Telephone/Cable/Internet
\$100 car insurance
\$300 health insurance, co-pays, medications
\$800 food
\$200 household maintenance

That’s about \$6000 a month. With no car payments, no entertainment costs, no vacations, clothing, etc. That’s \$4000 a month left over, for a grand total saved of (including 35k on 401k): 83k. Potentially one could say tax returns and such might account for 3-4k back too. Still falls short of 50%.

Also, does 529 count as savings? I’d say no.

• P says:

All of your cost estimates seem really high to me, but maybe that’s why we’ve been able to save so much by our early 40’s without either one of us earning 6 figures, ever. (1.2 M in investable assets) I work very part time from home for the last four years, home with youngins. Most of our costs are about 1/2 of what you state. (Main car gets almost twice the mileage, but drive less than 8,000 miles/yr including both cars. Cars can consume so much \$\$.) No TV. We travel to see family and we take vacations. We’ve saved enough at this point that we’re scaling back and trying to learn to spend a bit more on the things we really value. (Travel, time with family, hiking, etc.)

Sorry, there’s nothing middle of the road about 2 adults earning 200k. Sure it won’t put you in the top 1%, but it isn’t middle of the road.

• That looks like the budget of a very comfortable lifestyle. If you earn like your neighbors and spend like your neighbors, you won’t retire any earlier than your neighbors.

The median household income in Orange County is \$75k, and that is before Social Security, Medicare taxes, and income taxes. Half the population lives on less than that.

• brkf says:

Sorry, what part seems high?

And yes I realize that the median income is far lower. Just pointing out in SoCal the idea of 50% seems extremely difficult if one has to include childcare.

In reality, we make significantly more than the figure I tossed out but, our mortgage is far higher (I only have one rental where the house payment with insurance/taxes is below \$1500 a month but everything is in California now) and on a few numbers we’re higher/lower.

Food – that’s right in line with estimates for a family of four in so cal.
Cell (telephone)/TV/Internet is actually low at \$150 a month.
Household maintenance at 200 a month is low when you consider most figures state one should assume at least 1% of your home value per year on upkeep.
Car insurance? Car maintenance?

Here’s something from 2010 showing median expenses and this covers the USA, not an expensive area like socal:

http://thesimpledollar.com/how-the-average-american-family-spends-their-income-and-how-to-trim-it/

Now if you visit a cost of living calculator and compare say San Diego to Idaho Falls, it shows a swing of over 50k. Then the idea of saving 50% of your pay sounds feasible. In a major southern california city, it’s a stretch.

• My point is that it’s supposed to be a stretch. I’m not one of those bloggers that says that everyone can retire early, it’s easy, everyone can do it. Not everyone can do it. It takes living differently than your neighbors.

Having two kids is tough these days, trying to retire in 15 years plus kids is even harder. But you’re not always gonna be paying 18k a year for daycare, right?

• brkf says:

True about day care. We personally pay less than that as we get two free days from a grandma. I just used numbers from listening to friends and family complain.

Honestly, though we probably put more into our kids’ 529s than most people put into their normal savings. We’re quite lucky and while in that position we’ll make the most of it.

• p says:

I saved most of my money while living and working in SoCal. I turned down the job offer in Orange Co b/c I couldn’t see not feeling stuck given the high cost of housing. I accepted a better job in a less desirable So Cal area that let me save more than 50% (I lived near my job). Then I got out. And yes we ubersaved before children. All of my in-laws are in Orange County, and it’s a tough place to ignore the Jones. We have scaled back working way before them despite making far less b/c of what we consider necessities. If you’re happy working a well paying job until standard retirement age, that works. But if you’re not, it IS doable even in So Cal if you’re willing to make non-standard choices.

• Alan says:

“But you’re not always gonna be paying 18k a year for daycare, right?”

I just finished putting one kid through college, and I have another currently in college. Even with saving for college since they were toddlers, my experience has been that “what I pay for daycare” hasn’t gone down in any given year.

Jonathan, It seems from your plans based upon comments, that you will be estimating an increase in spending during retirement, is that true?

• Paying for kids college is another debate. But even so, your kids will be graduate one day and weaned from Bank of Mom and Dad one day right? 🙂 I view college tuition as a lump-sum to put aside for, not an ongoing expense. “Here’s XX for your education, son.” But yes with health insurance premiums I’ll pay more in retirement.

