How Much Money Do I Need to Retire at 40?
January 5, 2021Retirement Wealth
Do you wonder what you need to do to make enough money to retire at the age of 40, and how much you need to retire that early?
If you want to retire at the age of 40 or thereabout, then all your retirement savings and investments should be aimed at accumulating not less than $1 million dollars. This will be enough to fund your retirement lifestyle, assuming you live till 80-85 years old.
Around 2010, millennials around the world began a popular movement known as Financial Independence and Retire Early known as FIRE, to encourage peers to stop working earlier than the older generation did.
This model includes having a lifestyle centered around frugal spending, calculated saving, and vigorous investment. While a lot of millennials bought this idea, some conclude that it is realistically impossible. But how much money can you possibly save or gain from investment to retire at 40 years old and what are the strategies to go about this?
Table of contents
What Investment Plan Can I Do to Retire Early?
Investment is one of the smartest ways of making money. It is basically using your money to make more money, and this is one of the strategies to help you make enough money to retire early.
To retire at the age of 40, FIRE recommends the conventional investment strategy of keeping money that is half a year's worth in a fund trust or as a liquid asset.
A lot of millennials these days make use of savings accounts for all money-related issues, including investment and savings. However, the FIRE model is against this because of the ridiculous bank rates and low interest in today’s economy.
As an alternative, you can look to optimize your interests with an exclusive cash market account or make use of a savings account that offers better rates with high-interest yields.
The best option is keeping the investment in a certificate of deposit. This offers a better interest than both the cash market and an optimized savings account. You can also keep the money for a very long time, but the flip side is that you may not have access to it as an emergency fund.
What is the Right Asset Allocation to Retire Early?
How much money you need to retire at the age of 40 depends on the assets you invest in.
Today, everyone is one tap on a smartphone away from investing a large amount on a website. Even though the seamlessness is encouraging, the danger of investing is now on the high side because millennials buy into the hype of investment in a sector that is doing well, without much research, and lose a large ton of money in the eventuality of an unfortunate downturn.
According to FIRE, the best strategy for asset investment is diversity. This is the best way to endure market volatility and garner as much investment interest as possible.
Diversification simply means investing in various sectors to offset the occurrence of a loss in one sector with another to keep your portfolio ashore.
The best diversification ideas for an early retirement plan is Emergency Trust Funds and Mutual Funds.
To build an investment portfolio for retirement, you can make use of an asset allocation calculator.
How to Decide Investment Fee for Early Retirement?
Aside from asset volatility, investment fee is another thing that you have to be conscious of while financially preparing for early retirement.
Most mutual funds have hidden investment fees that you need to ascertain before making a purchase for your portfolio.
As a rule of thumb, the best expense ratios are the least ones. Also, make sure that you are not spending a lot on third party commissions. The best way to avoid these commissions is by buying directly from the investment company. You can also sell with the company’s platform when it's time to do so.
What is The Best Account for Early Retirement Savings?
To retire early at the age of 40, you need to consider opening an Individual retirement account. The best available options are IRS and 401(k) accounts.
An IRS account will help you plan your retirement account such that when it is time to withdraw your money, you will not have taxation disadvantages.
Also, the rate of saving depends on how much you will need after 40 years old. This retirement account will also help you set saving goals; how soon, and how much you can hit your retirement money goal before you become 40.
A lot of companies across industries today offer to help employees with a portion of their 401(k) savings. If you work for any of these companies, then saving up faster for retirement will be easy, and you will benefit from this free money.
However, if you do not work for a company with this offer, consider using an individual retirement account. There are a lot of IRAs, so it is important to make your own analysis. But the best option is the most flexible one that comes with less withdrawal charges.
How Can I Save To Retire at 40?
The standard for those saving for retirement is about trying to replace around 80% of the income earned before retirement. This is the only way you can save enough money to maintain your active year lifestyle when you finally retire.
How Living Expenses Can Affect Early Retirement?
How much you earn, and the percentage of that, that goes into your lifestyle is a major determinant of your ability to save and invest your way into early retirement.
Frankly speaking, the dream of retiring at the age of 40 will remain a dream if you do not have a lot of flexible income because saving your way into early retirement is hard.
But even with the best saving models, your living expenses in your active years must be aimed at only one thing, living a comfortable life after retirement.
If you do not have a lot of income sources, then you may have to look at becoming a minimalist and embracing frugal lifestyles.
If you are able to achieve a lot of your life goals with a little percentage of your income, then chances are high that you can cope with a small income retirement rate and still be comfortable.
Some of the lifestyle associated with frugal living for early retirement include the following:
- Staying in a small home.
- Buying already used furniture, electronics, clothing, and automobiles.
- No vacation treats.
