Retiring Early: How Much Money Do You Need?

I struggled with this question ten years ago when I retired at the age of 48. Everyone wants to know: “How much money do I need to retire early? Is it one million? Is it less? More?”. Unfortunately, there is no magic number. Everyone’s situation is different and the answer to this question will depend on a number of factors, which can be very difficult to know in advance.

In my case, predicting how much money I would need to retire was complicated by two factors: 1) I was retiring over a decade earlier than average; and 2) my wife is 15 years younger than me. Right off the bat, my situation is unique, which changes the traditional math for retirement. If I want to leave some money to my wife when I die, I need my retirement nest egg to last for more than a half-century. To say that everyone is different is an understatement.

Nailing down the magic number is also complicated by needing to predict retirement needs long before retirement. It can be hard to know exactly how your retirement will play out. What will you be doing in retirement? Traveling? Collecting vintage cars? Predicting your retirement is not easy so the only thing you can do is try to extrapolate what you currently do and spend. Even with all this in mind, I struggled to figure it out. Ultimately, I retired from my job without knowing for sure whether or not I would be living in squalor. As it turns out, my predictions worked and I have enough money to enjoy my retirement. However, it was a little uncertain at first. I spent my first year of retirement mowing people’s lawns for extra cash, just in case. I’m serious.

Factors to Consider for Early Retirement

Ok, so there is no magic number, everyone is different, and everyone has to figure out their own number. But how? Here are some of the factors that I considered when I was determining my own magic number.

Before continuing on, I should be specific about what I mean by early retirement. The average age of retirement in Canada is 64. For the purposes of this article, I consider early retirement to be before the age of 50, a totally subjective number. The idea here is that you are still very far away from any federal/provincial retirement or old age benefits.

How much do you spend every year? How much do you save?

Most people have no clue. If you want to maintain the same lifestyle into your retirement, you need to know these. I suggest using a spending app to record your spending for a year or two. I did this and it was incredibly eye-opening.

What returns are you getting from your investments over the long run?

This is important to know because mathematically it has a big effect on how much you need to save. If I return 10% annually on my equity portfolio and you return 2% annually on a bond-heavy portfolio, you will need 5 times more savings than me. If I can retire on $1 million, then you might need $5 million! I cannot express how important it is to maximize your returns pre and post-retirement. Realistically you will likely need to be invested in equity if you want to retire early. I am invested 100% in equity and have learned to deal with the extra volatility, but I understand that not everyone can.

What is your expected drawdown?

In other words, how much of your nest egg do you plan to take out annually (in percent) once retired? Historically, retirement experts quoted 4% (the rule of 4), which was designed to get you to your deathbed and still have a little money left over, under the worst economic condition scenario. This rule was designed for someone who retires in their 60s and dies in their 80s (give or take). It also assumes a typical return on investment based on a 60% stock, 40% fixed income split. But what if you retire early, like before age 50? What if your super-human genes get you to 100 years old or more? The rule of 4 is just a guide and may not work well for everyone, especially over very long periods.

Experts have started questioning the rule of 4, first under the super low-interest rates scenario and now under the high inflation scenario. I personally use a 2.5-3% drawdown in order to build in some safety. Under normal conditions, the portfolio will grow and given enough time, create more safety should stock returns fall to zero for extended periods. Again, small changes in drawdown mean big changes in the amount you need to retire. At a 2.5% drawdown rate, you will likely have a perpetual money machine where the portfolio still grows regardless of the drawdown, but it also means that you need more money to retire.

Planning is Crucial

If you’ve reached this point in the article, it’s become obvious to you that planning early is crucial to pinpointing your magic number. Just winging it and living “in the now” can work, but you will be at the mercy of randomness. I have known many people who reached their early 60s and shockingly discovered that they are not in a position to retire or that retirement will require lifestyle changes that are unexpected or unappealing to them. For example, having to sell their house or cottage, move to a more affordable city or province, or move into a van and become nomadic. All of these things can be positive (moving into a van is my personal favourite), but no one wants to have to do these things unexpectedly and out of necessity.