• Murphy says:

@brkf, according to the numbers that you used, 83k is actually more than 50% savings rate of your income not considering taxes. I am using per year numbers for below calculations from your example.
Annual Gross income = 200k
Annual 401k contributions = 35k
Annual after tax income = 120k (10k per month * 12, excl 401k )
Annual expenses = 72k (6k per month * 12)
Annual after tax savings = 48k (4k per month * 12)
Annual after tax savings rate = 40% (48k/120k)

Total savings = 83k (35k + 48k)
Total savings rate = 53.54% (83k/(120k + 35k))

• Jeff says:

Childcare isn’t forever. 3-5 years at most.

10. NM says:

Interesting post!

My company contributes 18% of my 100k salary (on top of my salary, not taken out of it) to a SEP IRA, and I contribute about 10% currently through a ROTH, I guess I gotta ramp it up! Thing is, I have no mortgage because I’m renting (\$800) and I am looking to buy a home soon. I am single and have no kids, so it’s no excuse for me not to save (although, I have 80k in a checking account…guess I need to put that somewhere else).

Thanks for making it clear, Jonathan.

• Nick R. says:

NM, why would you let your 80K sit in a checking account and have inflation eat it away every single day? That’s just crazy!

• bgdc says:

Dunno. Maybe he has been burned?

Maybe he’s got a strong enough position on investments he wants to avoid putting himself in a difficult place by putting it all in non-liquid options?

Maybe he likes opportunity cash?

Above are three reasons we keep more cash than that in liquid form. Ya never know.

• Nick M says:

I was holding 80k in a checking at about 1% interest (Capital One checking) because I thought I was going to buy a house, but I keep putting it off every year. What should I be doing with it in the meantime?

• Fex says:

I’m young single female in the same predicament although i get no employer contributions for my 100k only because I work PRN. I didn’t initiate a 401k when i worked full time either. I rent have a cheaper rent and getting 100k from a sale i’m wondering what to do with it. it’ll bring my liquid assets to about 120. I used to trade a bit actively but I haven’t touched my brokerage account in since may ’13. I’m reading a few books and planning how to allocate everything. i’m starting an iul, definately opening a roth, considering RE and a few other things. definately going to stop renting as I’m thinking of going back to a full time employer although I do enjoy my current flexibility. Banks don’t pay any these days so i don’t think it’s a good idea to let that much cash sit there. I miss the 5% savings rate I saw back in college. But the other commenter is right, at least put it somewhere you can at least beat inflation.

11. Great post. Nobody every got rich by spending money, however when many people observe lavish spending they conclude that, that person must be rich…. nobody notices the careful saver. One component that another poster mentioned was principal reduction on mortgage debt, this should be factored into savings.
I mention mortgage debt (real estate) as this is generally an appreciating asset class whereby as the loan is paid off the equity in the asset increases contrary to consumer debt, i.e. car, boat etc. I presently pay off about 100k annually in mortgage debt with my rental properties and consider this my main savings vehicle.

• Fex says:

@Dan, i think real estate can be viewed 2 ways. I think in recent times, we’ve learned it does not always appreciate. Some places and sometimes it does. I’ve seen houses bought during the height of the market drop precipitously in value. the way i see it, if the costs of mortgage, maintenance and all else leaves you with something significant, then yes, it’s a good investment. But even then, what is your annual yield from your rentals. 8%? 10%? more? less? are you factoring in costs to clean up after a tenant vacates? vacancies? major repairs? After factoring in all of this, i ask myself, can I do better in the market. Thanks to zillow and state records, it’s easy to see what a house sold for x years ago. I’m seeing things sell for less than they were purchased. I’m seeing some sell for what they sold for in 1994 or 2001. So assuming one sells a house 15 years from now, with mortgage paid off by tenant, for the original purchase price, the profit is not the sale price. if averaged over the years, what is the annual yield? opportunity costs? Again, did the market fare better?
Now I’m not a finance major so i’m just adding things up in my head and probably looking at it from one dimension so I could be wrong as my background is in the sciences. I think RE is facinating and i’m trying to educate myself.

• brkf says:

Real estate is super tricky. I sold CA properties right before the crash and reinvested outside CA. I had a strong feeling CA was about to go boom. Looking back, taking the cap gains hits would have been better because I could have bought the same homes for hundreds of K less two years later. Shrug.

Instead I went into places in other parts of the country, believing that markets outside CA/NV/FL wouldn’t fall as hard. Ha. Didn’t turn out that way. And I learned how insanely nasty weather is outside CA. I’d been spoiled by sun and rain, not realizing real weather does real damage. Eventually I got out of the rentals outside of CA and still walked away with cash. But not as much as I could have had in 2005.