Eliminating Debt for Early Retirement.
A high debt to income ratio makes early retirement impossible. So if you want to retire at 40, one of the things you should look at eliminating is high-interest debt.
One thing that is common with people that successfully retire at 40 or thereabouts is that before they transited into their retirement lifestyle they became debt-free.
Keep in mind that debt, in this case, refers to consumer debts and not real assets compulsions that have to do with home residence or property rent, or debts that are as low as possible.
If you are planning to retire at the age of 40, then you should be looking at a debt to income ratio of around 20% or less.
How Does Medical Consideration Affect Early Retirement?
Early retirement means that you are forgoing some of the conventional retirement benefits because most of them are not available for retirees under the age of 65.
One of these benefits is Medicare entitlement, except you are a young person with terminal illness or disabilities, then you cannot apply for Medicare entitlements at a very young age. So, to retire early, you have to factor in other ways for affordable medical insurance.
Even with the best health insurance policy, medical expenses can still pile up quickly because you have to factor in dental, vision, and hearing disorder fees.
Other Retirement Income Sources
Apart from Medicare eligibility, retiring at the age of 40 means that there is a possibility of forgoing other social security income sources that comes with retirement. If at all you gain from these benefits, it will not be to the same extent as those who retire around the age of 62.
Social security income sources for retirees are based on monthly earnings during the active year where a person earned the highest taxable income.
But if you can afford to save and invest your way into financial independence that will make you retire early, then social security benefits should be the least of your worries.
Being able to retire early and careless about the many benefits of conventional retirement has to do with the following:
- Having a savings to income ratio of 50% and above.
- Having an income to debt ratio of at most 20%.
- Extremely frugal living.
- Proper investment strategy.
How Can I Set Up My Early Retirement Goals?
Before you get into the figures of early retirement, you need to gain clarity on what retiring at the age of 40 will possibly be to you, and what post-retirement plans you have.
Take, for example, you assume you will live till at least 80 years. How do you want to live for the next 40 years after retiring? Can your savings and investment sustain this lifestyle? Will you need to begin a side hustle or business? Do you have fantasies you want to live, or places you want to visit?
Also, your marriage life is important. How do you intend to bring in your family or children into your retirement plan? Is your spouse planning to retire too? How will you manage a retirement lifestyle with your kids?
These are personal questions to help you set up retirement goals that no one but you has answers to.
What is the Exact Amount You Need for Early Retirement?
The exact figure you need to retire at 40 is not definite, but there is an estimation for you to have an idea of how much you need to fund your retirement life.
First, calculate your intended annual expense for retirement, and multiply it by 25. With this, you can estimate how much you need to reach your early retirement.
Next, the standard for retirement saving is the ability to withdraw 4% of your yearly investment. Using this, let’s assume that your retirement plan is to set up at an investment of $40,000 each year.
To reach this amount, you must have saved $1 million or thereabouts before reaching your desired retirement age.
For a 25 years old individual, looking to retire at 40 years old, earns $50,000 a year, and saves half of this for 15 years. With a return profit of just 7% yearly, the money saved will be around $308,000 which is way below the $1 million standard.
With a ballpark estimate, this individual will have just above $25,000 as an annual income upon retirement, because the 4% is the limit for how much he or she will be able to withdraw in a year.
Note that this 4% rule is an estimation standard and not a guarantee. In recent times retirees have faced challenges in the sustainability of retirement accounts.
However, rates lower than 4% reveals a high probability of the account lasting the whole duration years.
But for an early retirement age of 40, there is a lengthy withdrawal period than those with the conventional retirement age. This brings in constraints such as uncertainties in the future, hence why early retirees must look for a more sustainable and flexible income plan even at retirement.
So basically, working and saving in a retirement account, for 15 years, to sustain a retirement lifestyle looks impossible for an annual income of $50,000.
For another case scenario, if a 25 years old working in a well-paying company with a salary of $100,000 and saving 15%, even at an interest rate of 7%, is going to end up at $420,000 at the age of 40. This is still not sustainable for early retirement as it is less than half of the $1 million mark.
But for a very disciplined investor, earning at the same rate of $100,000 maxes out his/her 401(k) diligently, and saves in another brokerage account. If he or she manages to save half of the salary, with an interest rate of 7% in a year, then when it’s time for retirement at 40, the amount saved will be about $1.14 million.
With a monthly expenditure of about $2,500, the retirement account will sustain such an individual past the 80 years old mark.
This is why you must invest as much as possible and limit living expenses to sustain a 40 years’ retirement lifestyle.
About THE AUTHOR
With multiple family members currently in senior living facilities, David is in the trenches every week, learning the ins and outs of nursing homes, assisted living, memory care, and general senior living.Read more about David Bolton
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