I haven’t addressed considerations such as the Canada Pension Plan or Old Age Security in this article because if you are going to retire early, these sources of income will not be available to you for a decade or more. In my opinion, you will need to be financially independent when you retire early and these income sources become future perks. For those who retire at an average age (i.e. early-mid 60s), you can build these income sources into your “how much do I need to retire” scenarios. It’s worth mentioning that if you plan to live alone, you will need more money. Sharing expenses reduces your spending and therefore lowers your retirement income needs. Sorry, single friends.

Let’s Play a Game

So everyone is different, but let’s play a game with scenarios for fun. These scenarios assume an early retirement (by ~ age 50), sharing expenses with a partner, and a 100% equity portfolio. Note: The amounts to retire below are per person.

John lives in Canada and retired on $250K. John is eccentric. He and his equally eccentric girlfriend Moonshade are willing to live an extremely frugal life. He works part-time here and there as a dog walker to add to the $8K ($667 a month) he receives out of his portfolio each year. John gets around by bicycle – no car for him. He and Moonshade rent a room in a shared house, away from the big city. He doesn’t mind borrowing things when he needs them. He makes some of his own clothes and forages in the woods for mushrooms. John is super happy but this lifestyle isn’t appealing to most people and it doesn’t leave much room for unexpected expenses.

Mary retired on $500K. Certainly, that should be more than enough to retire comfortably? Well, we’re getting closer for sure. Mary pulls out about $16K tax-free from her account each year (~$1,350 a month). Mary is quite frugal; she does not own a house or live near a big city. She shares a small apartment with her boyfriend Max and together they could likely afford to purchase an inexpensive car. She occasionally works part-time at a job she enjoys to make ends meet. Although Mary makes her retirement work, it’s worth highlighting that her annual income is borderline poverty according to Statistics Canada.

Ken retired from his acting career with $750K. This sum and the lifestyle it can afford is much closer to what most people would consider “normal”. Ken is able to pull $22.5K (~$1,900 a month) tax-free each year from his account. He lives in a modest home (fully paid off) that he shares with his wife, Barbie. They share a car together and enjoy some normal luxuries, like a gym membership and light travel. His budget is frugal but in no way extreme. Ken doesn’t need to work at all and he can afford to wear nice clothes that are Barbie-approved.

Mindy retired with $1 Million, and she is able to pull $30K (~$2,500 a month) tax-free each year from her account. Mindy is a millionaire! Let’s not celebrate yet, as being a millionaire isn’t what it used to be. It’s actually very similar to retiring on $750k but everything is just a little easier. Compared with Ken, Mindy owns a better house, is closer to the city, drives a better-used car, and can afford to eat out and travel more often. That said, she is in no way “well off”, she’s basically average.

So, how much is enough? It depends entirely on the retirement lifestyle you want. If you are accustomed to new cars, live in a house or condo in a larger city, own a cottage, and enjoy traveling, you may need $2M or more to maintain that lifestyle. There is really no limit. A simple formula for estimating the amount needed to retire is:

What you spend now / your drawdown = the sum needed to retire.

For example, if you spend 50K annually / divided by .03 = $1.67 Million.

CONCLUSION

The above scenarios are based on my experience living in central Canada. It goes without saying that where you live plays an important role in determining your magic number for retirement. Most people will need at least $1 million to retire early and comfortably. How fast you get to a million or more all comes down to how much you save and what kind of returns you average. Market-like returns are essential to retiring early, which means investing in stocks. If you’re not comfortable with 100% equity then you will need to save more money to make up for the relative underperformance of fixed income.

I would also advise overshooting your goal slightly as a safety measure. Who wants to climb a rope designed to hold their exact weight and no more? On average retired people spend 25% or less than they did when they worked, so that can be a simple margin of safety.

Note: In Canada, there is the Canadian Dividend tax credit which essentially gives Canadian taxpayers a break on the dividends earned by eligible Canadian corporations. As the scenarios that I presented assume 100% equity, John, Mary, Ken, and Mindy would not likely pay taxes due to this credit.