My CA rentals… they keep chugging along. Less than 1k a year in maintenance, Same renters for years and years. And the values have started to climb again. They’re not at pre-crash levels but still seeing 10%-15% gains each year is nice. And the new home market is so stunted rentals are in high demand. We have a ~2.5% vacancy rate in my city. In other words, a renter leaves, we can get a new lease signed in a day or two.

Long run rentals can be profitable but they take some steal…

• brkf says:

steel…

• Dan W says:

Great comments on Real Estate. Investors need to be aware that all financial investments are subject to cycles; unfortunately stocks, real estate and other financial assets do not move in consistent predictable upward patterns year after year, however over a long term they make money for the prudent investor. I make most of my money in rental real estate, although my values suffered during the downturn, my rental income increased every year. In some cases my gross rental income has doubled in properties I purchased in the late 1990’s. I rarely sell a property and slowly reduce debt and increase income year by year, in less than 20 years I have a semi-retired life style with a very substantial cash flow. Over the next 20 years even if values never change, I will make another \$3 million due to debt reduction thanks to my tenants. This can be a great get rich slow business, but not for everyone.

• Fex says:

Good points above from you two. I think rentals are more profitable when self-managed as a property manager can eat into gains. some of the bad stories i’ve come across are people who were cash flow negative each month thinking they’ll profit from the appreciation of property values AND horror stories about property management companies. Real estate does go through cycles just like the market. One of the hardest thing about stocks, i think, is knowing when to sell. I’ve seen a house sell for about 98k in 1998, 139k in 2003 and 224k in 2008 and is now listed at 75k. I’ve seen similar trends recently with REOs. Also with RE, markets vary across the country. While it’s certainly not for everyone, I think with the proper due diligence, real estate can certainly be a good money maker for the prudent investor.

• Principal can be accounted for as savings in my opinion. I view my paid-off house as an asset that creates the rent that I would otherwise have to pay.

12. Dan White says:

Fex
You are on the right track. I have had rental property my whole adult life and learned that best results are achieved through self-management and education. Real Estate is very localized so having a moderately growing local economy is important, Entry point is important to, in the industry we say you make your money on the “buy”. With a growing economy you will experience regular rent increases, most of your rent increase is profit, in rental real estate you have a large fixed cost but it does not change much. Over a long period of time yow can develop a large income that requires a modest amount of work, finding good handy people… Join a local rental association before buying anything and pick the brains of seasoned local landlords.

13. Ron says:

Jonathan what is your plan for healthcare coverage with children once you and your wife both stop working full time? That is the one item I can’t seem to nail down when trying to plan out an early retirement. I had a few high deductible plans I researched a few years ago that looked good but Obamacare’s requirements have sent the costs of those plans and the deductibles themselves sky high from what I can see now. Please do share what your plan is regarding this, thanks.

• Good question, but will have to save the answer for another post, too many details. The ACA (“Obamacare”) actually make early retirement a lot easier for many folks by breaking the link between job and health insurance. There are catches of course, like you must be living on an income level under 4 times the poverty line which means their premiums are subsidized and/or capped.

• Robert says:

It didn’t break the link. If you’re on your employer’s group plan, you still get kicked off when you leave the company. That hasn’t changed.

14. George says:

I don’t understand this calculation. If you save 100% of your income, you retire instantly? Also the average American saves about 9% in retirement accounts (\$2733 average contribution/\$51,000 median income +4.1% employer average 401k contribution) which means it will take then about 55 years to retire according to the graph. If people start contributing after graduating from college they will retire at 77….

• Saving 100% of your income would mean your expenses are zero. If your expenses are zero, then yes you can retire at any time, right?

The calculation ignores Social Security, which will probably get people closer to 67 or so.

15. Jordyn's Mom says:

Hi Jonathan,
I just wanted to say that I was impressed by your blog and that it can be done.
I am a 42 yr old women that just retired for a while at least..to finish up travelling
the globe (114 countries left) with my 12 yr old and my senior parents…crazy huh?

But like you said it can be done…but you must have a GOAL…write down what you want,
..be specific…similar to a bucket list…but knowing you won’t be too old to enjoy all you
want to experience. This is the fuel to make it happen.

I like you had nothing as of 2003 ( messy divorce ) and
was able to save approx. 75% of my annual income per year for the last 11 yrs.
If by chance I run out and have to go back into the workforce…it will
be at something that I will look forward to every day. For now I am out of the rat race…
enjoying each moment of the life I was too busy to take in…and determined to help my
daughter to detach from her electronic devices…
Regards and enjoy your well earned early retirement!
-Sandra

• p says: